Numbers do not lie

Kosta Kioleoglou

It seems that the Real Estate Market’s dominance of the Kenyan economy is coming to an end. Unless big changes happen very soon, the property sector cannot sustain its status and definitely cannot continue growing.

Kenya’s real estate market has gained fame within the last few years. Most Kenyans believe that “You cannot go wrong with Real Estate”. The market is considered to be creating amazing returns to investors. It is also considered to be one of the main contributors of the country’s GDP growth.

I have been following up with the Real Estate Market of Kenya for the last three years and have been researching on a regular basis all the available data trying to understand what is really going on with this interesting market.

Recently, Kenya Bankers Association (KBA) released its Housing Price Index (KBA-HPI) for Q4 2015. Although the overall house prices have been on the rise, the increase has been at best gradual. According to the available data of the House Price Index, price increased by 2.75% during Q1, 0.2% during Q2, 1.25% during Q3 and finally by 1.14% during the period of the last quarter of 2015. That is a total of 5.34% for the whole year. At this point, I have to mention that according to the KBA, the total house price index increase since the first quarter of 2013 is just 8.19%.

These numbers combined with the fact that there is a cyclone of more development and construction that is boosting the supply, especially in Nairobi, adding more units to the already available inventory, is definitely ringing a bell. This is not the first notice. In contrary, I could risk to say that this could be the final notice before we see big changes in the market. This is a market that cannot support its value against inflation, which obviously is not producing real capital growth or positive Return on Investment (R.O.I) and definitely not real wealth. A single-digit price increase over a three-year period is a reflection of general price stability, thus, providing a guide to the extent of risk both by developers and financiers in the housing market according to the KBA.

In order to analyze the above, I have to use some more numbers as well as explain the correlation of inflation and real estate market. The truth is that, eventually, prices tend to rise over time. There are many economic reasons why prices rise gradually over time, but in short, this is a normal economic phenomenon.

Inflation though, is the means by which, over time, any currency will be worth a little bit less every year. Over the last few years, Kenya’s inflation has been 19.07% according to the available data from the central bank of Kenya, (5.7% in 2013, 6.8% in 2014 and 6.57% in 2015). This has several implications on your daily life as well as your investments. Inflation is working against us. Sh1 million is a lot of money today but will it buy as much in 5 to 10 or 20 years as it can today? I believe everybody remembers the real value of Sh1 million 10 years ago.

Like any other investment, the first challenge that 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, and any currency devaluation and produce an extra percentage.

Comparing the 8.19% increase of the house price index since 2013 with 19.07% inflation (total %, cumulatively 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 compete with the 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 are not helping. It is creating worries concerning the inflows that should be expected during 2016 from the Kenyan diaspora. The huge capitals that have been invested in the recent years from the Somali community in the real estate of Kenya are 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.

It seems that the Real Estate Market’s dominance of the Kenyan economy is coming to an end. 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.

My opinion is that, this will be one of the most important years in the last decade concerning the future of the Kenyan economy and Real Estate. The key factors of the economy have been producing mixed performance results, generally lower than what was forecast by analysts. The increasing inflation, the weakening Kenyan shilling and the rise of the external and state debt are some factors to worry about.  The global economic turbulence, the Chinese crisis that is getting bigger day after day (and China is playing a key role in the Sub-Saharan growth the last years) together with a market that is based on rumors, expensive finance, non-existing mortgage market and an economy that is not growing equally are all indicators that one should be seriously worried about.

I strongly believe that the only way to change the current situation is by changing the environment for mortgages. This is by decreasing the cost of money to reasonable and sustainable levels. The government should create proper conditions and provide incentives for the developers to stop building unaffordable properties. Focus should be directed to affordable housing by targeting the real demand of the property market, which is the middle and low-income Kenyan families.

The coming months will be critical for the future of the Kenyan property market. All interested parties should start preparing their strategies and be ready to face any possible scenario. Kenya’s property market is faced by a challenging period and not all the options will lead to profits. Investors should be extremely careful. The global volatility is affecting directly all the markets, especially the emerging ones.

The market has to prove its sustainability for it to continue attracting investments. In the middle of a global financial vortex, expected in 2016, awareness, patience, constantly following up with the market indicators and economic data, will be the best advice. Obviously, profits will be made from Kenya’s Real estate this year, but it will not be that easy. The risk factor has to seriously be considered by all parties.

Kosta Kioleoglou
REValuer by Tegova
Civil Engineer Msc/DBM
Director of Engineering and Property Appraisal