Use pension funds to finance mortgages and boost home ownership

President William Ruto speaks during the launch of the annual state of the Judiciary in December 2022. [Samson Wire, Standard]

President William Ruto’s adoption and promotion of the Affordable Housing Programme will change the lives of many Kenyan families.

I fell in love with affordable housing in 2008 when I visited Malaysia and saw families buying two bed-room apartments for $20,000.

If they did it in Malaysia why can’t we do it here? Singapore has made affordable housing a cornerstone of its social policy making sure that every family owns a home over time. This creates a middle class which brings social and political stability. Nobody burns his own home during times of political crisis. When people own their own property, they care more about their neighbourhoods.

Of course, there are challenges. Morocco has made distinction between affordable housing targeting the emergent middle class and slum upgrading schemes. Unfortunately, slum upgrading has not worked in India, South Africa and Morocco.

Slum dwellers simply sell their new apartments and move back to the slums. Second, the chance to get an upgrade from a shack to an apartment only increases migration into urban slums. I don’t have an answer for this conundrum, but let us focus on affordable housing for the youth and emerging middle class.

There are two challenges to building affordable houses - on the supply and demand side. Let's look at both. The challenge on the supply side is to build enough houses at an affordable price. This is largely a cost-driven exercise. Price of steel, cement and other inputs cannot be reduced too much. Where government can help is with land, infrastructure support and tax reduction.

What is affordable? Governments have tended to focus on the construction cost of the house which as we can see is not very flexible. What is more important is the affordability of the monthly mortgage payment. The sweet spot in the affordable market segment is the two-bedroom apartment which should sell for around Sh3 million. How do we make this affordable? Let's look at the monthly mortgage payment.

At the current interest rate of 12 per cent for 15 years, the monthly mortgage payment would be Sh36,000. This is unaffordable to many households. However, if we could cut this to half or Sh18,000 a number of households would afford it. How do we do this?

Suppose we break down the payment into two parts. The first to be paid by the family through a mortgage payment of Sh18,000 monthly and the second via pension funds upfront by issuing a zero coupon bond with a maturity of 10 years, earning an interest rate of 10 per cent. What does this mean?

Pension funds would pay upfront on behalf of the buyers and receive no interest payment for 10 years. In 10 years, the home buyer would have an additional loan of 2.4 million. Why is this helpful and how does it work?

Most pension funds are earning less than 10 per cent return on their investments at the moment. All of them have maturity profiles that exceed 10 years. This means they don’t need funds on an annual basis because many of their clients won’t retire in the next 10 years.

Therefore, receiving cash flows on an annual basis is of little value to them. They can wait. A zero-coupon bond secured by a house that is appreciating in value. Fifty per cent of this asset is owned by a client who has been paying for years and is very unlikely to default and lose his/her house.

For the homeowner, Sh2.4 million coming due in 10 years is okay because most people's revenues would have increased in the next 10 years. One also has an option of reducing that loan whenever they get a windfall. Worst case scenario, if the homeowner still cannot pay the Sh2.4 million after 10 years, he will have a track record and can borrow again to pay the new loan. It’s a win-win scenario.