Building Institutions that Make Property Markets Work

Property rights are among the most fundamental principles enshrined in Article 17 of the United Nations’ Universal Declaration of Human Rights. Yet access to and protection of property rights vary greatly. What is more, in many countries the understanding of property rights remains limited to property titles, without deeper appreciation of the underlying and interconnected institutions that allow property markets to function.

Why Property Rights and Markets Matter

In The Mystery of Capital, Hernando de Soto shows that in many economies small entrepreneurs in particular hold “resources in defective forms: houses built on land whose ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located where financiers and investors cannot see them.” Because property rights are not properly documented and institutions that make them meaningful are weak, this “dead capital” cannot be easily turned into productive use.

If a business does not have a title to the location where it operates, it cannot use it as collateral for a bank loan to invest or expand operations. If the justice system is dysfunctional, entrepreneurs cannot resolve disputes over property or any other business matter. If regulations are too complex and costly for compliance, businesses are forced to operate in the informal sector. These examples illustrate that property markets are complex frameworks reflecting the state of a country’s institutions that build democracies and market economies alike.

The International Property Markets Scorecard is a tool jointly developed by the Center for International Private Enterprise (CIPE), IHC Global, and World Citizen Consulting to map the institutional components of property markets and evaluate their effectiveness. The Scorecard provides a methodology for system analysis to investigate the six core elements necessary for sustainable property markets: property rights laws, access to credit, effective governance, rational dispute resolution, financial transparency, and appropriate regulations. This Scorecard illustrates the linkages between these elements and helps identify gaps where important institutions remain weak and should be prioritized for reform. CIPE and others have since used the Scorecard methodology to highlight barriers that small businesses face, in particular when it comes to women’s property rights.

Shared Findings

Although country circumstances vary, there are common threads among institutional weaknesses that they share. Today, many of these long-standing problems have been additionally amplified by the COVID-19 pandemic.

• Level of legal protection often does not match implementation. Laws on the books do not always match what is happening on the ground. Around the world, the implementation of laws and regulations governing property markets varies in practice, leaving many small businesses vulnerable. In Kenya, for instance, biased practices against women’s land ownership persist despite the fact that equal rights are enshrined in the Constitution. Illegal evictions and insufficiently compensated government expropriations are also a problem. In Nairobi, mass government evictionsearlier this year displaced more than 5,000 people, putting them at further risk of contracting COVID-19. These shortcomings of property markets are an indication of larger governance issues.
• Tenants’ rights are of particular concern. Many small businesses cannot afford to purchase the premises where they operate and remain renters who often lack adequate protection from arbitrary termination of lease contracts. When a business must unexpectedly vacate its premises, it not only bears the cost of finding new space and moving, but also often loses investments in equipment and improvements to the occupied property. Many rental arrangements are informal and provide no legal recourse for tenants.
• Blurred line between formal and informal sector. When it comes to small businesses it is hard to separate formal from informal. The same factors that keep businesses informal or semi-formal play a role in whether they participate in formal property markets. Many entrepreneurs are not registered because of the high costs and onerous bureaucracy involved. Many choose to forgo formal property purchases or rentals for the same reason. Also among real estate service providers, the formal vs. informal line is not always obvious as many try to avoid paying professional fees.
• Fragmented nature of property market information. It is difficult to accurately estimate the size of property markets in many countries because of the fragmented and opaque nature of real estate information and deliberate reporting of false information to avoid excessive taxes and fees. The division between commercial and residential property is not always clear and comprehensive data is rarely accessible in searchable electronic formats. Pieces of information on sales and rentals remain dispersed on various websites, databases, newspapers, real estate offices, or simply travel by word of mouth. Ownership information becomes difficult to ascertain as a result of a common practice of multi-level subleasing and the veracity of available pricing is undermined by problematic valuation of property.
• Complex regulation governing property rights. Land regimes tend to be overly complex with multiple agencies dealing with land and property issues, some with overlapping responsibilities. This complexity not only creates inefficiencies but also opportunities for corruption. It also leads to a common lack of awareness among small businesses of the legal provisions and rights involving land ownership and transactions. What is more, businesses are not always adequately informed when property-related laws change.
• Computerization of land records is not a cure-all. Where land registries are still paper-based and operated manually, computerization of records is a welcome improvement. It has the potential to not only improve information management and accessibility but also limit interactions with public officials thereby limiting opportunities for corruption. However, digitization is not a silver bullet and it often proceeds slowly.
• Corruption in property transactions. In addition to bribes sometimes involved in registry record searches, corruption is present in other stages of property transactions: from questionable land deals involving government officials, through ill-compensated land takings, to favoritism in public land sales to developers, or preferential zoning. Corruption in many of those cases is not overt. Rather, it permeates the system of property transactions behind the scenes through conflicts of interest and collusion involving public officials, developers, and individual buyers or sellers.
• Difficulty in accessing credit. Lending based on real property collateral remains the norm. That excludes many small businesses because most do not own immovable property or their ownership title is not formally documented. Lending based on business ideas is slowly being introduced, but businesses often lack proper accounting skills and financial projections needed to develop solid business plans. What is more, interest rates offered by banks are unaffordable for many.
• Weak judiciary and dispute resolution. The protection of private property requires an effective judicial system. Yet, the courts in many countries tend to be expensive, overburdened, and slow. Judges are not well trained for adjudicating commercial cases and often subject to political pressures. As a result, many businesses do not trust the justice system and do not consider it as useful for resolving disputes, including those related to property. Most rely on trust based on previous transactions and reputation rather than on written contracts that are often unenforceable.

The Way Forward

The work conducted by CIPE and others provides important recommendations for reforms. Key ones include: simplifying and harmonizing property rights frameworks; strengthening legal protections of tenants; developing new forms of financing tailored to small business needs, restructuring agencies dealing with property; strengthening dialogue between the public and private sectors on needed reforms; providing judiciary training on property-related cases; improving the uniformity of valuation and data standards; implementing policy and administrative improvements to reduce bureaucracy and corruption; and raising the qualifications of real estate professionals.

Country-specific research also yields more granular recommendations, like the ones recently developed by the Nigeria Chapter of the International Real Estate Federation (FIABCI-Nigeria) in the Nigeria Scorecard. These initial findings are now undergoing consultations with the broad range of stakeholders – happening even during COVID-19 through a series of webinars. The latest one took place of November 5 and focused on effective governance and rational dispute resolution (recording available here), featuring CIPE Africa Program Officer Lola Adekanye and World Citizen Consulting Principal  Bill Endsley. The next online consultation is scheduled for November 26 and will cover appropriate regulation toward financial transparency (register here).

The importance of improving property rights and markets goes beyond the economy. Complex requirements for property registration and leasing, building permits, or taxation are often at the root of corruption and undermine democratic governance. Therefore, reforming property market systems cannot be viewed in isolation but rather as a part of a comprehensive process. In The Spirit of Democracy, Larry Diamond argues that constitutional protection for property rights is one of the fundamental aspects of the rule of law and that “guarantees of property rights, including the ability of small holders and informal sector workers to get title to their land and business property, set a broader institutional landscape that limits government corruption.” Indeed, the development of competitive and transparent property markets that support growth of businesses of all sizes requires not only legally protected rights but also strengthening of the broader institutions of good governance and market economy. This is the challenge – and opportunity – that countries around the world face.

This blog is based on an earlier article on the findings of CIPE’s work in Armenia, China, Kenya, the Philippines, and Russia using the Scorecard methodology. Read the original article here.