The Influence of Political Risk on Real Estate Market in Pakistan

The influence of political risk on real estate market in Pakistan

Fawad Ali Khan

fawadusafxai@gmail.com

Ph.D Finance, International Islamic University.

        Dr. Faisal Rizwan

faisal.rizwan@iiu.edu.pk

Assistant Professor, International Islamic University.

The influence of political risk on real estate market in Pakistan

Abstract

Assessment and management of political risk is considered to be very vital in an investment decision making, the study attempts to investigate the impact of political risk on real estate markets in highly politically instable economy like Pakistan. The findings of the study reveal significant negative relationship between components of political risks and real estate prices. Findings also disclose that house prices among all the other components of real estate markets are most sensitive to political risk in Pakistan.

Keywords: Political risk, Real estate markets. 

Introduction

Development of any emerging and developing economies largely depends upon the likelihood of making lucrative investments (Matthias & Hefeker, 2007). One of these profitable investments includes real estate investments; which gains considerable attention from both local as well as international investors. Real estate is generally defined as fixed geographic space with specific economic value, represented by a person for the purpose of having any activity for some definite time period. Activities regarding buying/selling or renting of economic valued space combines to form real estate market. The performance of these real estate markets; resulting by investor’s investment decisions, can highly be influenced by several socio-economic and institutional variances amongst countries, (Lee, 2006) and (Edelstein, Qian, & Tsang, 2011). (Tom & Austin, 1996) considered Institutional factors as noteworthy subject matter having a very significant role in assessing real estate investment profits. The excellence of these political institutions are linked to various components of political risk, includes; internal and external conflict, corruption, military in politics, religious tensions, law and order, ethnic tensions, democratic accountability, and the quality of bureaucracy, (Busse and Hefeker, 2007).  

The importance of political risk has recently been highlighted by many researchers as determining factor of operational and structural characteristics of firm,  (Cashman, Harrison, & Sheng, 2015). Political risk can be generally defined as the adverse consequences resulting from unpredicted political actions (e.g., Root, 1972 and Kobrin, 1979). It shows the possibility of economic losses in terms of obstruction restriction and prevention of investment opportunities due to government activities (Tom & Austin, 1996). In this study will focus different aspect of political risk and will attempt to identify components of political risk that influences real estate markets the most.

Investment decision starts with an assessment of risk. According to (Brink, 2004) political risk assessment is considered to be the first step in investment decision making, it emphasizes on problems which demands for decisions related to executions of investment actions. In short it can be termed as dealing with decision problems. Theories’ describing political risk analysis and its measurement includes “decision theory” and “problem solving theory”. Decision theory offers valuable understanding for investors regarding when, whether and where to invest (Brink 2004).

( Bailey & Chung , 1995) advocated that, firms are highly exposed to political risk whose cash flows are reactive to overall economic conditions. The same notion stands for real estate markets also, both economic and political stability of the country are the two main drivers of performance of real estate markets; as these factors have an extensive influence on the economy. Previous literature highlights and theorize the fact that private capital are responsive to domestic political environment and exits poor and politically risky countries in order to seek safety and growth in rich and politically stable countries (Badarinza and Ramadorai 2015). Political risk is believed to be the main force that hinders investment opportunities and accelerates transfer of funds from more risky to less risky economy and consequently influencing economic advancement adversely.

The importance and impact of political stability, government control, regulations and legal framework, economic strength and stability of a particular country on investor market perception has been widely accepted and emphasized by many researchers. In this study our central objective is to find out the influence of political risk on local real estate markets. The study will shed light upon different aspects of political risk and will try to find out the impact of each factor separately on different components (Houses, Plots and Residential property) of real estate market.

The finding of the study led us to understand the importance of political risk management in enhancing development in real estate market. Political risk in relation with real estate prices has been studied by many researchers in developed economies like UK and Canada, but unfortunately no one till now has investigated the association between these factors in the highly politically instable economy like Pakistan. The findings of the study reveal significant negative relationship between political risk and real estate prices. The study will assist investors in making their investments profitable by classifying real estate products (Houses, Plots and Residential property) according to sensitivity or resilience to political risk. The study will help investors; both local and international in estimating, and handling/diversifying their exposure to risk properly in highly politically instable economies.

Following the introduction, section two consists of previous literature regarding political risk and real estate prices, section three consists of methodology of the study, Section four consists of results and discussion and section five will summarize conclusion.  

Literature Review

Investment in real estate markets

Performance of real estate markets can be measured in terms of its products value, which depends upon investor’s investment decisions in this particular businesses line. Greater interest has been shown by investors through capitalizing in Asian emerging markets. Investment in these markets has been driven by three main motives, first is solid financial position of the region, Lee, (2007). Second is the provision of very high returns by these economies, Lim (2000).  And the third one is diversification benefits which can be attained by investments in such markets, Lee (2007).