Revisiting Home Ownership Savings Plan in light of the Finance Act 2019

Kenya’s housing sector is largely characterized by deteriorating housing conditions countrywide arising from a demand that far outpaces supply, particularly in urban areas. According to the National Housing Corporation (NHC), Kenya has a cumulative housing deficit of 2m units growing by 200,000 units per year driven mainly by rapid population growth of 2.2% p.a. compared to the global average of 0.9%, and a high urbanization rate of 4.3% against global and Sub-Saharan averages of 2.1% and 4.1%, respectively. 

Supply, on the other hand, has been constrained mainly by the high construction costs, high costs of land in urban areas as well as high cost of capital, with the Ministry of Housing in Kenya estimating the total annual supply to be at 50,000 units.

Notably, the Ministry indicates that 83% of the existing housing supply is for the high income and upper-middle-income segments, with only 15% for the lower middle and 2% for the low-income population. In short, while 74.4% of Kenya’s working population requires affordable housing, only 17% of housing supply goes into serving the low to lower-middle-income segment. This shortage in housing has manifested itself through the proliferation of slums and informal settlements in urban areas and poor quality housing in rural areas.

Source: Ministry of Housing

It is in this regard that the President declared the Affordable Housing Initiative under the Big Four Agenda in 2017 aiming to deliver 500,000 homes by 2022 with a price range of Sh600, 000 and Sh3m.The target beneficiaries for the units are Kenyans who are unable to access long-term housing finance. This is as most local banks have products for households that earn above Sh150,000 per month.

As a low middle-income country, Kenya’s largest challenge has been access to finance. As a result, previous government regimes had introduced some measures aimed at alleviating the housing finance crisis, including a Mortgage Relief which was introduced in the 1995 Income Tax Act cap 470, borrowers of mortgages from a registered financial institution to purchase a home or to improve a home guarantees them tax relief on interests paid to the registered financial institution of up to a maximum of Sh300, 000 p.a., and Home Ownership Savings Plan: Introduced in 1995 in the Income Tax Act and amended in 2018, savings with a Registered Home Ownership Savings Plan for a maximum of ten-years allows the subscribers tax exemption on income to a maximum of Sh8,000 per month or Sh96,000 annually and on interest income earned by a depositor on savings of up to a maximum of Sh3m.

However, since the declaration of Affordable Housing Agenda, the current regime has gone ahead and passed a host of more legislations meant to enable the affordable housing initiative. These include Affordable Housing Relief where the Income Tax Act was amended in 2018 to allow 15.0% tax relief up to a maximum of Sh108, 000 p.a., or Sh9, 000 p.m., to affordable home buyers; Stamp Duty Act that was amended in 2018. The Act allows for the exemption of first-time homebuyers under the affordable housing scheme from paying the Stamp Duty Tax, which is normally set at 2% – 4% of the property value depending on location, and; Kenya Mortgage Refinancing Company, set up with the intention of enhancing mortgage affordability in Kenya by enabling long-term loans at attractive market rates through the provision of affordable long-term funding and capital market access to primary mortgage lenders such as banks and financial co-operatives.

The government has over the past three years also introduced a host of other measures to help ease construction costs for developers of affordable housing, key among them being: 50% corporate tax break from 30% to 15% for investors who put up 100 and above affordable housing units; Scrapping off, of the NEMA and NCA levies, which used to be 0.1% and 0.05% of the project costs, respectively; Exemption of VAT for supplies imported or purchased for direct and exclusive use in the construction of affordable houses by licensed Special Economic Zones (SEZ). Developers will also need a recommendation from the Cabinet Secretary for Housing, and a minimum of 5,000 units to qualify; Exemption of companies implementing projects under the affordable housing scheme from the application of thin capitalization rules.

Others include exemption of the transfer of a house constructed under the affordable housing scheme from the developer to the National Housing Corporation from Stamp Duty; Reduction of Import Declaration Fee (IDF) on inputs for the construction of houses under the affordable housing scheme approved by the CS Finance from 2% to 1.5%, and; Under the Nairobi City County Sessional Paper Number 1 of 2018, waiving of building fees for all affordable housing projects in Nairobi.

The above measures are aimed at lowering construction costs by approximately 30.0%, from the average market rate of Sh44, 754 per Sqm toSh31, 328 per Sqm, thereby fostering the development of affordable homes. 

Measures such as zero-rating VAT, reducing IDF Fee, and the 50% corporate tax reduction for developers will indirectly reduce home prices by at least 16%, 0.5%, and 8%, respectively, while the scrapped off stamp duty outright saves the homebuyer 2% or 4% of the home value. 

On average, therefore, the incentives will help increase affordability by up to 27.5%. Taking, for instance, an average two-bedroom unit priced at Sh7m in the prevailing market values; with the government incentives applied, the unit price, therefore, will cost Sh5.1m. Other measures such as the incorporation of the Kenya Mortgage Refinancing Company will also ease the cost of buying in the long run, particularly for mortgage borrowers. 

Recent Developments

It has been our view that linking housing finance systems to the capital market, which is capable of offering attractive rates to Kenyans saving for homeownership will enhance financial liberalization and assist low-income earners to efficiently save towards homeownership as part of the overall government’s development strategy.

Income Tax Act cap 470 defines a Home Ownership Savings Plan (HOSP) as a savings plan established by an ‘approved institution’ and registered with the commissioner for Income Tax for receiving and holding funds in trust for depositors. It is a tax-sheltered savings plan whose main objective was to enable individual depositors to save for home acquisition or development and was introduced in Kenya in 1995. 

It is important to note that Registered Home Ownership Savings accounts in Kenya are restricted to first time home buyers. The accumulated funds are withdrawn tax-free to strictly purchase or construct a house. Thus, if the depositor utilizes the funds for any other purpose other than to acquire a house, they become taxable in the year of withdrawal.

Source: Ministry of Housing

Home Ownership Savings Plan in Kenya has not been very successful in its overall objective; to avail housing finance and promote a culture of savings for aspiring homeowners, as evidenced by the fact that only one institution, Housing Finance, explicitly offers the product to the public. Low homeownership rates in the country per Kenya Integrated Household Budget Survey of 2016 stood at 26.5%; and the relatively low mortgage uptake with 26,504 mortgage accounts recorded as at 2018 against an adult population of 23m and the existing housing deficit estimated at 2m by the National Housing Corporation. Yet Income Tax Act restricted the product to a few approved institutions, which were; banks or financial institutions registered under the Banking Act, insurance companies licensed under the Insurance Act or building societies registered under the Building Societies Act.

It is in this regard that real estate and capital market players lobbied for the passing of Registered Home Ownership Saving Plans to include Fund Managers and Investment Banks under the Capital Markets Act. We commend the government for heeding this call. The Finance Act of 2019, passed in November, expanded the scope of approved Institutions which can hold deposits of a HOSP to include Fund Managers and Investment Banks registered under the Capital Markets Act.

Benefits

The current attractiveness of HOSP schemes to stakeholders stems in part from the financial and housing market conditions that prevail today in the Kenyan market characterized by lack of long-term savings, the huge housing shortage, affordability problems as evidenced by extremely high price-to-income ratios, relatively high and volatile inflation, as well as reduced wage incomes. For the government, HOSP schemes alleviate the housing problem by enabling homebuyers to have the required funding to acquire a home. As it is, there exists a direct correlation between the existing housing finance system and the level of informal settlements in the country, which the World Bank estimated to be 61% of urban dwellers as at 2017. 

For financial institutions, HOSP schemes can offer effective screening and monitoring as well as establishing the reputation of steady savers as future borrowers, thus lowering credit risks. Savers, on the other hand, stand to benefit in the following two ways: Tax Rebates, as shown in the table below, credit profile and household savings.

The provision of loans for private households is rather restricted locally, which also implies exorbitant interest rates and very short repayment timelines. This is mainly because lending institutions are not in a position to evaluate the creditworthiness of potential customers as the majority of people do not have bank accounts or have very irregular incomes with 83.4% of the working population being within the informal sector. Having an active HOSP sector can help customers establish their creditworthiness through their regular saving. Those who can save a small portion of their income regularly will be identified as reliable borrowers

As for household savings, it facilitates the accumulation of equity for households or the depositors by establishing a savings discipline, which can be non-existent in many emerging economies like Kenya. As such, the schemes provide a concrete goal for homebuyers and offer prospects of a well-priced loan, which ultimately makes it easier for an individual to acquire a home by efficiently raising a deposit for a future house loan.

Structural Impediments

There are still three key structural impediments to the Capital Markets Based Home Ownership Program that require urgent review. In any case, the biggest financier to sustainable affordable housing is going to capital markets funding. The Government and the Capital Markets Authority, CMA, should look into these three issues with due speed since they are huge impediments to capital formation towards
affordable housing:

Allow specialist funds: Our archaic capital market rules currently do not allow investors to form a specialized fund, such as an affordable housing real estate fund, because the Collective Investment Schemes regulations allow only 25% of a fund to be invested in one sector; so even if you form a real estate fund, only 25% can go into real estate, the rest has to go to other sectors,

Remove conflict of interest by banks: The regulations currently require that the overseer/Trustee of a collective investment scheme must be a bank, and indeed only 5 banks are registered as Trustees. Obviously, commercial banks are good in deposit gathering and lending, not capital markets instruments, but more importantly, they will be more comfortable with allocating investor savings back into the banking sector rather than into the housing sector,

Reduce the minimums for investors wishing to put money together to invest in affordable housing:  CMA rules essentially require that an investor must have at least Sh1m in the case of a real estate high yield fund, or Sh5m in the case of real estate investment trust, in order to come together as investors to invest in real estate. These amounts are too high for regular Kenyans and seem designed to lock them, leaving them with no option but to join informal schemes such as Ekeza, where they end up risking their savings. 

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