OPINION: Socio-economic polarization due to rising property prices

Dr. Andreas Petrou, Cyprus International Institute of Management

 

The high growth of property prices we have been witnessing in the last few years is predominately due to the uncontrollable increase of land prices, which can be attributed to the fact that the market for land is not functioning properly. The reason for this malfunction is attributed to the supply of land, where decisions to sell are often not based on need, but rather are discretionary and consequently, speculative. In other words, the land owner, (given that he/she often has no reason to sell), will place any price tag on their property.

This malfunction of the land market is hard to regulate and, therefore, any attempts to control growth must be considered carefully. For example, the idea to extend building zones may not have the desired effect, as it does not eliminate the discretion to sell the land. Extending the building zones doesn’t necessarily imply that more land will be available for sale. Such a move will certainly make land owners richer faster. Similarly, increasing the floors of apartment buildings, (another idea that has been suggested), may have the same results, as the benefit will be cancelled out by land price increases.

Unsuccessful efforts to regulate the market will have a very negative socio-economic implication, which we have only just started to witness. Once upon a time, there was a large middle class in Cyprus. Today we witness a polarization trend, some citizens becoming richer fast and others becoming poorer equally fast.  The parameter that drives this polarization is real estate ownership, predominately land ownership, which unfortunately is strongly correlated to whether a citizen is a refugee or not. Extension of this polarization may have far reaching implications.

So what is the answer to this problem? To find the answer we must first try to identify the sources of demand for land. Based on anecdotal evidence, the majority of demand is coming from contractors, who try to satisfy the demand for housing, and from speculative investors, who consider land as a safe bet, since they have never experienced a property downturn.

The obvious answer to control demand would have been higher interest rates, but this is not to the discretion of the Central bank of Cyprus anymore. Furthermore, Eurozone interest rates are unlikely, based on current trends, to reach levels which can significantly reduce demand. Another possibility would be a reduction of exogenous demand. This could happen in case there is a property crash in the UK or an emerging market crisis such as the Russian crisis in 1998. Again such events are hard to predict and policy makers can not rely on them to regulate a market which is so important for Cyprus.   

Consequently, other effective approaches need to be considered. An effective remedy could be higher taxation of certain land transactions and allocation of the receipts to a fund that would aim to reduce polarization. One may argue that higher taxation will increase the cost of housing, but this will apply to people who can afford it, who in turn will directly contribute funds to the housing for the less privileged. Another alternative, which could be considered along with demand reduction, would be the de-incentivization to hold certain types of land for the long term. This again must be achieved through taxation and again it is imperative that funds must go to the ‘anti-polarization’ fund.