It is accepted that most Developed Economy have a fully functioning Real Estate Market that is well regulated and is able to attract investment and to underpin the wider economy. These countries also have a culture of domestic savings and investments. A lot of attention is given to Developing and Transition Economies ability to attract Foreign Direct Investment (FDI) whilst too little attention is given to their own internal ability to generate domestic savings and investment; lets call this Domestic Direct Investment (DDI).
The World Bank states that land and real estate assets comprise 50-70% of the national wealth of the world’s economies. In Developed Countries in general, a person’s or small to medium company’s greatest asset is their land and property and in most cases their greatest liability is the mortgage or other loans secured against their land and property.
The transition economies of Central, Eastern & Southern Europe and the Commonwealth of Independent States (CESE&CIS) have, since the change from a centralised to a market economy, largely passed the ownership of land to their populations. They therefore have the assets, but without a fully functioning real estate market do not have the capacity to trade these assets or use them as security. They are therefore asset rich but cash poor. This is also the case in many developing economies where individuals inhabit land without formal ownership. Their economies could be transformed with formal land rights and property markets.
Various commentators are starting to make a very good case for not relying on FDI alone for economic growth. They make the case for in-country strategy options and, whilst the case is perfectly valid, a problem still remains, especially for individuals and SME’s – the difficulty in obtain funding and liquidity for expansion and development. The following highlights an in-country strategy that could help solve this problem.
Available help
International Real Estate Advisory Network – IntREAN (a not-for-profit company based in the United Kingdom) aim is to help the countries in development and transition to build their real estate markets and therefore enhance their economies, estimated to be capable of growing between 20-30% with a fully functioning real estate market. In the majority of the transition economies of CESE&CIS, property ownership has been transferred to the individual over the last 15 years. In many countries it is now as high as 90%, but in general there is no active property or mortgage markets, and where there is, its largely in hard currencies rather than their domestic currency. Therefore there are no significant outstanding liabilities by way of borrowing against these assets that would normally be seen within a fully functioning real estate market in a Developed Country. See chart below for comparisons:
Source: Eurostat and European Mortgage Federation
Source: Eurostat, US Federal Reserve, EMF
To achieve a fully functioning real estate market, a country needs well regulated institutions that can demonstrate their efficiency to potential investors, whether domestic or foreign. Also, each of the professions in a real estate market needs to understand the interdependency that they have with each other. These include Governments, Public Sector Organisations, Land Registries, Lawyers, the Judiciary, Financial Institutions, Surveyors, Valuers, Agents, Brokers, etc. who are all essential in their own right but all must be equally capable to enable a real estate market to function. IntREAN works closely with the UN, EU, NGO’s, etc. in helping Developing and Transition economies to achieve these aims.
We conceive the real estate market as having “6 Pillars” that support the market:
Fully Functioning Real Estate
The main financial centres in developed countries all have world class companies and organisations in all of these “pillars” that together create and sustain their real estate markets. The UK is probably better placed than any where this is true.
At IntREAN we have worked over many years to address this matter. A primary cause of the difference in economies between the developed countries and the developing and transitional economies is the presence or otherwise of a comprehensive, well regulated financial and institutional infrastructure.
It has taken the developed countries hundreds of years to evolve the institutions necessary for the real estate market to function effectively. They are by no means perfect, but they have been economically highly effective.
In the above illustration of the 6 Pillars, the roof, representing the dynamic real estate market, is held up by the pillars that represent the many institutions that go to make up a fully functioning real estate market. If any one pillar fails, then the roof may fall or at least weakened. There may be many good parts of the building already developed – perhaps a good insurance sector, a good banking system, suitable laws, a successful construction industry. However, without all the pillars firmly in place, the roof, and thus the market, will not be upheld.
Also we learned that there are many individuals and businesses aware of this problem but uncertain how to apply their knowledge and expertise cost effectively. In a market that is partially effective it may take only a few fundamental changes to allow the system to flourish.
Examples of Domestic Direct Investment
For example, in the UK, figures from the Bank of England (April 2007) indicate that the amount outstanding to individuals is £1,325 billion of which £1,112 billion is secured on dwellings. The remaining £213 billion is consumer credit, most of which is granted against the knowledge of borrowers’ ownership of property and/or permanent employment that contribute to their credit rating. The majority of this borrowing is fed back into the UK economy either by way of savings and investments or consumer spending. There is also the benefit to the country of property related taxes, stamp duty, other financial services, etc.
The borrowing in the UK equates to over £28,000 (US$55,000) for every adult in the country and is above the annual average gross income on a per person basis. The population of the UK is therefore over 100% borrowed on an annual income basis. Yet not only is the UK economy able to sustain this level of borrowing, it underlines the benefit of spreading the risk and demonstrates the part that land and property play as security in underpinning the UK economy. Estimates show that the value of the UK housing stock is over £3 trillion and the level of borrowing currently accounts for about 30% of this. This is similar in other developed countries and something we believe that the developing and transition countries need to follow if they are to expand their economies and be able to sustain competition within the European Union or on a global basis.
Approach within Central & Eastern Europe
The emphasis within the CESE&CIS economies, during the first decade of their switch to a market economy, would appear to be on the need for FDI. This seems to ignore the internal potential of their land and property stock. The following figures show the FDI per capita and estimated stock per Region in 2006:
Central & Easter Europe – Euro 236 per capita –stock of Euro 1625 per capita
South Eastern Europe –    Euro 365 per capita – stock of Euro 1693 per capita
European CIS countries – Euro 136 per capita – stock of Euro   914 per capita
(The Vienna Institute for International Economic Studies).
If a country with a population of, say, 10 million and only 1% borrowed, say, $5,000 against their property this would generate the need for half a billion dollars of capital that would almost all be used within the domestic economy. If as many as 5% of the population, consisting of the emerging professional middle-class, borrowed $10,000 then that would generate $5 billion for internal investment, far in access of any potential FDI available in the short-term. Also, a country would not have to "sell" any more of their state or major company assets to achieve this, of which there are now fewer left.
This could be funded by external lines of credit, i.e. a form of FDI given by Developed Countries for on-lending by local financial institutions as mortgages or consumer loans but mainly against security. The Economic Bank for Reconstruction & Development (EBRD) are now actively starting to provide these lines of credit to various banks in many of the transition economy countries.
Firstly, any country has to have the political will to want to have an active real estate market and be prepared to back this up with the necessary laws, regulations and institutions. Consumer credit, if firmly underpinned by actual assets like fully registered land and property, is the basis for development of economies and trade. It would open up the ability for their population to move for employment within a country and help to reverse the “brain drain” or help stem economic migration that many of these countries are experiencing. In the meantime, they would achieve additional benefits to their GDP, which as stated above, has been estimated to be between 20-30% and they will also have a more settled and contented population. This would all be achieved without having to “sell” their state assets to obtain FDI and would help secure more domestic stability.
Brian Emmott,
International Real Estate Advisory Network Limited
International Real Estate Advisory Network Ltd