Property market: A boom with too few beneficiaries

If prices are anything to go by, Nairobi is at the centre of a property boom that is without precedent in Kenya.

While the capital may have lost its position as the city with the fastest-rising housing market in the world, according to the Wealth Report published by estate agents Knight Frank, it remains in robust health.

Selling points

Prices are forecast to rise by between 10 and 12 per cent this year, with some estimates suggesting Nairobi property prices have nearly tripled over the past decade. Mombasa, too, is booming as foreign investors, particularly Europeans, buy up land and property.

For its part, the Global Property Guide ranks the capital as the top city in sub-Saharan Africa to invest in — beating out Cape Town to the top spot — citing good rental yields and a landlord-friendly legal framework as the most attractive selling points for investors.

The surge in Kenyan property values outstrips that for most countries across the world. A World Bank report on the Kenyan mortgage market rates the country as the third-most developed in sub-Saharan Africa, with assets equivalent to over 2.5 per cent of the country’s gross domestic product.

Reasons to be cheerful then? Is Kenya becoming a country of budding property experts vying to make their millions from a boom in bricks and mortar?

Growing house prices are usually a positive indication that people are gaining confidence in their economic prospects. But Kenya’s property boom does not bear the normal characteristics of a boom.

For one thing, only a fraction of the population has benefited because too few Kenyans own property, while the mortgage market is nascent at best.

A report published by the Mortgage Company (TMC), found that only a fifth of Kenyans living in urban areas can afford a home loan priced at Sh1 million and above.

Indeed, the Government’s ambitious target of one million Kenyan homeowners will require a gargantuan leap from the fewer than 30,000 mortgage holders at present.

Such a low level of ownership begs the question: when fewer than 1 per cent of Kenyans can afford their own homes, how can a boom, let alone a bubble, of any magnitude develop?

The most common cause of a housing bubble is when a surge in house prices is accompanied by a comparable rise in the availability of credit, says Min Zhu, deputy managing director of the IMF.

The larger the ratio between the size of mortgage loans and salary, the greater the risk.

Boom and bust

This is why, historically, there is such a clear link between a housing crash and a wider recession.

IMF research has found that more than two-thirds of the 50 major banking crises across the world over the past 40 years were caused by boom and bust housing markets.

That is what caused the sub-prime crash in 2008 in the US and Europe, where economic growth was fuelled by a real estate and construction boom that became epitomised by the infamous 125 per cent loan-to-value offers from lenders desperate not to miss out on the obsession with bricks and mortar.

Money was too cheap, lenders took on unsustainable levels of risk, and eventually the Tower of Babel had to collapse.

Kenya faces the opposite problem. It is still difficult to get credit. The cheapest mortgage interest rate among commercial banks is the 13.9 per cent offered by Standard Chartered.

Although rates below the 10 per cent mark are offered to investors wishing to pay from euro or dollar-denominated accounts — another appeal for foreign buyers — most banks offer rates between 15 and 20 per cent.

To get an idea of just how eye-wateringly high this is, consider that the average interest rate in Europe, where credit still remains tight, or the US, is below 5 per cent.

For the vast majority of Kenyans, interest rates are prohibitively high. There is little value in taking out a long-term mortgage over 20 or 25 years — the length normally chosen by European and US consumers — unless you want to pay for your home four or five times over.

With such high interest rates, the housing market encourages cash purchases or mortgages lasting less than 10 years, a privilege only available to people with deep wallets and sizeable savings accounts.

It is the combination of high

interest rates and transactions costs — stamp duty, lawyers and estate agents’ fees typically add up to 5 to 7 per cent of the purchase price — that pose the greatest risk to Kenya’s housing market.

This toxic combination, coupled with the fact that rents are rising slowly but not keeping pace with house prices, shuts out middle and low-income earners.

It is little wonder most Kenyans have no choice but to rent.

However, crippling interest rates are not just a barrier to a balanced property market.

They hit the wider economy by dampening demand in the construction sector. The result is that the Government’s target of seeing 200,000 housing units built each year looks more and more ambitious, which, in turn, ensures the amount of affordable housing for low and middle earners remains small.

Credit noose

Despite the central bank steadily cutting its base interest rate from 18 per cent down to 8.5 per cent since 2012, the drop has not been passed on by banks.

However, it is not as though the Government is heedless of the fact that the credit noose being dangled in front of consumers by commercial banks is too tight.

Deputy President William Ruto has said the Government has opened talks with lenders to put pressure on them to reduce mortgage rates to single digits, and there are signs that this could start to happen in early 2015.

Combined with the launch of the Kenya Bank Reference Rate (KBRR), this suggests that rates will start to fall. The KBRR is based on the central bank’s headline interest rate and weighted two-month moving average of three-month Treasury Bill rates, and works out at 9.13 per cent, with a review set for January 2015.

All banks and mortgage finance companies are now expected to price their flexible rate loans using the KBRR as a base rate, and although it will likely take months for it to filter down to would-be customers, it is nonetheless a ray of light.

Some analysts have compared the Kenyan housing market to an inverted pyramid — where most of the new housing supply is aimed at the top of the market, leaving severe shortages of housing for those on low and middle incomes, even though that is where most of the new demand lies.

The distortion caused by interest rates is that most new developments in Nairobi are aimed at the top end, where investors and expatriates are less likely to be put off.

Bubbles in any sector of the economy are caused by distortions in the market, in this case the supply of property and credit.

The sub-prime boom and boost in the EU and US was fuelled by cheap credit, lax regulation and too much risk-taking by financial institutions. As a result, regulators in Europe, the US and Asia have introduced new rules applying stricter capital requirements for their banks to prevent risky trading. Kenya faces no such problems.

Toppling tower

But unless developers remember that home ownership is not just an aspiration for the rich, eventually, a saturation point will be reached and Kenya could face its own toppling Tower of Babel.

The longer that home ownership continues to be a pipe dream for all but the wealthiest, the more likely the Kenyan boom will turn out to be a bubble.

The main solution, however, is simple and easily reached: banks need to drop their interest rates, now.

[email protected]