Ron Pol argues there's a missing dimension to Auckland's housing debate with new controls needed to curb criminal investment

By Ron Pol*

In the midst of a commentary tsunami on Auckland's housing market, coupled with openly left or right leaning mud-slinging, it has sometimes been       difficult to distil rational policy debate based on best available data and clear societal outcomes.

Whether we should introduce curbs on non-resident purchasing, and if so what form it should take, seems trapped in the glare of ideological headlights, with the Prime Minister now testing the political waters with a possible stamp duty on foreign buyers.

Spotlight needed on corrupt and criminal proceeds flowing into real estate

But one issue has been largely absent from much of the debate. With anecdotal reports of purchasers snapping up dozens of houses at a time, how much criminal money is also being pumped into real estate? What impact does it have on prices? And what should we do about it?

With house prices surging in London as in Auckland, the UK government is taking affirmative action. A recent "mansion tax" on residential properties owned by secret layers of companies and trusts generated much more revenue than expected (£142m [NZ$337m] in the 2014/2015 first quarter alone), and revealed the scale of property ownership shrouded in secrecy.

The UK Treasury promptly lowered the threshold and raised the tax rate, and Britain's National Crime Agency frankly admitted that house "prices are being artificially driven up by overseas criminals".

British Prime Minister David Cameron last week responded by pledging to stop criminals buying real estate with "plundered or laundered" money. Singling out corruption, "a cancer ... at the heart of so many of the world's problems", Cameron said "the world has looked the other way for too long", and a "global effort" is needed.

Broader debate needed on stopping criminal proceeds into real estate

Interest.co.nz has called for the second phase of stalled money laundering rules to be accelerated, and reported that the Ministry of Justice is mulling who will supervise real estate agents and lawyers when the net is finally widened. Gareth Vaughan says that our flawed anti-money laundering laws have been exposed by an apparent 'major international fraud' involving more NZ-registered companies wreaking havoc on overseas investors and our international reputation.

And this week Caroline Courtney called on New Zealand to join the UK in staunching the flow of billions of dollars of criminal proceeds from around the world being pumped into housing.

Yet even amongst hundreds of articles on Auckland's housing market, few TV, radio or print journalists have addressed the issue of criminal gangs and overseas corrupt officials buying real estate here, beyond Tim Hunter's early call for New Zealand to follow Australia's lead in investigating the scourge of criminal proceeds flowing into the housing market ('Let's start tracking hot real estate money', NBR, 15 May), Caroline Courtney's 10-page North & South feature on the "staggering amount of ill-gotten gains" washing through the economy (July), and Fran O'Sullivan reporting the concerns of New Zealand's main banks about the "obvious money laundering" occurring in Auckland ('Govt must act over foreign house buyers', NZ Herald, 14 July).

Not all 'investment' is equal: most is good, but some is very, very bad

If the impact of criminal funds flowing into Auckland's housing market is largely unaddressed in a big part of the public discussion, comments by Steven Joyce, seemingly discordant with the official explanation for Auckland's housing crisis, might help explain why. The government has consistently said that rocketing Auckland house prices are a supply issue, and Building and Housing Minister Nick Smith is seeking to boost house building activity.

It therefore seems curious that a policy setting which appears to offer a supporting supply-side solution has been rejected seemingly out of hand. Many commentators have suggested that we copy Australia's policy preventing foreign residents buying existing houses. Restricting overseas investment to new housing should help boost supply. And if there is indeed high foreign demand for Auckland's existing housing stock, diverting some of it towards supply (of new houses) would presumably also help cut the demand side (for existing houses), and may take some heat out of the market.

So if the suggested policy setting seems to complement the supply-side work the government considers the best solution, why was it peremptorily rejected? But first we should kill a red herring.

The glib response, that high prices in Sydney means that the policy has failed in Australia, is flawed:

• The Australian House of Representatives found "a significant lack of leadership" at the Foreign Investment Review Board, revealing that "enforcement of Australia's rules on foreign ownership of housing appeared virtually non-existent."

• To the extent that restrictions were enforced, the situation in Sydney might have been worse without it.

• A Credit Suisse report suggests that domestic policies on foreign investment in housing also requires a regional perspective to be effective. Even with its foreign investor restrictions and stamp duties, Australia still has fewer costs and barriers to foreign investors than alternatives like Singapore and Hong Kong. In a relative sense, then, even if foreign investment is restricted to new housing, Sydney remains extremely attractive. As does Auckland, with virtually no restrictions at all.

Back to the question then. Why discard at least seriously considering a simple policy setting that appears consistent with and should complement the supply-side solution said to be the core of the issue? What's missing? Joyce's rhetorical response to TV One's Katie Bradford on 14 July implied that there's no "good" or "bad" investment in housing. That all investment is equal, and has the same effect.

Many commentators and officials also speak about "investment" as a homogeneous concept. It is of course a policy decision for government whether to allow investment in New Zealand real estate by foreign nationals and whether to impose any barriers or restrictions, and that's where much of the debate has raged.

But there is an important difference between "good" and "bad" investment in housing, irrespective of residence or nationality. Money earned legitimately, whether from residents or non-residents, helps the economy into which it's invested. This is the classic perspective, imbued with the positive impact of the "income multiplier" effect familiar to economists. It presumably permeates Joyce's every waking thought as he discharges his role as Minister of Economic Development seeking to boost the country's economic performance. And rightly so.

But his colleagues wearing different hats, for example those responsible for the Justice, Police, Revenue, Customs, Immigration, SIS, Internal Affairs and Foreign Affairs portfolios might suggest that investment from the proceeds of serious crime is different. Allowing drug dealers and corrupt officials to buy real estate and other assets only helps criminals profit from their crimes.

A letter in the August edition of North & South (released 13 July) comprehensively answered the Minister's rhetorical question a day before he even asked it: "The billions of dollars laundered each year is not 'just' money - it's from serious crime. Every cent carries human misery; from domestic drugs and organised crime gangs, from arms dealers supplying ISIS, sex traffickers destroying lives, and corrupt officials stealing billions from their own countries to hide elsewhere... When drugs cartels and corrupt officials buy up real estate, from New York to Auckland, it might help drive up prices, but ultimately benefits no-one except murderous thugs and thieving oligarchs - and spreads more economy-sapping misery."

Auckland a magnet for corrupt money and criminals?

Overseas research suggests that the impact on prices is actually much greater when real estate is purchased with money generated from criminal activities than with income earned legitimately. It also found that this effect is concentrated towards big cities. That's where the criminal king-pins want to live or invest, and because their funding is sourced from serious crime, it needs to be laundered as well.

So when criminals "invest" their ill-gotten gains in housing, whether from overseas or locally, it may have a disproportionate effect on local prices. Whether this applies in a similar way in New Zealand is, however, another evidence-free zone. The research is new and needs more testing in the mainstream economics and money laundering literature to be validated, and I'm not aware of any similar research here.

How much criminal proceeds is out there, and where does it come from?

So, how much illicit funds are thought to be flowing around the world looking for a safe haven? By its very nature it's impossible to know for sure. Estimates need to treated with real caution. The US State Department's comprehensive 2015 global report on money laundering and financial crime, which lists all high risk countries (and with refreshing insight includes the United States itself) is nonetheless revealing. For example:

• "The Australian Crime Commission conservatively estimates that serious and organized crime costs Australia near to A$15 billion each year, [and] money laundering remains a key enabler of serious and organized crime."

• "The Central Bank of Russia estimates that US$26.5 billion... left Russia [in 2013 alone], through... fictitious transactions [including] payment for narcotics, bribes to government officials,... organized crime, evasion of tax and customs duties, fraud, smuggling operations, and corruption."

• "China leads the world in illicit capital flows", with "estimates that over $1 trillion of illicit money left China between 2003 and 2012", and that "massive outflows continue."

We currently have no way of knowing how much of those outflows of criminal proceeds arrive each year on our shores, nor for that matter the hundreds of millions of dollars officials believe is generated by local crime groups, let alone the impact it might be having on Auckland's property market.

It does however seem perfectly reasonable to assume that most of our capital inflows are in fact legitimate ("good" investment), but we don’t currently even monitor the full extent of all foreign investment, let alone have much idea how much of it might be from illicit sources, or its impact.

Other countries taking decisive action

The absence of reliable data clearly hampers the development of effective policies, but other countries have frankly acknowledged the issues and are already responding to fill the gap. David Cameron, highlighting the fundamental difference between good and bad investment, has vowed to stop London's real estate market being used as a safe haven for "plundered or laundered" money.

At the highest levels in Australia too, a joint parliamentary inquiry has been launched into the effectiveness of policies targeting organised financial crime and money laundering. The Australian Crime Commission, like its UK counterpart, has also forthrightly acknowledged that "some of Australia's most expensive real estate is being bought by global crime syndicates", and has launched an investigation to crack down on the influx of dirty money.

Queensland's government has also taken action. A Commission of Inquiry is investigating the economic and societal impacts of organised crime, including money laundering into real estate which involves "key enablers" such as lawyers and real estate agents.

Let's at least collect good data

In New Zealand as in other countries, hard data are scant, so we could glibly assert that "no data means it's not happening", or we can use the opportunity at least to start collecting better data from October, when we will require tax and local bank account details. Whether the data will be useful in developing effective policies, however, depends on the data that officials actually collect.

Whether the government decides to introduce any of the measures already influencing policy settings in many of the world's other so-called "hedge cities" (where property prices have been inflated beyond the reach of many locals by massive capital inflows seeking a safe haven), we should at least build in some extra safeguards against criminal proceeds supporting terrorists and other criminal groups and distorting the economy.

The new requirements due in October might themselves help deter some of the least sophisticated criminals. But if the rules can easily be circumvented - for example, if IRD numbers can be issued to corporate or trust 'vehicles', professional facilitators or personal 'fronts' in whose names property is purchased, or if bank accounts opened with legitimate funds can later be supplemented with criminal funds or need not have an ongoing connection with subsequent transactions, the new system might prove instead to be an expensive exercise in futility. And it might generate scant data on which to base effective policies.

A tax on houses without any clear ultimate beneficial owner, as in the UK, might also help generate hard data, and revenue.

Anti-money laundering rules can be more effective

At the very least, properly connecting the new requirements with existing anti-money laundering rules should also help. If banks, lawyers and real estate agents (all of whom have existing - albeit differing and sometimes conflicting - obligations to detect and report suspicious transactions) are more effectively in the mix, we might at least keep some criminal money at bay, without deterring legitimate "good" investment from whatever mix of resident and non-resident investors the government considers appropriate.

But even with anti-money laundering policies similar to ours, Australia and the UK recognise the hard reality that dirty money continues to flow into the real estate market. That's because there's a yawning gap between an extensive system of anti-money laundering rules (as New Zealand, Australia, the UK, and nearly every country in the world now has), and an effective system, in terms of actually achieving the intended policy outcomes.

My research has identified flaws in terms of the effectiveness of the existing regime, and potential solutions which might help make banks' systems more effective, and which might better engage with professionals like lawyers, accountants and real estate agents who structure, facilitate and implement financial transactions.

But these things take time. In the meantime, Australia and the UK are taking more decisive steps than data collection, and some banks and government agencies are actively investigating these more effective solutions to help curb the scourge, and distorting effect, of criminal proceeds.

If we do likewise, it might help reinforce New Zealand's reputation on the world stage as a good place to do lawful business; not as a safe haven for criminal "investment" to artificially help inflate property prices and add capital gains to the profits of corrupt overseas officials and organised criminal groups.

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*Ron Pol, LLB(Hons), BCom (Econ), a legal business consultant and former lawyer, is completing a PhD on policy effectiveness and money laundering in the New Zealand real estate sector.

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14 Comments

What about a ferret hunt?

Great article Ron. For me part of the problem is the professions failure to take money laundering seriously. They continue to go down the perception route and some regularly fail to report what you/'me would regard as suspicious. Time for some leadership and compulsory CPD on this so that the excuses are removed. 4 hours a year should be enough and all lawyers, accountants and realtors should have to attend.

Thx adogadoNZ. I think you're right that it wouldn't need much CPD at all. In my experience the typical AML courses which try to teach "integration" and "layering" etc rather miss the point. Doing it in a way that resonates with their real-life practice and experiences is more effective. There's often no need, and it can be counter-productive, to try and teach a new language. Ditto for bank staff. Having induced group catatonia, the message actually delivered is all too often "this is hard, we'll leave it to the compliance staff and software". And the greatest resource they have has just tuned out.

This article is predicated on the assumption that we have an honest government working for the good of the country. I would suggest that there is plenty of evidence suggesting that this is not the case and that the government has more in common with the money launderers, so I would not expect much action.

I think the author of this article severely over estimates the skills and motivations of lawyers,realestate agents et al. They don't and won't care, it's all comission and fees to them. Banks are the choke point in the funds channel. They can, and will, sin bin incoming funds, if they fail the sniff test. It is a matter of Bank compliance, but they are harder targets to get into line than the average real estate agent.

In 2010, Senators Carl Levin and Tom Coburn released an investigative report suggesting that the Congress should remove the Patriot Act’s money laundering exemptions given to real estate and legal officials. So far, the real estate industry has been successful in combating such changes. Read more

You may be right. I do believe that lawyers, accountants and agents do indeed have tremendous skills and perceptiveness, and I find that when they do 'turn on' to this stuff, those skills are very, very powerful indeed. More so than the banks, actually, who just process transactions, so they do a remarkable job with one hand tied behind their back. Whereas the professionals who structure and implement the transactions, and often have the closest contact with the people involved (even if behind a few layers), are often better placed to spot anything untoward. But yes, the biggest barrier is perhaps the "already thinking" within these professions which drive deeply ingrained behaviours, so those who see that this stuff is not anti- but complementary to their professions and turn their prodigious skills to bear in this area as in others are currently the minority.

Cut and paste.
Suggested before, start with a prohibitively high stamp duty of say 50% of the sale price on all residential properties with an existing dwelling of any type. From that exempt NZ passport holders buying in their name half of it, then exempt them the other half if they reside in it for minimum 12 months. If you want to buy a home it costs you nothing. If you want to park money the sums do not add up for existing, but you can build or buy newly developed without duty. Could also add ongoing tax, 10% of purchase, to those not fully exempt to make the "ghost houses" seriously not worthwhile. Failure to pay means forfeit to crown and auctioned. Implement without warning and require all properties registered with true ownership by a 6 month deadline or forfeit and auctioned. It would be funny to see the scurry to the exits.

Does this mean that you'd buy a million dollar house in a locally domiciled trust and then sell it to yourself from the trust for $1, so that the trust can claim capital losses and you only pay 10% of $1 pa after your $0.50 stamp duty?

That's called evasion.

What if it was moved around for 75% of it's value? How would you detect and enforce such policies?

Simple really. Just tax on the highest of the actual price or the RV.
Don't the IRD already charge 150% of their assessed tax for evasion?
So just apply that rule.

totally agree spinach - its the only way to curtail. the AML issue is a smokescreen. regards pop eye

Good article Ron, thanks. It'll help move the conversation in the right direction.