What if Kenya's property bubble were to go burst?

According to real estate firm Hass Consult, property prices in the nation’s capital have risen 535 per cent since 2007, with an acre of land now going for Sh473 million in Upperhill, Sh361.7 million in Westlands and Sh370 million in Kilimani.

All this is correlated to the growth of Kenya’s middle and upper classes. Combined with the hold that aspirational marketing has on our country, we have more people able to spend money on luxuries like gadgets, holidays, fine wining and dining, and cars.

But when it comes to owning property, as a country, we must exercise caution, particularly because Kenya’s housing market seems to be displaying some signs of a bubble that could enrich a few and burn many – as happened in Spain, Ireland and the US.

People who buy their homes during a property bubble may believe that due to the exorbitant amounts they paid, they have a good amount of equity stored up in their purchase. This may lead them to overstate their financial position and take on unnecessarily large loans, using their homes as collateral.

Unfortunately, many do not realise that their houses may not be worth as much as they may imagine, given that they are likely grossly overvalued in the current market. Should there be a burst, the value of the house will drop, but the value of the loan taken will remain static.

DIPPED VALUE

During a property bubble, those who take up mortgages may come find that they paid too much for their houses when they complete payments 25 years later and realise their value has dipped. Kenya’s inadequate financial literacy has seen borrowers snap up houses without critically thinking about repayment terms and future earnings.

Tenants are also falling victim to the current property prices. Rent is on the up and up, largely because property is getting more expensive so homeowners are asking for a lot more to compensate them for their investment.This makes it harder Kenyans for to save enough money to own a home since a large chunk of income is going towards rent.

And when it comes to buying and selling property, investors have to be careful. Right now, demand outstrips supply, so the market remains lucrative. However, it is slowly getting to the point where equilibrium will be reached; remember, the housing market is largely catering to a dwindling pool of high and middle income buyers.

A property burst would spell bad news for banks, especially given the increasing ease of access to credit and the problem of borrowers’ presenting overvalued collateral. In the US, loosened criteria for loan eligibility played a big part in the country’s sub-prime mortgage collapse in 2008. Anyone could access a loan as banks engaged borrowers to avoid falling behind their rivals. This competition, coupled with greed, led to fewer regulations around lending.

In Spain, the story was more or less similar, with about 137,000 mortgages issued per month between 2005 and 2007, all without due diligence from banks. Ireland also engaged in massive and unchecked lending.

Government regulation in all three countries was severely lacking, and their economies suffered stagnation and regression, investments dried up, jobs were lost across industries and the relationships between customers, banks and government turned sour.

FINANCIAL RESERVES

Does Kenya have the financial reserves to save the economy if the property market goes belly up? Are banks taking on too many risks in a market that is running on speculation? Do Kenyans fully understand the impact a burst could have on their lives and the region?

Fortunately, a burst would not happen overnight. We must be cautious going forward, because even if all looks well and good now, it is important to remember housing does not respond quickly to changes in demand because of how long projects take from conception to completion.

In finance, when markets exhibit rapid appreciation or depreciation, in time, they return to the point in price that puts them in line with their average rates of appreciation or depreciation. This process is called a mean reversion.

Long-term averages are a much better tool to take into consideration when dealing with any asset class. They give a good picture of where prices will eventually fall after rapid appreciation or depreciation. However, most people tend to consider only the current market performance as a basis for investment.

Using one flawed metric to make the bulk of your investment decisions and hoping it will catapult you to fortune is far from wise. Markets can and do correct themselves, and it is not at all pretty when it happens.

The writer is pursuing a Bachelor’s degree in commerce.

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