All that glitters is not gold


Every day, Kenyans are anxiously wondering about the future of the real estate market. Many people have put their future’s family financial stability in real estate investments. Over the last almost four years the market has not been able to meet their expectations.

Real Estate in Kenya was mistakenly seen by many as an easy and secure way of enrichment. Unfortunately, the reality of the property market is disappointing, as the return on the real estate market is not yet close to their awaited expectations.

In the vortex of the property market over the last years, several people have managed to make some impressive returns. More are left with overvalued properties, exposed financially with liabilities mainly to the banking sector or SACCOs, suffocated as their capital is trapped in the stagnated property market.

Several factors determine the minimum expectations of an investment. They include the cost of money and finance, inflation, and the risk premium that has to be accounted for depending on the level of risk of each market. These factors plus the targeted profitability of each investor will determine, amongst other factors, the expected rate of return of each investment. 

The nominal cost of finance in Kenya has been over 13% over the last years while some had to pay a lot more than this percentage in order to access finance. Inflation on the other side is over 5% on average for the last years. Saying that, it is clear that any investment using finance of any kind requires at least 18%+ annual return just to cover basic cost of money invested. This is purely for the cost of money and inflation without considering other factors such as the currency devaluation and the weakening of the buying power.

As per available reports, the market has been under pressure over the last few years. Prices are struggling to marginally increase all over the country while demand is falling and access to finance becomes harder day after day. There has been a lot of discussion regarding the way the market has been affected temporarily by the 2017 elections. It is true that election periods are always affecting the markets but the sustainability of the markets depends on much more than that. In Kenya we have seen that despite the end of the elections and the ongoing political stability prices have not recovered and the market is not growing as per investor expectations. The fact is that most of those who have invested in the market are facing big challenges to sell and recover their invested capital and they also have to face losses month after month.

A few days ago the Kenya Bankers Association released its quarterly market report for the last quarter of 2018. Again, the outcome of the report was disappointing no matter how positively one will try to look at it.

House prices in Kenya increased marginally by 1.49 % in the Fourth Quarter of 2018. This slight registered growth shows that the market is under pressure and does not seem to be capable to reverse the current trend. According to the Kenya Bankers Association House Price Index (KBA-HPI), the pattern mirrors the price evolution experienced in 2017 with indications that the slow pace of price growth experienced in the past quarters will continue to prevail.

The Index notes that while the modest rise provides respite from the depressed price outlook, it reflects the general house-price stability, attributable to the supply-demand dynamics in the housing market. Simply, as per the KBA reports prices increased by 6.68% on average in 2018. (The house prices increased by 1.49 Q4, 1.35% Q3, 1.76% Q2 and 2.08% Q1).

Inflation for the same year was registered at 5.04%. That leaves us with 1.64% to pay interest, other expenses and then also register our profits. It is clear that there can be no profits with this kind of price increase. Supply and demand dynamics, both influenced by credit constraints, saw homeowners’ preferences tilt in favor of apartments, which accounted for over three quarters of the sales in quarter four.

In reality the market is trying to react to the current dynamics first by adjusting demand to affordability. That means that buyers are now focusing on cheaper options, leaving behind expensive mansions, villas, and houses as well as expensive apartments. That was clearly observed during the last months with the preference of buyers targeting smaller properties, cheaper areas and property offers.

In general, developers and sellers are becoming more flexible regarding their asking prices and mode of payments with several offers both in commercial and residential properties attracting the interest of the market. The actual ongoing market correction is bigger and faster than what it seems at first sight. Although the property index shows a marginal increase of prices, in reality the assets are losing in real value very fast. They are not been able to keep up with the constant weakening of the buying power of the KES and the cost of money.

The alluded general stable prices have been a market characteristic even though the various segments targeting different income brackets have different price experiences. Based on the Index methodology, the evolution of the KBA Housing Price Index (KBA-HPI) has risen by 27.00 (i.e 26.995) per cent as at the end of the fourth quarter of 2018. Since 2013, it has been based on the moving base as is shown in Table 1 and Figure 2.

During the same period, 2013 – 2018 we have seen the Kenyan shilling depreciating by over 20% back in 2015 and inflation has been running with an average 6,47% per year (respectively) according to available data from the Kenya National Bureau of Statistics. That is accumulated inflation of 38,82% over the same period (2013-2018).

With simple mathematics it is clear that the housing market has produced negative returns of 11.82% over the same period just because of its inability to grow faster than inflation. Add there all the rest of the factors such as cost of money, finance, opportunity cost, currency devaluation etc, so as to understand the real outcome of the property market over the last six years.

The problem is that real estate and property investments are much more complicated than what the average investor believes. A lot of knowledge and research is required in order to be able to make a quite safe decision before you buy or sell. It is also critical to be able to understand that risk is a key factor that needs to be seriously considered. Property same as any other investment is based on a risk return trade off which will determine the risk premium that investor is looking at as well as the risk exposure of the project.

One of the main and most usual ways that people use to judge property market dynamics is supply and demand. The understanding of this relation usually determines the decision to buy or sell for the majority of non-professional property investors. I am afraid though that even this methodology is not so easy if you want to use it correctly.

To apply simple supply and demand analysis to real estate markets, a number of modifications need to be made to standard microeconomic assumptions and procedures. In particular, the unique characteristics of the real estate market must be accommodated. These characteristics include:

< Durability. Real estate is durable. A building can last for decades or even centuries, and the land underneath it is practically indestructible. Because of this, real estate markets are modeled as a stock/flow market. The largest par of supply (About 95-98%) consists of the stock of existing houses, while the rest consists of the flow of new development. The stock of real estate supply in any period is determined by the existing stock in the previous period, the rate of deterioration of the existing stock, the rate of renovation of the existing stock, and the flow of new development in the current period. The effect of real estate market adjustments tend to be mitigated by the relatively large stock of existing buildings.

< Heterogeneity. Every unit of real estate is unique in terms of its location, the building, and its financing. This makes pricing difficult, increases search costs, creates information asymmetry, and greatly restricts substitutability. To get around this problem, economists, define supply in terms of service units; that is, any physical unit can be deconstructed into the services that it provides. They describe these units of housing services as an unobservable theoretical construct. Housing stock depreciates, making it qualitatively different from new buildings. The market-equilibrating process operates across multiple quality levels. Further, the real estate market is typically divided into residential, commercial, and industrial segments. It can also be further divided into subcategories like recreational, income-generating, historical or protected, and the like.

  • High transaction costs. Buying and/or moving into a home costs much more than most types of transactions. The costs include search costs, real estate fees, moving costs, legal fees, land transfer taxes, and deed registration fees amongst others.
  • Long time delays. The market adjustment process is subject to time delays due to the length of time it takes to finance, design, and construct new supply and also due to the relatively slow rate of change of demand. Because of these lags, there is great potential for disequilibrium in the short run. Adjustment mechanisms tend to be slow relative to more fluid markets.
  • Both an investment good and consumption good. Real estate can be purchased with the expectation of attaining a return (an investment good), with the intention of using it (a consumption good), or both. These functions may be separated (with market participants concentrating on one or the other function) or combined (in the case of the person that lives in a house that they own). This dual nature of the good means that it is not uncommon for people to over-invest in real estate—that is, to invest more money in an asset than it is worth on the open market.
  • Immobility. Real estate is location immobile. Consumers come to the good rather than the good going to the consumer. Because of this, there can be no physical marketplace. This spatial fixity means that market adjustment must occur by people moving to dwelling units, rather than the movement of the goods. For example, if tastes change and more people demand suburban houses, people must find housing in the suburbs, because it is impossible to bring their existing house and lot to the suburb (even a mobile home owner, who could move the house, must still find a new lot). Spatial fixity combined with the close proximity of housing units in urban areas suggests the potential for externalities inherent in a given location.
  • Market segmentation. Market segmentation has long been a controversial empirical issue in the use of the property market analysis. It happens when a given market, such as housing, is organized into a series of submarkets each of them showing a unique functional relationship between prices and (property) attributes. Since in every market countrywide, segmentation does exist, trying to use generic data to determine supply, demand, prices and trends for the whole market provides faulty estimates and wrong conclusions. In order to face this problem, it requires an appropriate basis for segmentation to be identified.
  • As for housing markets, segmentation is often described on the basis of spatial effects or neighborhood boundaries. The data set is then stratified according to income, accessibility to employment, or household social status. Segmentation may also come as a result of significant differences in the demand or in the supply structure. The rental housing market in big cities is an obvious example. One can expect the structure of demand to vary between different areas and group of residents coming from different social classes. Just as one can expect the structure of supply to differ between apartments let or sell to low affordability buyers and those sell or let to the niche part of the market and foreigners. Making simple assumptions that there is a huge demand for housing in the country without determining for which sector of the population and what type of properties and which level of prices reflect properly demand, the market can be dangerously misleading to make wrong assumptions and decisions providing the wrong supply which the market cannot afford to buy.
  • Market Efficiency. The ultimate aim of any investor is to maximize return with a minimum of risk. An efficient market is one where prices incorporate and reflect all relevant information. An efficient market with perfect knowledge would certainly minimize the risk to an investor allowing them to make rational decisions on up to date information. Unfortunately, in most countries, there is not sufficient and easily accessible information and data regarding the market. That means that since prices do not reflect accurately all relevant information and data is neither updated constantly nor available to decision makers then the market efficiency is low affecting the ability of the investor to achieve his aim to maximize return with a minimum of risk. Saying that it is obvious that it is very difficult to properly determine the real supply – demand levels of a market and this is why this correlation should be used very carefully in order to avoid making decisions based on wrong assumptions.

The Kenyan property market is without any argument under big pressure. It seems that the government has finally realized that the main housing demand is created from the poorest sector of the population. There is a lot of discussion about affordable housing. If the government together with international organizations and possibly other stakeholders will find a way to provide affordable housing it will be a relief to the huge need for sheltering of the biggest part of Kenyan population and families. It has to be clear though that this is not changing or affecting in any way the current market dynamics as affordable housing belongs to a different market segment from the property market that Kenyans have been investing the last years, targeting the upper middle and high financially class, foreigners and irrational investors.

In order to see the dynamics and the price flexibility of the property market in Kenya you need to explore and understand in depth the real  economic  growth of the country and where it is based, the average real affordability, the rate and development of unemployment, the non-performing loans, the banking sector, the cost and availability of finance ,  inflation and the cost of money  amongst other factors that directly or indirectly are affecting and forming the real market trend and dynamics.

So far, things do not look very promising. It is key to remember is that during 2018, house prices increased only by 6.48%, while demand continued to slow down. The number and volume of non-performing loans related to property, development and construction are increasing fast while access to finance nowadays is almost impossible and still very expensive.

Investments are subject to market trends, cycles, volatility and risk. So the moment you decide to participate in the market you are immediately exposed to all these elements which depending on your strategy will determine the profits or the losses of your investment. Finally before you decide to invest your hard earned money, remember “All that Glitters is not Gold” 

Kioleoglou Konstantinos REV Valuer by Tegova Civil Engineer Msc/DBM Managing Partner, Avakon Ltd.

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