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Transaction costs: A global rip-off?

The rocketing cost of buying and selling residential property abroad is a significant negative factor for overseas investors...

In Organization for Economic Cooperation and Development (OECD) countries, transaction costs are generally below 10%. However, there are some countries where transaction costs are unnecessarily high.

South Korea has the highest housing transaction cost, at 22% of the property's value in Seoul, according to work by the Global Property Guide. Transaction costs in Belgium, Italy, France, Luxembourg and Greece exceed 15% of the property's value.

On the other hand, total costs for purchasing a house in Slovakia, Iceland and Denmark are around 3% or less. Transaction costs are typically between 5% and 7% in the UK, Norway, New Zealand, Switzerland, Australia, Japan, Sweden, Poland, Ireland, and Canada. 

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Assumptions

To make the calculations comparable, the Global Property Guide has assumed that the property purchased is a condominium worth either €250,000 (for European countries) or US$250,000 for other countries, and located in the financial or administrative capital. This allows us to arrive at a 'typical' transaction cost figure, though in practice transaction costs are a range, depending on many factors.

Transaction cost figures reflect the purchase of old properties, not new (therefore in most cases Value-Added Tax (VAT) is not included). The costs also reflect foreigners' costs, not locals' (often very different). Where foreigners must purchase property through companies, the cost of forming and maintaining a company is not included.

Costs included in the term 'transaction costs':

• Registration costs.
  
  
• Legal fees.
  
  
• Real estate agents' fees.
  
  
• Transfer taxes.

Property and capital gains taxes are not included, although they must typically be paid before the property is registered. Fees in acquiring the prerequisites for property purchase such as residency permits and company formation are also not included.

Over-taxed

South Korea's very high transaction costs are largely attributable to the unusual feature that all real estate transfers are subject to 10% VAT (only vacant land and government produced housing are exempt).

In most countries, in contrast, only new properties are subject to VAT.

Property buyers in South Korea are also obliged to purchase Housing Bonds worth 5% of the official price. Proceeds from the Housing Bonds are intended for construction of housing for the poor. Typically, most buyers immediately sell the bonds at a discount of about 10% to 15%.

Buyers in South Korea must pay registration tax (3% of purchase price), education tax (20% of registration tax), acquisition tax (2% of purchase price), agricultural and fisheries tax (10% of acquisition tax) and stamp duties (maximum of 0.2% of property value).

These taxes are intended to dampen demand and discourage property speculation. However, in reality, these very high transaction costs exacerbate the housing shortage, by adding to the overall cost of housing.

The costlier housing is, the less people can afford to buy it, the less gets built. The housing shortage can better be relieved by other means - better rural transport and services, more competition in the construction industry.

French law is a handicap

Average transactions costs in countries with French legal origin are significantly higher than elsewhere, as noted in a previous article about European costs (Housing transaction costs in Europe).

The same phenomena is observed throughout the OECD. Average transactions costs in OECD countries with French legal origins are 14.2% of property value; while in German origin countries they are 11.5%, Socialist 7.4%, English 6.5%, and Scandinavian 5.2%.

Grouping countries in terms of legal origins reveals institutional differences in property transactions. Sales and transfer taxes are more common in French legal system countries. Roundtrip transaction costs normally exceed 10% of property value.

The services of lawyers are used most widely in French and English legal systems. In several countries with French legal systems the use of lawyers is mandatory with fees set by law.

Countries grouped by legal origins:

• English common law: Australia, Canada, Ireland, New Zealand, UK, US;
  
  
• French commercial code: France, Belgium, Greece, Italy, Luxembourg, Mexico, Netherlands, Portugal, Spain, and Turkey;
  
  
• German commercial code: Germany, Austria, Japan, South Korea, and Switzerland;
  Scandinavian civil law: Denmark, Finland, Iceland, Norway and Sweden;
  
  
• Socialist civil law: Czech Republic, Hungary, Poland, and Slovakia.

Source: La Porta et al, 1999

Restrictions on foreign ownership

Several OECD countries restrict foreign ownership of houses. In Iceland and Denmark, only resident foreigners are allowed to purchase houses. The property can only be used as primary residence and not as a rental investment.

In Switzerland, the Federal Government has set an annual quota of permits for non-resident foreigners seeking to acquire property. Generally, major cities such as Zurich, Frankfurt and Lausanne are closed to foreign buyers.

Foreigners need the approval of the Administrative Office (AOB) before they can buy property in Budapest. In Australia, approval of the Foreign Investment Review Board (FIRB) is needed.

Foreigners can freely buy condominium units in Poland but buying land is a bit trickier. Generally, a permit from the Ministry of Internal Affairs is needed.

In Greece, EU nationals can freely purchase property, while there are few restrictions for non-EU nationals. Acquiring property near national borders and in some islands requires special permission from the Local Council. Such permission is not granted to non-EU nationals.

In Turkey, property purchases are open to foreigners, on the basis of reciprocity, i.e., Turkish people must be entitled to purchase real property in the country of the foreign national buying property.

In Mexico, foreign buyers need to set-up a bank trust called 'fideicomiso' to be able to buy properties. The bank (trustee) holds the trust deed for the purchaser (beneficiary). While the trustee is the legal owner of the real estate, the beneficiary retains all ownership rights and responsibilities and may sell, lease, mortgage, and pass the property on to heirs.