‘Real’ Estate: Part I

by James Cox

True Story – The gentleman was large, confident and amicable. He listened patiently whilst I explained why, given that he had not paid rent for two months he should move out. He sympathized with how he was causing me unfair expense and inconvenience. Whilst he acknowledged the logic in my arguments, he adamantly stated that I was incorrect – despite the fact that he no longer wished to pay rent, he did not need to leave ‘his’ apartment for another four out of the six months that it was ‘his.’

It was disturbing to be told by the town council that my tenant was correct. After two months of not paying rent he can be sent an official warning, two months later they would serve him with an eviction notice which would require him to leave within two months. In the meantime, should I fail to pay the mortgage, management fees or taxes the property would ultimately be confiscated. This made me question to what extent was the property ‘mine.’

Most property investors are familiar with the difference between ‘freehold’ and ‘leasehold’ and would choose the former given that there is a time limit associated with leasehold property. But the phrase ‘freehold’ is (perhaps deliberately) a little misleading and this is where the fun starts. Even if your house is freehold you are not the ultimate owner. Some legal history and etymology might be useful in order to explain further.

The world’s legal systems can be defined largely into three different classifications; civil law, common law and religious law. In reality, most legal systems are a mixture of all three classifications. Whilst civil law (codified rule based) is dominant for much of the world, common law (rulings decided by a judge) is preeminent for land ownership and stems from European feudal legal tradition that was later spread around the world largely via the British, French and Spanish Empires.

In order to be the ‘owner’ of a piece of real estate, what you need is to have is an ‘allodial title,’ that is independent of any superior landlord. This is extremely rare and can be found only in the Orkney and Shetland isles as well as Native American reservations in the USA, although these are held by the Native American nation rather than the individual. Allodial title is related to the concept of land held “in allodium”, or land ownership by occupancy and defense of the land. And here we must understand that ‘real estate’ does not mean that it is ‘real’ but rather takes its name from the French world ‘royale’ or more precisely the Spanish word ‘real.’ In order to ‘own’ land you need to defend it and this is the exclusive right and responsibility of the royal family or the ruling governmental elite. This happens to be the case not just in the UK, France, Spain or their ex colonies but also in the rest of the world as well.

The highest form of land ‘ownership’ that you can hope for is in fact a title named ‘fee simple.’ The word “fee” is derived from fief, meaning a feudal landholding. This is subject to eminent domain meaning that the state has rights of taxation, compulsory purchase, police power and escheating. (This last phrase, not to be confused with cheating, is derived from mediaeval French word escheoir ‘to fall out’ – a common law doctrine which transfers the property of a person who dies without heirs to the crown or state.)

If you are still under the impression that your property is ‘yours’ you could perhaps try stopping paying your property taxes or refuse to pay inheritance tax and find out what happens. Given that this is not sensible, we must accept that (at best) you have paid for the use of land with further stipulations and fealties (fees) that may change at the whim of the state. The system is still essentially feudal. This situation will probably be fine if the state has all the money it needs. But it might not be fine should the state find itself in financial distress.

In order to learn from a preview of the effects of eminent domain on the real estate market in a state that is in financial distress we would do well to have a look at Greece. Greece has some of the world’s best real estate – hundreds of stunning islands spread across the turquoise blue Aegean Sea, a fantastic climate ideal for everything from wine to olives, a strategic location near the Bosphorus Sea and Suez Canal and the architectural and cultural fingerprints of numerous civilizations – and collapsing real estate prices.

Finding itself in a debt trap and a crashing economy, the Greek state finds itself desperate of funds and a citizenry that is unwilling or unable to pay taxes. Proving the sales or profit figures of a given person or restaurant or hotel is rather difficult. Sending a letter to a fixed address demanding more money with the threat of changing the name on a title deed is rather easy. Greece now has some 40 property-related taxes and fees on construction, rent, sale, inheritance, transfer, and legalization of illegal structures. In response to a ‘pool tax’ Greeks have taken to using green camouflage in order to fool Google Earth satellites. The now permanent ‘one off’ Enfia Tax is the most unpopular – a tax merely for owning property but, at an 82% compliance rate it is probably Greece’s most successful tax.

For generations, Greeks invested in real estate as a sensible hedge against the country’s track record of high inflation. Now, a popular way for grandparents to discipline their grandchildren allegedly is to threaten to leave the farm in their name.

Globally, government debts are increasing exponentially. The tax bases are becoming more elusive – business and commerce are becoming more internet based, multinational corporations and high net worth individuals are moving their residencies and HQ’s to small Caribbean islands. In the developed world, the number of young people entering the work force is decreasing (less revenue) whilst the number of pensioners is increasing (more expenses). Governments will require greater revenues. And soon enough property taxes across the globe will go up.

Next week, we shall consider how this will affect the world’s most popular asset class.

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