Is there a Real Estate Bubble in Kenya?

It is evident that the property market in Nairobi has been burgeoning, with buildings stretching far and beyond. In the recent years, the Nairobi Metropolitan Area has recorded increased development activities, and the same is evident throughout the country. In terms of performance, the sector continues to record relatively high returns with the 5-year average coming in at 20.1% p.a., compared to traditional assets at 8.7% p.a., boosted by; (i) the availability of development class land, (ii) positive demographics, (iii) continued entry and expansion of multinationals companies, fueling the demand for commercial and residential space, (iv) the improved ease of doing business, and, (vi) the improving infrastructure, which has continued to open-up areas for development. Despite the above, real estate firms have been reporting decline in residential units’ occupancy rates especially in the high-end market segment, while the commercial office and retail sector have continued to record an oversupply. This has resulted in speculation that Kenya’s property market is having a bubble or headed there. To start with, a real estate bubble is defined as a run-up in property prices fueled by demand, speculation, and exuberant spending, bringing the sector to the point of collapse. This has been witnessed in mature, first world economies such as Japan, Poland and United States of America. A real estate bubble is characterized by; (i) a rapid increase in property prices driven by speculation, (ii) easy access to credit which means inordinate credit growth in the market, increasing the demand for property, and, (iii) changes in the credit market mainly in the form of an increase in interest rates leading to an increase in defaults levels and non-performing loans, which exposes the banking system. With the reduced credit supply, demand suddenly falls leading to a sharp fall in prices. At this point, the bubble is said to have burst. For the Kenyan market, we believe this is not the case, and this is supported by; (i) inaccessibility and unaffordability of credit as there are stringent underwriting rules and credit is extended to only creditworthy individuals, in addition to the relatively high interest rates on loans averaging at approximately 13.5%, with the interest rate cap, and are expected to go even higher following the repeal of the cap in 2019, (ii) the huge housing deficit of approximately 2.0 mn housing units, according to the National Housing Corporation, (iii) positive demographics which means sustained demand for property, (iv) availability of development class land especially in the satellite towns, (v) regulatory measures such as the Capital Gains Tax which pressurizes land owners to release land for development rather than hold on to it, while awaiting its appreciation, and (vi) entry and expansion of local firms and multinationals resulting in the continued uptake of commercial spaces. Currently there exists an oversupply of space in the commercial office and retail sectors estimated at 5.6 mn SQFT and 2.0 mn SQFT, respectively. We attribute the surplus to relatively low uptake of space as compared to the existing supply. However, the market has continued to witness increased entry and expansion of multinationals, local and international retailers, such as French Retailer Carrefour, who have continued to take up available retail space. In addition, the market has witnessed a slow-down in incoming supply with no new developments expected to come into the retail market in 2020 and thus, we expect the market to absorb the surplus supply in the short- term. For the residential market, in Kenya, there is a need for over 200,000 houses annually and the demand clearly outweighs the supply indicating that there is no bubble in the market and no burst is likely to be experienced, at least in the medium to long term. The sector’s resilience will thus, be backed by fundamentals that determine the demand for real estate products. There could be oversupply in some markets, especially in the upper middle income areas, and thus investors should conduct proper market research to identify the pockets of value. In conclusion, we do not foresee a real estate bubble occurring in Kenya, as the market is still constrained by issues such as unavailability of credit and relatively high interest rates, tight credit underwriting standards, inaccessibility of mortgage financing and thus, there lacks the possibility of unsustainable demand that will supersede the current supply across all the sectors. Currently, the sector is just experiencing the normal real estate cycles, and the rapid price increments and declines being witnessed are a result of low supply and high demand, and vice versa in select sectors. For direct long-term investors, the opportunity lies in differentiated concepts such as the shared offices, Grade A office spaces and serviced apartments which are in low supply 2 and present attractive returns to investors, (b) land banking especially in satellite towns, and (c) low to mid end residential market where there lies a huge demand, see the Cytonn 2020 Markets Outlook for more details. Alternative investment firms also offer other ‘sharp’ ways in the form of client-based structured products such as: (i) a short to medium-term debt obligation issued to finance a project or multiple projects such as Cytonn Project Notes (CPN), and (ii) Real Estate Backed Medium-Term Notes (MTN), a debt note that usually matures in 5–10 years and is backed by cash flows from Real Estate projects.