Why Kenya’s property market will not tumble any time soon

Most commentaries on the ever-rising prices of real estate in Kenya easily fall into an emotional warning of an approaching bubble burst.

But a deeper analysis of the fundamentals influencing property prices suggests that the market is not about to experience a burst any time soon, and there are several reasons why this might be the true position.

To get there, however, we need to first understand what a real estate bubble is. Experts define it as a rise in housing prices fuelled by demand, speculation and the belief that recent history is a perfect forecast of future behaviour of the market. Housing bubbles, therefore, usually start with an increase in demand... in the face of limited supply.

A combination of very low interest rates and easy credit can bring borrowers into the market, fuelling demand. Speculators then jump into the fray, believing that profits can be made through short-term buying and selling, and thus further driving up demand.

A rise in interest rates and tightening of credit standards can lessen demand, and if the demand continues to drop while supply continues to rise, a sharp drop in prices may result, leading to market collapse. That is natural.
Other general economic and demographic trends can also create a housing bubble. However, due to the large transaction costs associated with owning a house, real estate markets are not traditionally as prone to bubbles as other financial markets. For example, it took almost 70 years for the US to experience another housing bubble burst after the Great Depression.

Yet the current fear of a real estate market bubble in Kenya is fuelled by the recent collapse of property prices in the US and Europe. These, however, are radically different markets. An analysis of the US bubble burst, for instance, shows factors that do not exist in Kenya.

First, what would surprise many Kenyans is that the US housing market controls have been very relaxed so that almost everyone with some disposable income can get a mortgage.

But the Kenyan mortgage system is very rigid, small and controlled by the numerous legal and financial regulations. While the US government policy encourages low-income households to own homes, the Kenyan market is highly in favour of up-market and middle class ownership.

Secondly, the interest rates in the US before the burst were enticingly low. At one per cent, many rushed to take loans and invest in the real estate sector, which offered more returns. A lot of people took several mortgages, a trend which ended up releasing more houses into the market. This is different from the Kenyan scenario, where interest rates have never been very friendly to the ordinary Kenyan wishing to own a home, and where the average Joe is apathetic to bank loans.

MANY LOST HOMES TO FORECLOSURES

So when the US interest rates climbed up sharply in 2007, many Americans were unable to service their mortgages because most of them were variable interest packages, which means servicing the mortgages became difficult.

Many people lost their houses through foreclosures, further releasing more houses into the market, and of course, leading to a sharp fall in prices.

Thirdly, the relaxed mortgage system in America and the low interest rates simply fuelled speculative madness to a level not seen in Kenya.

The belief that house prices could only go up brought all players into an irrational enthusiasm: no one questioned the sustainability of the prices, not the government, and neither the mortgage lenders nor the investment bankers. Not the credit rating agencies, and in the least not the homebuyers.

Fourthly, the scale of the Kenyan real estate mortgage is too small to cause any alarm in the economy. There are only 20,000 mortgages in Kenya, representing a minute portion of the home-eligible people in the country.

Further, many Kenyans who want to own a house simply buy cash, while many more just buy some land and construct their own homes. If there is any housing bubble, it will be in a few areas in Nairobi and Mombasa, mostly in the upmarket estates.

Fifthly, many county governments in the US had imposed land use restrictions that created a land shortage, driving the prices of houses through the roof. By 2007, prices in some areas were 120 per cent of their market value.

In Kenya, at least for now, there are no such strict rules and regulations and land is easily available. So, what is driving the property market in Kenya? It is true that Nairobi’s real estate prices are some of the highest in the world.

In fact, property market analysis firms such as Knight Frank and Citi rank Kenya’s real estate prices as some of the highest in the world, in the league of New York, Miami and Dubai.

By 2012, for instance, it cost $1,800 (about Sh153,000) per square metre in the upmarket Karen and $1,500 in Mombasa, which was very high compared to New York and Dubai. Some new apartments in Mombasa are reported to cost Sh100 million apiece — and there are few remaining!

Some regard this as pure madness, and in a way it is. But there are several reasons why that Sh100 million price tag, though nauseating to some, makes sense to an increasing number of buyers.

One, the country is a ‘growth hot spot’ and has been attracting increasing global investment in the last decade. This is confirmed by the number of global corporates and NGOs pitching camp in Nairobi. Google was first here, followed by General Electric.

And then chic hotel chains like Herriot, Accor, Starwood and Kempinski joined the party. The managers of these businesses and organisations require offices, homes and accessories that match international standards. With the discovery of key minerals, and the expansion of infrastructure across the region, notably to Ethiopia and South Sudan, this investment trend can only intensify.

POPULAR DESTINATIONS

Two, analysts have attributed the high property prices to the ongoing economic shift from the West to the East, with Africa and the Indian Ocean as the fulcrum. More concretely, wealthy people from Europe and America have been pouring money into Africa, and Nairobi and Mombasa are some of the most popular destinations.

Up along a nondescript stream on the slopes of Mt Kenya, high-value bungalows have been cropping up. Many rich Kenyans and foreigners are rushing there to own a piece of the mountain. And you would be surprised to know who own some of those highly guarded villas along the coast and upmarket Nairobi.

They are ‘the who is who’ of international corporate, culture and entertainment. Further, many savvy investors prefer buying in Africa as the European, Middle Eastern and Asian real estate markets are considered mature and prices there can only go down.

Three, the Kenyan middle class has been expanding rapidly in the last decade. The World Bank estimates that Kenya’s middle class (populated by those able to spend about Sh200 per day) now stands at 34 per cent of the total population.

This is the class that is, by socialisation, unattached to their rural backgrounds, hence prefer buying small plots in the cities. Since prices of property in prime areas like Karen are way above what they can afford, most follow infrastructural development.

That is why land along the Nairobi by-passes was quickly gobbled up when the bulldozers and earthmovers rolled in. The reason some analysts think the Kenya market is a property bubble is that most people want to be as near the city as possible.

That is natural, but economic sense quickly pushes people out of the city, where land is cheaper and easily available, hence the current exodus towards Thika and Machakos. Note that the traffic jam on Thika Road is quickly stretching towards Roysambu despite the super highway!

Fourth, a lot of diaspora money has been going into the real estate sector. Many Kenyans living abroad and wishing to build a house or invest in real estate have been using relatives and friends to oversee the projects. Data related to this practice is not formally available, but what is clear is that there is a lot from abroad.

Of course all these factors fuel some speculation, which is normal in a market. This drives up prices and can be dangerous in an unregulated land market like Kenya’s. There is most likely going to be a market correction, but certainly not a crisis as was in the US. The feared bubble burst is just that: fear.

Further, it is important to note that, like all bubbles, it is difficult to predict a real estate one. Bubbles are easier to understand and analyse after they burst. Like the overinflated balloon, one only knows that it has burst after the ‘pop’!

Dr Mbataru teaches agribusiness at Kenyatta University’s School of Agriculture