Why defaulting won’t lower house prices

Kenya’s home loan market is so small that it cannot affect key market dynamics like housing prices.

That is the damning conclusion drawn from the latest Hass Consult Property Price Index quarterly report.

In its 2011 fourth quarter findings, the report notes that ordinarily, the two major factors that often cause a slide in pricing are massive new builds ahead of the population available to buy, or a sudden arrival on the market of a big number of housing units for auctioning as a result of mortgage default by borrowers.

It is this second phenomenon — waves of defaults — that saw house prices tumble elsewhere in the world, especially in the United States.

But according to the report, there is no likelihood, or even possibility, of a wave of mortgage defaults that would lead to a tumble in house pricing locally.

In Kenya, it notes, there are very few mortgage holders — no more than a few thousand — all of whom are mortgaged by just a handful of institutions, which are now geared towards extending repayment periods rather than triggering defaults in this high interest rate era.

“With few mortgage owners, and ongoing economic growth, we see no prospect for a collapse in house prices,” said Ms Farhana Hassanali, HassConsult property development manager.

“Kenya isn’t yet oversupplied with housing, or seeing a slice of homeowners needing to sell because they cannot make loan repayments,” she added.

The report is right in its assertion that Kenya’s mortgage market is currently too small to have any serious impact on housing prices.

But it is also of note that the report raised the issue of how tumbling prices in America’s housing sector led to the global economic crisis.

Over the last few years, many Kenyans have been concerned that the skyrocketing housing prices could lead to what happened in the US, and that is why we sometimes hear questions like: “Are we likely to see a bubble burst in the real estate sector soon?”

It is important to note that the US situation was caused by the boom in sub-prime lending (the secondary mortgage market, where those who originally issued a mortgage sell the mortgage to another company) for a number of years prior to 2007.

The crisis resulted from poor credit underwriting coupled with high risk products for even riskier borrowers, where lenders had used continuing house-price appreciation as a safety net.

This was made worse by poor levels of disclosure and consumer protection as well as unregulated primary lenders having no incentive to preserve the quality of their portfolios.

The US sub-prime crisis also revealed the existence of funding models that had proved too complex and too reliant on short-term debt to satisfy the appetite of investors for higher yields.

The crisis, however, does not negate the goal of expanding access to housing finance.

Instead, it shows what happens when this expansion is done with no consideration for basic credit precepts such as the need for robust loan underwriting standards, the need for financial transparency, and the risks of excessive leverage.

But for us in Kenya, such lessons will start making sense only when our mortgage market starts having some significant numbers, perhaps the day we will have one million Kenyans repaying their home loans.