Dec 22, 2019

This week we revisit our 15^th September 2019 topical on Home Ownership Savings Plan, following the enactment of the Finance Act 2019 on 7^th November 2019; the Act included Fund Managers or Investment Banks registered under the Capital Markets Act as approved institutions to hold deposits of a Home Ownership and Savings Plan (HOSP). The act will be effected as from January 2020. As such, we revisit the following:

1. An Overview of the Affordable Housing Initiative and Home Ownership in Kenya,
2. Background of Home Ownership Savings Plans in Kenya,
3. Recent Development with regards to HOSP as in the Finance Act 2019,
4. Impact of HOSP on the Affordable Housing Initiative,
5. Areas that need to be focused on to make HOSP effective,
6. Our Expectations Going Forward, and Conclusion.

Section I: An Overview of the Affordable Housing Initiative and Home Ownership in Kenya

The Kenyan Government established the Affordable Housing Initiative, as one of its Big Four pillars to promote long-term economic development, focused on delivering 0.5 mn housing units for the lower and middle-income population segments by 2022. The main goal was to improve homeownership especially in urban areas where homeownership rate stands at 26.1% according to the 2015/16 Kenya Integrated Household Budget Survey (KIHBS) with 61% living in informal settlements according to World Bank. This is in comparison to countries like South Africa where homeownership is at 53.5% or the United States at 64.5%. The National Housing Corporation estimates that the country has a housing deficit of approximately 2.0 mn units, which grows by 200,000 units per annum. This is largely driven by a rapid population growth rate at 2.5% p.a. with an urbanization rate at 4.3%, compared to 1.2% and 2.0% globally, respectively, with 97.1% of the population also earning below Kshs 100,000 per month according to KNBS. This is worsened by other factors such as:

1. Inadequate credit supply and high cost of funding for first-time buyers to access capital towards housing unit purchase,
2. Soaring property prices boosted by the demand-supply forces,
3. Exclusion of informal sector employees due to insufficient credit risk information, despite making up approximately 83.4% of Kenya’s workforce according to KNBS,
4. Lack of capital markets funding, which tend to be long-term, and can enable real estate purchases for end-buyers, and,
5. High-interest rates and deposit requirements for mortgage loans, which lockout majority of potential borrowers.

Section II: Background of the Home Ownership Savings Plan (HOSP)

We previously wrote about Home Ownership Savings Plan (HOSP) in our topical dated 15^th September 2019, with the link here, where we covered what it is, its benefits and limitations. To recap, according to the Income Tax Act cap 470, a Home Ownership Savings Plan (HOSP) is a savings plan established by an ‘approved institution’ and registered with the commissioner for Income Tax for receiving and holding funds in trust for depositors. Introduced in 1995, its main objective was to aid in housing finance for first-time homebuyers and promote a culture of savings for aspiring homeowners.

Registered Home Ownership Savings accounts in Kenya are restricted to first time home buyers and to purchase of a ‘permanent house’, which the Income Tax Act defines as a residential house that a financial institution would accept as collateral for a mortgage, and includes any part or portion of a building, used or constructed, adapted or designed to be used solely for human habitation. The accumulated funds are withdrawn tax-free to strictly purchase or construct a house. However, if the depositor utilizes the funds for any other purpose other than to acquire a house, they become taxable in the year of withdrawal.

So far, the government put in place measures to fulfil its pledge to promote low-cost housing. Some of the measures included:

1. Increase of tax rebates issued to depositors to Kshs 96,000 from Kshs 48,000 annually (Kshs 8,000 per month from Kshs 4,000 per month) as per the initial Home Ownership Savings Plan (HOSP) regulations in 1995,
2. Formation of the Kenya Mortgage Refinancing Company (KMRC) whose main function is enhancing mortgage affordability by enabling long-term loans at attractive market rates through the provision of affordable long-term funding and capital market access to primary mortgage lenders such as banks and financial co-operatives; as per our Kenya Mortgage Refinancing Company Update of 28^th April 2018, KMRC would reduce the monthly mortgage by about 14%, thereby improving affordability,
3. Establishment of the National Housing Development Fund (NHDF). The fund was established under the Housing Act 2018 Section 6 (1), under the control of National Housing Corporation (NHC) as provided for in the Housing Act Cap 117. The aim of the fund is to allow mortgage and cash buyers to save towards the purchase of an affordable home through the Home Ownership Savings Plan (HOSP). Individuals who will have made contributions to the housing fund will be given the priority to buy low-cost houses, and,
4. Tax relief for mortgage borrowers. As per the 1995 Income Tax Act cap 470, borrowing money from a registered financial institution to purchase a home or to improve a home guarantees the borrower a tax relief on interests paid to the registered financial institution of up to a maximum of Kshs 300,000 p.a.

Despite the above, some of the factors that have hindered the success of the Home Ownership Savings Plan in Kenya include:

1. Few Product Offerings: For the past two decades, the scheme was a preserve of specialist lending institutions such as banks and building societies as stipulated in the Income Tax Act since 1996, restricting the number of products offered. Linking the schemes to capital market capable of offering attractive rates to depositors will enhance financial liberalization and assist low-income earners to efficiently save towards homeownership as part of the overall development strategy,
2. Relatively Low Yields: Currently banks offer interest rates of 4.6% on average for fixed savings accounts. This in comparison to the inflation rate, which has been oscillating between 3.8% - 6.6% in 2019, means much of the benefits accrued are eroded,
3. Little Public Knowledge: There is limited information available to the public about Home Ownership Savings Plan,
4. Mortgage Market/Housing Deficit Mismatch: The availability of housing loans is a prerequisite for Home Ownership Savings Plans to be fully effective as upon maturity the savings only serve as a deposit. House prices in Kenya are relatively high in comparison to what individuals can afford to save due to the low-income levels, necessitating the need for more funding options after the saving period. Additionally, mortgage interest rates must be close to the savings return rate. As it is, few banking institutions offer mortgages, evidenced by the few mortgages registered and the interest rates are relatively high in comparison to the yields they offer for savings accounts, and,
5. Liquidity Risk: In Kenya where the median income is relatively low at Kshs 50,000 p.m., the savings and the loan repayments could also be insufficient to fund more loan demands from subscribers completing their savings phase creating a liquidity risk for the deposit-taking institutions. The tax rebates incentivize savers meaning the product would have a high demand if properly placed in Kenya. This was the case in Ethiopia where the house savings scheme as of 2013 had a waiting list of 900,000 subscribers.

Section III: Recent Development with regards to HOSP as in the Finance Act 2019

In light of the above stumbling blocks, on 7^th November 2019, the president of the Republic of Kenya assented the Finance Act of 2019, introducing into law several amendments touching on the affordable housing initiative. Among them, a section of the Income Tax Act was amended, to include Fund Managers or Investment Banks registered under the Capital Markets Act as approved institutions to hold deposits of a Home Ownership and Savings Plan (HOSP). This is in addition to the adoption of the Capital Markets Authority (CMA) investment guidelines to guide the investment of deposits held in a registered HOSP. Previously, HOSP guidelines only recognized prudential guidelines provided by the Central Bank of Kenya (CBK).

The amendment was aimed at deepening the capital markets, in addition to enabling the use of funds raised to fund the affordable housing initiative as part of the Big 4 Agenda. Previously, savings in CMA approved products, such as Money Market Funds didn’t qualify as HOSP, and contributors towards the HOSP only had the option of making saving through banks and financial institutions, which paid relatively low interest.

The amendment thus paved way for inspiring homeowners to make savings for the purchase of a home through Money Market Funds, through which their money gains interest over time, with the current top 5 money market funds’ yield averaging at 10.0%. This lightens the burden for the homeowners who will also pay rent for the house they will be living in during the construction period, in addition to benefiting from the tax rebates associated with the HOSP program.

Section IV: Impact of HOSP on the Affordable Housing Initiative

Globally, Home Ownership Savings Plan is also referred to as Contractual Savings for Housing (CSH) schemes. The other countries providing it in Africa include; Nigeria, Tunisia, Ethiopia, and Morocco. Contractual Savings for Housing (CSH) schemes function as an agreement between a financial institution and the buyer granting them the right to obtain a preferential mortgage after a minimal saving period. However, the CSH schemes have had minimal success attributable to; (i) lack of public knowledge, (ii) general lack of appropriate regulatory and technical structures, and (iii) they are mainly led by government-controlled institutions whereas, in developed countries such as France and Germany, they are mainly managed by private financial institutions and building societies, with minimal government restrictions.

The unique selling point of contractual home savings schemes such as HOSP has been the fact that interest rates on deposits and loans are not only fixed once the contract has been signed, but they are often below-market rates.  The instrument is also an efficient way of mobilizing long-term liabilities for financial institutions, which means that, its providers are able to offer long-term fixed-rate loans, thus boosting the mortgage market. Additionally, allowing private firms to offer HOSP will ensure that the instrument is efficient in its objective coupled with the fact that CISs activities will be overseen by the Capital markets Authority (CMA).

In Kenya, the Home Ownership Savings Plan is thus expected to boost homeownership through the following;

1. Providing a flexible platform for savings towards home purchase: Homeowners are able to make savings for the purchase of a home over time for example through Money Market Funds, which require a low capital outlay e.g. of Kshs 1,000 and through which the money gains interest over time with yields averaging at 10.0%. This lightens the burden for the homeowners who are also paying rent for the house they are living in during the construction period, in addition to benefiting from the tax rebates associated with the HOSP program. Funds raised under the scheme would also be able to serve as the mandatory 12.5% deposit under the affordable housing programme.

Below we illustrate an individual savings plan for a three-bedroom unit under the affordable housing scheme, whose cost is set at Kshs 3.0 mn, through (i) a bank-based HOSP, which is likely to offer a 2.5% return per annum, and (ii) a Fund Manager’s Collective Investment Scheme such as a money market fund offering 10.0% yield per annum; the purpose of the example is to show how long it would take save the requisite Kshs 375,000 over a 5-year period:

(All Values in Kshs Unless Stated Otherwise)

Saving Scenarios Under a Collective Investment Scheme and Bank-based HOSP
	Collective Investment Schemes (CIS)	Bank-based HOSP
House Value	3,000,000	3,000,000
12.5% Deposit	375,000	375,000
Tenor (Years)	5	5
Rate of Return	10.0%	2.5%
Monthly Payments	4,843	5,874

As can be seen in the table above, for a 12.5% deposit of Kshs 375,000, assuming a five-year savings period, an individual investing with a money market fund, which offers 10.0% yield per annum will be required to make monthly deposits of Kshs 4,843. This is 21.3% less than monthly deposits of Kshs 5,874 by a depositor saving with Registered HOSP such as a bank at an interest rate of about 2.5% p.a.

2. Offering tax advantage to savers: According to the Income Tax Act, individuals in a Registered Home Savings Plan are guaranteed tax rebates of up to Kshs 8,000 per month or Kshs 96,000 per annum, while interest income of up to Kshs 3.0 mn is tax-exempt upon withdrawal. With this, assuming a median income of Kshs 50,000, an individual depositing Kshs 8,000 per month with a registered HOSP account pays 28.1% less PAYE (Pay as You Earn) than one without HOSP account, as shown below:

(All Values in Kshs Unless Stated Otherwise)

PAYE Remittances Scenario
	HOSP Employee	Non-HOSP Employee
Monthly Gross Salary (Kshs)	50,000	50,000
HOSP Remittance (Kshs)	8,000	-
PAYE (Kshs)	5,459	7,596
Taxable Income (Kshs)	42,000	50,000

3. Development of a Credit Profile: The contracted savings made by a subscriber act as proof to the financial institution of their creditworthiness, thus raising their chances of accessing a mortgage loan upon maturity of the savings, and,
4. Promoting a positive Savings Culture: With an effective regulatory environment, the scheme encourages a savings culture which ultimately makes it easier for an individual to acquire a home by efficiently raising a deposit for a house loan. According to the World Bank, inability to raise deposits required to access mortgage has been proven as one of the reasons behind the small number of home loans, necessitating the need for tax incentives to boost savings for property acquisition.

Section V: Areas that need to be focused on to make HOSP effective

First, all funding instruments tend to thrive in a stable environment. It is, therefore, imperative for HOSP to have a stable macroeconomic environment to ensure the system works properly and encourages people to save. Moreover, the inflation rate should be neither too volatile nor too high. Second, there is a need for proper guidelines on the way forward especially with respect to the newly approved institutions. The CMA Act should provide the standard terms and conditions addressing the following:

1. The general framework for business principles and general contract terms with respect to institutions that offer HOSPs,
2. Rules on permissible business activities by the Fund Managers,
3. Approved methods of investing the savings whether in the stock market or government securities, and,
4. Guidelines on granting of loans after the ten years have elapsed and the appropriate loan-to-value ratio.

Overall, as the government attempts to provide housing for all, there is a need for:

1. KMRC to be operationalized; the institution will allow long tenor mortgages, and improve affordability by an estimated 14%, as discussed in our topical KMRC Update. With a HOSP structure in place, this will also ensure a two-pillar housing finance system which should ensure the majority of Kenyans have no challenges accessing funds,
2. Operationalization of the many legislations passed so that affordable housing developers can begin to access the incentives so that they can deliver the needed units. For example, the legislation to reduce corporate tax to 15% from 30% for those building at least 100 affordable housing units was passed in 2017, however, up to today, it is not clear how this tax incentive can be accessed. Thus far, with the many legislations introduced by the government, there are no application forms for developers and the application criteria remain unknown, so it remains an incentive on paper, but inaccessible, and,
3. Passing regulations that open up capital markets funding of real estate through Collective Investment Schemes regulated by the Capital Markets Authority. Specifically, (a) pass legislation allowing for specialized collective investment schemes that are focused on real estate, and (b) allow for non-banks to be Trustees just as in the case with Pensions schemes, the current regulation, that a scheme trustee must be a bank, restricts the market not to mention that it is discriminatory and unconstitutional.

Section VI: Our Expectations Going Forward, and Conclusion

We expect the Home Ownership Savings Plan to have the following effects in the near and longer-term:

Short-term;

1. We expect more institutions to accept the HOSP funds, thus creating a competitive environment, which will eventually result in market players offering relatively high rates with the aim of staying competitive. This will result in more options for savers and competitive interest rates,
2. We expect the Home Ownership Saving Plans to stimulate a savings culture especially among the young population and low-income households who will use the scheme as a major savings vehicle towards the purchase of a home given the flexibility, the guaranteed tax rebates of up to Kshs 8,000 per month or Kshs 96,000 per annum and tax-exemption of interest income of up to Kshs 3.0 mn which will also incentivize the individuals.

The duration for homeownership savings plans in Kenya is a maximum of ten-years. Assuming that’s how long median and low-income earners will require to have decent savings, we expect the following in the long-term impacts;

1. HOSP is expected to alleviate the housing problem by providing housing finance for home-buyers. According to the World Bank, the inability to raise deposits required to access mortgage has been proven as one of the reasons behind the small number of home loans, necessitating the need for tax incentives to boost savings for property acquisition,
2. We expect Home Ownership Saving Plans to minimize credit risk, as depositors can demonstrate their ability to make timely payments by saving a portion of their income throughout an extended period. This raises their chances of accessing a mortgage loan upon maturity of the savings,
3. We expect HOSP to stimulate the mortgage market by providing a platform where a potential home buyer can accumulate the required deposit over time, in addition to growing their credit profile thus enhancing their eligibility for a mortgage loan.

In conclusion, we expect the Home Ownership Saving Plan (HOSP) to continue drawing potential home buyers mainly due to its flexible platform and tax rebates for contributors. In addition, once the recent inclusion of Fund Managers and Investment banks as approved institutions to hold HOSP deposits is effected as from January 2020, we expect it to result in an enlarged umbrella of financial savings that will enhance the raising of funds for the Big Four Agenda on the provision of affordable housing.  The long-term, as well as closed nature of HOSP schemes, will help attract long-term finance helping institutions to avoid the usual mismatch between the maturity of deposits and housing loans, thus making it a sustainable funding instrument.

Disclaimer: The views expressed in this publication are those of the writers where particulars are not warranted. This publication is meant for general information only and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.