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Markets & Geopolitics

An environment built for laundering? Transparency in global real estate markets

The disclosures in recent years from the Panama Papers in 2016 and the Paradise Papers in 2017 have put corruption, tax evasion money laundering and the need for greater transparency on the international political agenda.

Kay Pitman, Global Research Project Manager, RICS
9 August 2018

The disclosures in recent years from the Panama Papers in 2016 and the Paradise Papers in 2017 have put corruption, tax evasion money laundering and the need for greater transparency on the international political agenda.

In the first quarter of this year, JLL reported global real estate investment and corporate occupier activity were at their highest levels for a decade. But as global real estate markets are set to grow – and total commercial real estate investment to reach $1 trillion by 2020 - there is a growing recognition of the need for greater transparency in the real estate sector globally.

A global problem

International efforts to combat the laundering of illicit financial flows are on the rise. The IMF announced its updated framework for engagement with countries on corruption and governance issues in April, RICS launched its consultation on AML in May (due to close at the end of August) and recent weeks also saw the release of the tenth edition of JLL's Global Real Estate Transparency Index (GRETI).

A lack of transparency in real estate markets undermines the development of fair market structures and interferes with competition – such distortion can in turn discourage investment. Greater transparency in the real estate sector can help to combat corruption, tax evasion and money laundering, which, although often associated with white collar crime in developed economies and the world's financial centres, is a truly global issue.

The UN estimates that the amount of money laundered globally each year is between $800 billion and $2 trillion US dollars, equivalent to between 2 and 5% of global GDP. To put this in context, that's the same amount of money needed each year to close the global infrastructure gap and meet the global demand for the basic provision of water, sanitation, power, transportation and telecoms.

So where does this money go?

A significant proportion of this is laundered through real estate. The UN Office on Drugs and Crime estimated this figure to be in the region of $1.6 trillion in a single year.

Illicit financial flows can drain a country of its foreign exchange reserves, undermine the rule of law, stifle trade and worsen macro-economic conditions. According to Global Financial Integrity, almost 80% of the estimated $1 trillion in illicit financial flows leaving developing countries each year could be taxed and provide revenues for public spending on global challenges such as infrastructure and climate change; action that could help the world achieve the targets set under the SDGs.

Growth in investment and innovation, growth in risk?

Financial innovations can inadvertently provide opportunities for money laundering. While innovations in the real estate investment sector (such as REITs and PIFs) have allowed normal citizens access to invest in markets that were historically only available to the very wealthy, this has also opened up new opportunities for money laundering, as real estate markets grow and become increasingly more complex and financialised.

Technological developments have the potential to make vast improvements in sector transparency. They can enable the capture, organisation and analysis of new volumes and forms of data, for example, through automated property valuation (House Canary is one to watch here, as are the rise of tokenisation and virtual currencies). But these developments also pose challenges as business and regulators strive to adapt to this rapidly changing environment. Consistency, accuracy and interoperability and the need for standards in data are key emerging challenges.

Global real estate transparency – disrupted progress

July 2018 saw the launch of of the tenth edition of JLL's Global Real Estate Transparency Index (GRETI). The main conclusion of JLL's GRETI is one of measurable improvements in market transparency, but at a pace that fails to meet rapidly rising expectations. The report also highlights the growth and impact of PropTech on real estate market transparency.

Eleven countries occupy the top ranks of the GRETI. Labelled 'highly transparent', the UK, Australia and the US take the top positions, while London, Los Angeles, Sydney, San Francisco and New York occupy the top spaces at the city level. This 'high transparency' is attributed to PropTech and open data initiatives, the rise of alternative sectors (such as student accommodation and self-storage) and robust investor demand.

Effective action on anti-money laundering?

This 2018 edition of JLL's GRETI also introduces new metrics relating to money laundering. These include whether a country has beneficial ownership records, anti-money laundering regulations and whether consistency in property measurement standards have been introduced.

2018 has seen an increasing global profile for action against money laundering. The IMF's updated framework for engagement with countries on corruption and governance issues published earlier this year was commended by Transparency International for drawing the link between corruption (generating illicit funds which require laundering), inequality and a public loss of trust.

Recent years have seen a shift in the international thinking on anti-money laundering from technical compliance to effectiveness. Since 2013, the OECD'S Financial Action Task Force (FAFT) has introduced new measures that focus on country effectiveness in combatting these issues. Transparency International report that, of the 46 countries assessed since 2013, only 7 countries (the USA, Spain, Italy, Switzerland, Australia, Portugal and Sweden) have achieved overall 'substantial' effectiveness (Transparency International's Effective-O-Meter provides an interesting visualisation of this progress).

FAFT notes that no country is fully compliant with its beneficial ownership recommendations for legal arrangements. Only six of the G20 countries have central registers of beneficial ownership, and only the UK has plans to make this publicly available. This is timely, as it is believed that the equivalent of around $5.8 billion in property in the UK is potentially being purchased with suspicious wealth.

Belarus, Slovakia and Ukraine score highly for beneficial ownership in the 2018 GRETI and many of these have introduced public real estate registries. Estonia is planning to utilise block chain technology for its property registry in the near future. In other countries, Macau, Hong Kong, Turkey and Tanzania are also highlighted for their increasing efforts to block the investment of illicit finance in real estate.

Technology, sector action and the push for greater transparency in global real estate

Increasing pressure from international bodies and non-governmental organisations is likely to push more of the GRETI 'highly transparent' countries to take further action.

At the international level, FAFT is undertaking an additional work stream this year to understanding the potential risks associated with the misuse of virtual currencies. FAFT already has existing work streams exploring the opportunities that new FinTech and RegTech innovations might provide to support responsible financial innovation.

On the financial side, a range of non-governmental organisations are calling for more open data and greater information equality in the automatic exchange of financial information between countries, in line with OECD's Common Reporting Standard. Following increasing global investment in real estate and the enduring international spotlight on money laundering, it is highly likely that these issues will penetrate the real estate sector more and more.

However, models developed for AML in the financial sector, such as the Suspicious Transaction Report (STR), are not always easily adapted to real estate. For example, a recent meeting of stakeholders in international real estate organised by Transparency International have questioned whether there should be a shift in focus from 'risky transactions', a term common to AML policy in finance, to 'risky relationships', recognising the variety of ways that real estate professionals engage with potential money launderers. Other challenges relate to recognising the high legal, governance and financial diversity across countries when it comes to improving transparency and designing AML policy.

It is not yet clear how disruptive technologies and the possibility for vast leaps in market transparency will affect the ability of businesses and regulators to combat money laundering. Further adaptations are required to improve transparency and raise AML action effectiveness high enough to meet societal expectations. For businesses, JLL advise that increases in demands on legal and financial disclosure, alongside responsible investment, cyber security and data protection are important issues to tackle over the coming years.

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