Sunday, June 22, 2014

Increasing the supply of affordable housing

The problem of affordable housing is a simple demand-supply issue. In cities where new lands available for development are scarce, the only way out are to go vertical or to restrain demand itself. Governments need to aggressively enact policies that address both these dimensions.

Restrictive zoning regulations constrain vertical developments. Several studies have shown that zoning regulations which restrict the Floor Area Ratio (FAR) to very low values are among the largest contributors to keeping property prices elevated. While the role of FAR has received much attention, that of other factors which contribute to inflating prices have received less so.

Liberal taxation policies, on both property and capital gains, coupled with non-transparent property valuation regime, does little to curb demand. In fact, it encourages speculation in property market, which puts upward pressure on prices. Property, especially in rapidly growing cities, becomes a highly profitable asset class for investors.

India has among the lowest property tax rates, whose adverse impacts are exacerbated by widespread outright evasion and under-assessment. Further, property tax regimes make little distinction between small and big houses, nor between sprawling individual homes and vertical housing projects. The large differential between the registration (and therefore taxable) and actual market values of properties makes speculation extremely attractive. The lower capital gains tax rate only adds to the attraction. The combined effect of all these have been that houses have become the most preferred investment asset.

In the circumstances, apart from raising FAR, any meaningful effort by the new government at Delhi, which wants to ensure adequate supply of affordable housing, to deliver on its commitment has to address all these disincentives. Vacant land tax, at a prohibitive enough rate, should be used to discourage people from keeping lands vacant inside the city. Higher property taxes on individual houses, steeply increasing beyond a certain square-foot area, can be used to encourage vertical developments. Similarly, lower building fees for vertical housing, progressively declining with height, can be used to incentivize vertical growth.

The elimination of the wedge between registration and market prices, coupled with much higher (and strictly enforced) capital gains taxes on short-duration owned property transactions could potentially dampen speculative transactions that contribute to upward pressure on property prices and also encourages people to keep them vacant. These policies are increasingly finding favor among policy makers across the world.

Switzerland recently voted to limit second home ownership in areas where they make up more than a fifth of the total stock. London and many other cities are considering the same. Momentum has been gathering in UK on imposing a tax premium on holiday home owners across many parts of the country who have priced out locals from the market. In fact, Larry Summers has argued that trophy-homes are among the biggest contributors to the widening inequality and massive rise in wealth at the top. 


Anonymous said...

"The elimination of the wedge between registration and market prices could potentially dampen speculative transactions that contribute to upward pressure on property prices........"

Q: How?

Gulzar Natarajan said...

Thanks for the question.

The elimination of the wedge would mean higher stamp duty payments for the buyer and higher capital gains tax payment for the seller. This is because both taxes would now be levied on the market value, than on the much lower registration value. This should act as a disincentive on speculation.

Anonymous said...

Thank you sir for the reply.
How will you eliminate the wedge between registeration and market prices?This is the key question.

Gulzar Natarajan said...

not easy, as you suggest. a few things

1. requires a multi-pronged approach which seeks to curb cash transactions (incl. withdrawals from banks), lower tax/duty rates etc
2. dispense off with the registration value/basic value notification - it anchors people into lower valuations
3. encourage mortgage financing markets - once banks enter the picture, it increases the likelihood of true price discovery
4.finally, a robust database of property transactions should be built up, facilitated by the government, but managed by a credible non-government agency (like cibil,rating agencies etc). The residex is the best we have as a starting point. The information should be public as in the US and transactions at very low valuations should be subjected to enquiry and action, if need be