The year 2015 will run in the minds of economists around the world for many years to come. It was the year that saw some major political, economic, military and cultural events take place around the world. The collapse of oil prices, the rebound of the US dollar, the slowdown of the Chinese economy, the weakening of the Russian economy, the European crisis, the fear of a Grexit and terrorism among other major incidents around the globe created a high volatile environment for all the markets.
Kenya being one of the emerging markets was directly affected by the international turbulences. In 2015, Kenya faced several challenges. The sliding of the Kenyan shilling against the USD and the British pound, inflation that exceeded 8% during the month of December, the CBR that increased twice in 30 days causing a big raise of the finance costs, the increase in the number of red loans, the stop of operations of 2 banks and the obvious slowdown of the Real estate market with the house price index gaining a marginal increase of 5.34% during the four quarters of 2015 according to the Kenyan Bank Association House Price Index.
The increase of the external debt and the need for money that pushed the yield of treasury bills to over 23% during summer were some of the main characteristics that marked 2015.
On the positive side, the real estate sector remained in the center of investment interest. As per the latest data released by the Kenya National Bureau of Statistics, the real estate sector’s year-on-year growth at the end of the third quarter of 2015 was 5.4 per cent and with the overall sector contribution to Gross Domestic Product remaining at eight per cent.
The growth in the real estate sector was driven by heavy government investment in infrastructure, which opened up satellite towns such as Ruaka, Mlolongo and Athi River within the Nairobi metropolis. At the same time, the devolved government system created investment and development opportunities in the counties since the decision was on each county to fund development. Favorable demographic trends including the burgeoning middle class that is spurring development across all real estate sectors also increased the sector’s growth.
The key question would be if the growth of this sector, that is majorly local, with a small percentage of foreign investors, will be able to maintain a R.O.I. that will keep investors’ interest high and the asking prices in the market sustainable.
Like any other investment, the first challenge that the Real Estate market has to face is inflation. If an investment earns you less than the rate of inflation every year, your investment is costing you money. Technically, this investment is losing you your buying power. To break even, any real estate investment that makes you money over the long term must make at least enough to match up with the rate of annual inflation. If you are looking for a good R.O.I, then, it should beat inflation, taxes, any currency devaluation and produce an extra percentage.
Comparing the 8.19% increase of the house price index since 2013 (according to the KBA – HPI Q4 report) with 19.07% inflation, for the same period, shows clearly that the reality is not as positive as it looks like. I know some people will ask about the yields that rental properties are producing. That is another interesting section of the market.
In order to identify a profitable buy to let investment, you need to compare it with your other alternative options. You also need to consider the cost of borrowing the money you invested to buy the property. According to data provided by “The Hass Composite Rental Index “ the average Annual % Change- increase in Rental prices between all types of properties was 5.4% during the year 2015.This increase on average was lower than inflation as well. Based on available data, gross rental yields on Nairobi apartments are standing at around 6.5% to 7%, while yields on houses are lower, at 5% to 5.4%. The gross annual rental income, expressed as a percentage of property purchase price in Kenya is 6.75%.
This is what a landlord can expect as return on his investment before paying his finance, taxes, maintenance fees and other costs. With the current interest rates averaging over 20%, borrowing money to buy a property makes absolutely no sense. Imagine you have a loan that is costing you 20% annually and your property’s yield is 7% while the value is growing slower than inflation. The investment is definitely not lucrative.
It is a fact today that the annual property price increase is smaller than the interest rates and cannot even compete with the country’s official inflation. This will cause the uptake of residential mortgages to remain low in 2016, while the volatility of rates create uncertainty to the market. The fact that interest rates are higher than Rental yields makes the Buy to Rent sector of the market slow down as well. The diaspora inflows have been a key factor for the Real Estate Market growth in Kenya. With over 1.1 billion dollars’ inflow last year, the market capitalized the possibility and sales to this sector. The global market volatility and the difficult economic year is not helping. It is creating worries concerning the inflows that should be expected during 2016 from the Kenyan diaspora. The huge capital that has been invested in the recent years from the Somali community in the real estate of Kenya is now heading back to Somalia. The global financial turbulence is not promising to present an increase of the international interest for bigger investments in the region.
Within the last few years, Kenya has been performing on average better than what was expected in the beginning of the year 2000, experts indicate. The country’s economy has continuously been growing with percentages that other economies cannot even dream of. With an average of over 5% annual growth since 2010, the Kenyan economy has been upgraded to a middle class economy and at the same time, everybody’s expectations for an even better future is growing too. In between the real numbers and the Kenyan’s expectations, the Real Estate Market has capitalized the most out of this positive course. Real Estate values have been growing all over the country with Nairobi and its satellite cities, gaining amazing price rises and making big profits for almost everyone involved in the property industry.
The above amazing performance, though, has to be associated with several factors. First of all, the key to this success was the political stability in the country that created a stable environment and the required feeling of “safety” to local and foreign investors. Equally important, was the fact that the global financial and economic circumstances have been favouring the growth of the emerging markets. Vast available capital from the big economies has been invested in most emerging markets around the world.
The expectations from the oil reserves discovered in the country boosted the positive attitude of investors and attracted especially foreign investors who wanted to capitalize early on a possible future economic growth. The Chinese plan to penetrate and dominate investment-wise in Africa and especially the sub-Saharan region is another very important reason for growth, as huge investments have been funded because of Chinese interests.
Finally, the stability of the Kenyan shilling over the last few years, together with a steady interest rate environment, played a role in the country’s amazing course.
Today, some of the above factors that boosted the Real estate market and the Kenyan economy are being challenged. The Chinese economy is shaking and the oil prices have been so low that they do not allow any investment for new oil exploitation in the country. Further, the stability of the local currency is under pressure. The upcoming elections during 2017 is another factor to be seriously considered.
This year, the sector’s growth shall be driven by several factors but mainly, the deteriorating housing affordability will majorly influence year 2016’s housing trends. The main problem of the local market is the lack of affordable housing. There is though a huge offer of highly priced and not affordable properties around the country.
Key factors that will play a vital role in the Real Estate market in 2016
Kenya’s Growing Middle Class: The rapidly expanding middle class in the country is searching for affordable, secure and aspirational living, which meets their housing needs. With the increased congestion within the crowded city centers, this middle class will have to be housed in the outskirts of Nairobi which have benefited from infrastructural upgrades. It is important to understand though the affordability of this new upcoming “Middle Class.” This class can definitely not afford to spend 5, 10 or more million shillings to buy a house, especially with the current finance policies and the high cost of borrowing money from the banks.
Existing Housing Deficit: According to the National Housing Corporation, there is an effective housing deficit of over 200,000 units per annum to cater for the low to middle income market. This is the most important fact that we all need to understand. The demand is there, but for affordable housing and office space. Currently, majority of the projects are targeting the higher class and prices have gone extremely high. Asking prices for a two bedroom apartment in areas like Kilimani are going for over KES. 20,000,000. Rentals are following this artificial trend and this is making the market very complicated as lots of new buildings remain vacant. Supply is targeting the wrong group of buyers and not covering the real demand needs. New projects must target the real middle class of Kenya and provide premises that will be affordable for the majority of the available demand.
Sustained investment in infrastructure and urban planning: Cities are growing rapidly due to high increase in population. Serious urban planning and modern infrastructure is needed. Increased development along key infrastructural nodes, which have been brought about by the development bypasses such as Ruaka and Karen are needed all over the country.
Nairobi as well as the rest of Kenya need to get modernized. What is the sense in living in the capital, or in any other city or town with a nightmare of serious floods whenever it rains? Wastage of time due to spending hours every day on the road trying to get at work. The government needs to invest more in infrastructure and proper urban planning. Make sure that quality is provided and this will in turn attract the interest of investors in maintaining the current level of property prices. This will provide a better daily life for the citizens and avoid a market collapse.
Quality – Quality and Quality: It was observed over the last few years that even during this amazing race of the real estate market, quality was not always part of the game. Low quality constructions have been built all over the country based on the fact that most of the sales used to be off plan. Currently, even with developers making huge offers, off-plan sales represent only a fraction of the market. Buyers are not as innocent as they used to be. Now a days, anyone looking to buy a house to live in or as an investment, require better quality standards. A safe and comfortable construction that will provide them a good standard of living and not one full of problems, expenses, constant headaches and will eventually lead to a decrease of the value of their property. Developers need to finally understand that the time to make huge profits by cutting on the quality provided is gone.
Finance: High interest rates in Kenya are hurting real estate investment. Interest is a cost to the developer of real estate as it is to the end buyer. The increase of the commercial banks’ lending rates caused a slow down to the market as it affected both existing and new loans. If something is to help the market’s growth, it will be the drastic change of the country’s financing environment; an ease of the interest rates and easier access to finance.
Lower interest rates allow more people to qualify to purchase a home, thus more people can afford to purchase. When more people are able to purchase homes, the amount of homes on the market will be reduced (reduces the supply) which in turn pushes up the cost. Conversely, when interest rates are high, fewer buyers are able to qualify for a loan which increases supply. Oversupply tends to push prices lower.
Devolution and political goodwill: The 47 counties established in 2013 are now fully operational and enjoy high independence from the central governance and this can make the difference in the sector’s growth. Devolution is assisting real estate development as it is placing onus on the county governments to improve the real estate landscape, which has led to reduced bureaucracy and investment in infrastructure.
Political Stability: Elections always affect markets, not only in Kenya but in all the countries around the world. Expectations and fears from a possible change of the governance create insecurity and high volatility. The upcoming general election in 2017 could create further slowdown in selected markets especially areas previously affected by political tensions in the past. Everybody needs to realize that exercising their political rights and democracy require patience, wisdom and avoidance of tensions as that could be catastrophic for the country’s course to further growth.
It seems that the Real Estate Market’s dominance of the Kenyan economy is facing big challenges. Unless big changes happen very soon, the property sector cannot sustain its status and definitely cannot continue growing. So, why should anyone invest in the most illiquid asset, property, while there are other available options like the treasury bills that provide both good returns and liquidity?
There are a number of risks associated with illiquidity that must be managed by owners and understood by investors. Property is essentially an illiquid asset that can’t easily be converted into cash. At the unfortunate event of a market turn, especially when prices start to go down, it is almost impossible to unload this type of asset from your portfolio without realizing big losses. All interested parties should be extremely careful as apart from the internal problems, the current global volatility is affecting directly all the markets and especially the emerging ones.
In 2016, the Real Estate Sector is expected to be quite volatile and challenging. This is the year that the sector has to prove its sustainability to continue attracting investments. Within this year, we will be in the middle of a global financial cyclone. Awareness, patience, constantly following up with the market indicators and economic data will be the best advice. Profits can always be realized under any circumstances, but it will not be that easy. The risk factor has to be seriously considered by all the interested parties.
Being “aggressive” this year may not be the best investment strategy. Safer strategies would be better choice for this year. Faced by a challenging 2016, we all need to stay positive and optimistic. Psychologically, this is very important to investments hence, no reason for panicking. Analyze the market, follow up with the news and get ready to make decisions if and when needed. The fact is that this is going to be a very exciting year, so get ready and enjoy the ride !!!
By Kosta Kioleoglou
REV- Valuer by Tegova,
Civil Engineer Msc/DBM
R.M.D for the East African Region
Africa Plantation Capital.