A Ship in the middle of a hurricane

Kenya’s risk of defaulting on debt repayment has increased from low to moderate and the upcoming repayment of a huge external debt, including part of the 2015 Eurobond, puts a lot of pressure on the country’s revenues

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BY KOSTA KIOLEOGLOU

Real estate market and a country’s economy are directly correlated and affect each other. For sustainable real estate growth to be achieved, a strong economic environment with positive economic data is required. Equally, real estate investments and prices are good measures for reflecting economic trends and serve as good predictors of economic growth.

To see the future of a real estate market, one should start by looking into the country’s economic data. This helps to understand the potential growth or possible shrinkage of a market.  Economic growth leads to an increase in affordability within the lower and middle class of a society. The exact opposite applies during periods of economic constraints. Macroeconomic factors show significant correlations with composite property returns and affect directly as well as indirectly the property market trends.

Kenya is struggling to maintain the status of a country with a fast-growing economy, political stability and sufficient resistance to global shocks. Despite the general belief and feeling of the majority of people who hope that all that is true, it is not a secret that economic headwinds in 2017 adversely impacted several sectors of the economy and revealed faster than expected the face of harsh reality.

The country’s macro and microeconomic status are struggling to remain resilient but the political instability, which the country faced during the last General Elections, triggered a sequence of negative events that existed before elections but were kept carefully under the radar. There is a lot of effort to present a different reality regarding the country’s real market dynamics and economic performance. 

Following carefully the local and international economic developments, one will find lots of negative reports, directives/warnings on Kenya’s economy, the viability of its external debt, sustainability of the shilling, fragile banking sector, collapsed stock market, inexistence of the tourist sector, weak agriculture, lack of infrastructure, huge import export deficit, the growing dependence on external resources and rampant corruption.

In one of its latest reviews on Kenya’s economic outlook, the IMF noted that Kenya was now more likely to experience difficulties in repaying its debts. The International Monetary Fund (IMF) has raised its assessment of Kenya’s external debt distress from low to moderate, citing the continued pile up of debt at a faster rate than revenue growth and export earnings. According to IMF’s report which was recently released, three external debt indicators — external debt service-to-export ratio, external debt service-to-revenue ratio, and the present value of external debt to export ratio — have been breached for an extended period of time under the most extreme shock. This debt sustainability analysis finds that Kenya’s risk of external debt distress has increased from low to moderate due to rising refinancing risks and narrower safety margins.

The higher level of debt, together with rising reliance on non-concessional borrowing, have raised fiscal vulnerabilities and increased interest payments on public debt to nearly one-fifth of revenue. Since Kenya was ranked a little richer and upgraded a few years ago to join the league of low middle income countries, the share of the country’s expensive commercial loans like the Eurobond increased dramatically.

As most of the external loans in US dollars matured, Kenya was forced to borrow so as to offset the maturing debts- what is known as refinancing. IMF warned that the country might experience refinancing risks, particularly if the shilling weakened and the country’s export earnings did not improve.

The interest paid on Kenya’s public debt rose past the Sh300 billion mark in the year to June 2018, new Treasury filings show, highlighting the steep cost of servicing the country’s debt, which has crossed the Sh5 trillion mark. The Treasury’s annual public debt management report shows that the taxpayer coughed up Sh321.2 billion in interest for domestic and external debt for the 2017/18 fiscal year, an 18.4% increase on the Sh271.2 billion in interest paid in the previous fiscal year. The cost of external debt rose faster than that of domestic loans, reflecting both the bigger stock of money borrowed from the international markets and higher interest rates as the country increasingly turns to foreign commercial loans. Foreign debt interest payments stood at Sh81.7 billion in the period, a 40% increase year-on-year, while domestic debt interest rose by 13% to Sh239.5 billion.

Total debt service (interest plus principal payments) amounted to Sh459.5 billion, up by Sh150 billion compared to the year ending June 2017. The ratio of debt service to revenue increased to 33.8% by end of June 2018 from 23.6% by end of June 2017. This was as a result of higher stock of external commercial debt maturing in 2017/18. The total stock of public debt stood at Sh5.05 trillion at the end of June. Kenya has taken on more foreign commercial debt through Eurobond issues and syndicated loans in recent years, with the country’s reclassification as a lower middle-income economy making it more difficult to access concessional loans normally offered to poor countries. The split of debt is now in favor of external loans, which account for 50.9% of total public debt, up from 44.5% five years ago.

Recently, Central Bank of Kenya (CBK) cautioned that the National Treasury may have to negotiate for refinancing of domestic debt, after maturity fell sharply to below five years from a high of 8.4 years in 2011. This means that CBK sees increased possibility of government having to mitigate the impact of debt repayments by negotiating for a series of refinancing given that the current profile is below its own targets. Short average maturity implies high refinancing risk through pressure on interest rates and liquidity. The current maturity averages are below the maturity profile target of 70:30 (long term to short term) under the 2017 Medium Term Debt Strategy, increasing the risk of a future failure to repay and possibly default.

Basic principle of economics and finance state that when a debt issuer is unable to successfully take in new debt at sustainable market rates to offset maturing debt then refinancing and defaulting risk arises. Looking back in 2010, average maturity of the country’s total debt was 8.9 years but this has been coming down over the years, potentially exacerbating Kenya’s debt sustainability situation. According to CBK, by the end of December 2017, Treasury bonds to Treasury bills ratio was 65:35, down from 67:33 in December 2016 and 73:27 in December 2015. As of end of December, total debt stood at Sh4.56 trillion but this has grown to 5.039 trillion by June 2018, according to latest CBK data. Domestic debt makes up 49.2 % of total debt.

As of end of September, Treasury bills (excluding repos) were at Sh867.51 billion, being 37.14% of domestic debt while Treasury bonds were valued at Sh1.468 trillion or 62.86% of total domestic debt. Out of the almost Sh5.1 trillion debt nearkt half of it, (Sh2.5 trillion) is domestic and Sh2.6 trillion external. The Nairobi Stock Exchange from its pick moment in February 2015 when it reached the 5500 units has lost over 50% of its value closing at 2777 on October 15 2018.

Kenya’s debt is directly correlated with its currency’s stability and strength. The International Monetary Fund (IMF) in its much-awaited report following a review on Kenya’s economic health released a few days ago, said the shilling risked being classified as “managed” rather than operating on the forces of demand and supply. The shilling is a sensitive subject for the country’s authority since with every percentage devaluation, the size of external debt grows. For every shilling borrowed for dollar loans such as the Eurobond in 2014 at around 87 units, a dollar will be paid back at 101.2 units a dollar currently, or higher if it depreciates further.

At the beginning of 2015 the shilling was under huge pressure and lost over 20% of its value against all major currencies. It is important to note that the currency never managed to recover the majority of these losses. The currency, seriously weaker, for the last three years in a ranging in lower levels is affecting not only the country’s macroeconomic indexes but day to day life too of every resident.

In the report, IMF looked at the gap between exports and imports referred to as current account deficit, both cyclical and actual, that are currently above normal. In reality what this implies is that the shilling’s strength may be interfering with the competitiveness of the country’s exports. The real effective exchange rate (REER) approach also shows a similar size of overvaluation, equivalent to about 18%. According to IMF, given the continued appreciation of the real exchange rate, the external position is assessed to be weaker than fundamentals.

IMF implied that Kenya, in an effort to cover the real numbers, seems to have gone to extreme levels to avoid letting IMF specialists put the value of the shilling to scale by failing to disclose crucial data to assess the shilling’s real value. According to IMF, Kenyan authorities did not produce the international investment position data on time. The World Bank and IMF noted that CBK engaged in periodic forex exchange interventions, typically unsterilized, to limit the shilling’s movement.

Following the IMF announcement that the country’s risk of defaulting on debt repayment had increased from low to moderate and the upcoming repayment of a huge external debt, including part of the 2015 Eurobond, there is a lot of pressure on the country’s revenues.

Over the last few months, a series of austerity measures have been taken to cover the country’s huge needs in order to be able to repay its debts. At the beginning of September a 16% tax on petroleum products was introduced, due to the impacts it had the Parliament controversially approved President Uhuru Kenyatta proposal to cut the VAT to %8. According to available data and reports, the government has been experiencing a slump in revenue collection both in 2017/18 and the current financial year, forcing it to slash its Sh3.026 trillion budget for the current financial year by Sh37 billion.

Banks are getting slammed too with KCB recently losing over 20% in less than a month. Media houses are also seriously challenged. The CPI increased by 1.02% from 192.18 in August 2018 to 194.14 in September 2018. The overall year on year inflation stood at 5.70% in September 2018. This clearly displays the volatility of Kenya’s economic factors. Inflation increased by almost +40% in September reaching 5.7% from 4% percent in the previous month and above market expectations of 4.95%. It was the highest inflation rate since October last year, mainly due to higher cost of transport and food and non-alcoholic beverages.

The Nairobi Securities Exchange has 3 Indices, The Nairobi All Share [market Capitalization Index], the NSE 20 and the NSE 25 [which are equal weighting indices where each of the 20 or 25 stocks that comprise the Index carry an equal weight]. The NSE 20 is -23.697% in 2018, it’s at a 19 month low and entered a bear market at the end of August. The Nairobi All Share is -15.02% in 2018, at a 16-month low and entered a bear market on September 19th. The last months we are watching a domino of price collapse and a whole series of share prices hit all-time lows. This list, which is not exhaustive includes Kenya Power [-48.9%] Deacons [-84.5% in 2018], Uchumi [-76.08%], Mumias Sugar [-50.00%]. These are just a few examples. There is no sector that defines this course.

The real estate perils

A collapsed stock market, an increasing external debt and account deficit, a fragile Kenyan shilling, a huge poor low-income class and a weak middle class with low affordability under the pressure of an avalanche of austerity measures form the real environment where the real estate market is operating.

A quick outlook of the sector’s performance is definitely not impressive but rather disappointing.  For the last 18 months, there was a general belief that the real estate market was slowing down because of the market volatility during the election period and the wait and see attitude of buyers and investors. Nine months since the end of the election period the market is yet to recover. Actually, there are a lot of signs that the market is entering into a recession period with unknown expectations.

Affordability and lack of cheap and available finance remain the key problems for the Kenyan market.  The types of properties that developers and investors had preferred to invest over the last ten years were targeting the wrong group that represents only a small fraction of the current huge housing demand of the country. A complete misjudging of the market’s real needs guided investors to make the wrong decisions regarding the market’s affordability and the types of properties that demand needed.

Kenya’s middle and lower class represent the majority of the demand with very low affordability. This target group cannot afford to buy the available supply.  Anyone expecting a quick market recovery with a continuation of the boom period after the elections is simply utopic. Available reports show that the market is slowing down. This is after a small rebound during the first quarter of 2018, which was not as strong as initially expected. All market indicators show that the market is heading to a recession.

According to the latest house price index report released in September 2018 from the Kenya Banker’s Association, there was a 1.76% overall increase in house prices during the second quarter of 2018 which followed a 2.08% increase in quarter 1. The small recovery recorded in the first half of 2018 came in the wake of strained market conditions after a series of lower rate in price growth for five consecutive quarters from the fourth quarter of 2016.

This dismal trend was attributed to various factors, including shrinking private sector credit growth and market anxiety as well as political instability that preceded the 2017 General Election. The increase in the first half of 2018 is considered as a reprieve associated with transactions from previous quarters that were put on hold due to market anxiety and lower lending risk appetite after the rate cap.

On top of that all available reports regarding construction materials and the value of building plan approvals show continuous slowdown month after month. Cement uptake in six months to June 30 fell 7.9%, while data from the Kenya National Bureau of Statistics (KNBS) indicate cement consumption in the first six months of the year stood at less than 2.75 million tons, down from 2.98 million in 2017.Consumption hit a four-year low after rising to a peak of 3.1 million tons in 2016.

Due to this development, Bamburi reported a 66.50% dip in net profit for the year ended December to Sh1.97 billion, while ARM Cement’s loss widened 133.9% to Sh6.54 billion. The same trend applies to almost each and every sector of material production and sales related to the construction and real estate industry. Production of galvanized iron sheets also went down by 6,500 tons to 111,562 metric tons, the data shows. The volume of construction material imports such as iron, steel bars and rods declined by 4.9% during the first quarter of 2018.

This decrease was an obvious result connected to the decrease of the total number and size of new buildings that are coming up as well as with the slower pace that developers are executing the existing projects under construction. It is notable that the value of building plans approved in Nairobi County decreased to Sh60.11 billion in the first quarter of 2018 compared to Sh61.72 billion in the first quarter of 2017. Lower imports, production and consumption of building materials, as well as less building plans, clearly indicate that the construction sector is slowing down. The current oversupply in the market and low transactions have made developers hesitate to commence new-builds.

Constraints are spread all over the property market sectors. Land investments, residential and Commercial property are facing huge pressure. While vacancies and the time to find a tenant or a buyer are increasing prices are sliding. Real estate professionals, developers and management companies are now more flexible and readier to negotiate as they are struggling with the market’s inefficiency.

Recently a management company decided to offer six months free of charge and following six months with 50% discount on rent in order to attract tenants for a mall they manage as it has been empty since it opened its doors a few years ago. The market is now going through a price correction period but there are fears that this is going to be a long and painful process for many investors who have entered the market without considering the possible market risks. Over-supplied markets during periods of economic turbulence can be really cruel and Kenya’s market seems to be in the middle of such a situation.

Lastly, it seems like the government as well as professional market players and market makers have realized that the real need for Kenya is housing for the lower and low middle class, which constitutes the majority of the current demand. Affordable housing seems to be the solution. Under the current plans, the government intends to build houses of one, two and three bedrooms, which will be sold at Sh600, 000, Sh1m and Sh3m respectively. It is obvious that this is not going to help at all the current market stagnation. In contrary it will reveal faster the current affordability problem.

Until now, Kenya’s real estate has been based on the affordability of investors and not the affordability of users. Thousands of properties built or under construction will struggle for years to find users who can afford them. The big price correction which will have to happen will lead most probably to panic and market collapse. Low cost housing projects cannot support the current market in any way. It is important to understand that this model of development does not make economic sense to investors as there is limited margin for profits. This is why it has been used mainly as a public or as PPP project schemes globally.

Affordable housing requires a government to create a source of funding which will support or even cover 100% the required capital. To finance the project, Treasury imposed a new tax where employers will contribute 1.5 per cent of monthly basic salary from each employee and remit it to National Housing Development Fund on or before the ninth day of the preceding month. Employees will equally contribute another 1.5 per cent subject to maximum contribution capped at Sh5,000 from January next year.

There is however a huge problem, maybe the biggest at the moment affecting Kenya’s property market negatively. The State’s disregard of genuine land ownership documents and regulatory approvals while demolishing multi-million shilling buildings. This has created a huge sense of fear to the local as well as international investors.

The already huge problem of land titles which the government cannot guarantee via its authorities; the land boards and the land registries is now becoming bigger as real estate investors fear the trend where State-sponsored demolitions appeared to target documented properties. While everybody supports demolition of properties irregularly acquired and approved, the government is part of that problem as all allocations and approvals are confirmed by State agencies. If a government cannot guarantee ownership rights where its authorities are issuing licenses, approvals and ownership titles, then who is going to trust such a market and invest.

According to available reports, the property market is experiencing huge distress as buyers are unsure of the authenticity of land ownership papers and regulatory permits presented during sale of any property. The risk position for property ownership papers issued by government has risen tremendously as the same government does not recognize its own papers.

Revoked titles, planning permissions and licenses, people losing their lifetime savings or invested capital, international and local investors suffering losses because of the inability of the government to secure a safe and stable environment for the property market is now the biggest market bias.

The market requires immediate fundamental changes both from the private and the public sector. The state needs to create the required environment that will protect every shilling legally invested in any property in the market. Instead of demolishing properties which bear legal state documents, scrape off all the corruption which is still dominating a large part of the structure.

Higher risk is associated with greater probability of higher return and lower risk with a greater probability of smaller return. This trade-off between risk and return will determine your portfolios’ success. If you are not a professional, always look for an expert, professional and legal advice in order to minimize your risk exposure.

Kioleoglou Kosta
Civil Engineer Msc/DBM
REV Valuer Tegova
Director Avakon ltd