Be careful, the bubble is about to burst

Farhana Hassanali likens Kenya’s housing market to an inverted pyramid. She says the supply of housing units at the bottom — the low and the lower-middle income segments — is as small as the tip of a pyramid, whereas the upper middle and the high-end of the market enjoy broad supply, just like the base of a pyramid.

“That is the tragedy of our housing market today,” Ms Hassanali, the business development director at HassConsult Ltd, the real estate firm that produces a quarterly index on residential property prices and rents in Nairobi, said last year during the launch of one of the Hass Property Index reports in Nairobi.

That claim might be hard to dismiss: According to available statistics, out of an estimated 50,000 new units produced annually, over 80 per cent (roughly 40,000 units) target the high and upper middle income earners.

This is despite the fact that the greatest demand is for the low-income and the lower-middle income that constitute 83 per cent of the total housing demand in the country.

That is now causing jitters in the real estate sector, with experts warning of a looming glut in the middle-class and high-end luxury accommodation segments where supply is almost outstripping demand.

A November 25 Sunday Nation report cited once apartment-boom neighbourhoods like Kilimani, Hurlingham and Kileleshwa as some of the areas choking with oversupply. Surprisingly, Kiuna and Runda estates are also listed as experiencing glut.

According to the report, many developers in those areas are unable to sell houses because they have been over-priced.

Affected most are the buy-to-let investors who are now forced to go back to their pockets to top up their rental incomes in order to service the mortgage loans they took at high interest rates.

Many now fear that Kenya’s property market could be headed for a real estate crash, after about a decade of booming business.

This is despite the severe shortage of new housing units in the lower market segment.

So, are we really headed for a possible property crash — or what is commonly referred to as a housing bubble burst?

“I think there is every sign that something terrible is just about to happen,” says Kariuki Waweru, the author of The ABC of Real Estate Investment in Kenya: The Law, the Logic and the Math.

Mr Waweru, a practising valuer and real estate investment advisor, says the mass exodus of renters from high-income neighbourhoods like Kileleshwa to Thika Road, Mombasa Road and other upcoming middle-income areas around Nairobi is proof that high rental levels and high housing prices are beginning to take a toll on developers in the up-market areas.

A number of people, he says, have built their own homes on the outskirts of Nairobi in Kitengela, Mlolongo, Syokimau, Juja, Ruiru, Mombasa Road and Ongata Rongai.

Apart from Kileleshwa, which more than two years ago suffered apartment glut, observers now say that all indications are that Kilimani, Runda, Kiambu Road and parts of Mombasa Road are likely to suffer a serious over supply, which might finally trigger a bubble burst in the housing sector. On the contrary, low-priced homes are being snapped up.

According to Waweru, the upper-middle, areas where rents are anything from Sh60,000 to Sh100,000 per month, are the most affected.

“In this segment of the market, people feel they have more options. For instance, instead of paying a Sh80,000 rent for a three-bedroom apartment in Kilimani, a prudent person would go for a five-bedroom bungalow or maisonette with a servant’s quarter in Garden Estate at the same amount,” says Waweru.

He, however, notes that the upper end of the market is still a long way from experiencing a housing glut.

“I think most of the voids (vacancies) we are seeing in the upper end are normal because that segment mainly attracts expatriates and sometimes it takes time to get such clients,” he says, noting that such neighbourhoods attract rents of Sh300,000 per month on average.

Early this year, giant global real estate management firm Knight Frank said in a report that Nairobi’s and Mombasa’s property margins were the fastest growing in the whole world.

In a study titled Wealth Report 2012: A Global Perspective on Prime Property and Wealth, the firm said that market prices in the luxury neighbourhoods and housing developments of the two cities rose by 25 and per cent respectively last year.

Waweru says that the high-end or leisure residential segment might still be safe from the threats of a possible bubble burst “because such developments are still not as common as those targeting the middle and upper-middle classes”.

In his book, Waweru notes that housing bubbles usually start with an increase in demand in the face of limited supply.

Speculators enter the market, believing that profits can be made through short-term buying and selling, further pushing demand up.

At some point, demand decreases or stagnates as supply increases, resulting in a sharp drop in prices — and the bubble bursts.

He says that a housing bubble is caused by low bank interest rates, variable rate loans, easy-to-get credit, a willingness of home buyers to take out second and third mortgages, long-term repayment terms and mortgages that exceed the value of the home.

All these factors, he says, will fuel demand for houses and bring borrowers into the market, making highly-priced houses more affordable.

“A rise in interest rates and a tightening of credit standards can reduce demand, causing a housing bubble to burst,” he writes.

That is roughly what happened in the United States over four years ago, where a huge default was triggered by sub-prime mortgages.

Most of these factors still do not apply to Kenya’s housing market. For one, the country’s mortgage market is still very tiny, with high interest rates putting off many prospective home buyers.

The secondary mortgage market, which played the biggest part in triggering the American crunch, is still very far from being a reality in Kenya.

But that still does not let Kenya’s housing sector off the hook.

First, reports that prices have stagnated in the upper-middle is in itself ominous.

Secondly, the fact that Kenya’s real estate market is largely being funded through “unconventional” means — that is why the Central Bank of Kenya governor Prof Njuguna Ndung’u said the regulator would commission a survey to ascertain the source of money being channelled into the country’s real estate sector — makes it easy to experience glut in a particular market segment thought by many to be lucrative.

Waweru, for instance, says that, while there still may not be cheap loans in the country, the high diaspora remittances, which are mainly being channelled into real estate, may trigger a bubble burst.

“As it is now, many Kenyans living abroad think the real estate sector is lucrative and want to invest through relatives or friends without necessarily conducting necessary research to ascertain how sound the investment option is. That can easily trigger a property crash,” says Waweru.

Daniel Cheruiyot, the head of property valuation at Regent Management, agrees that a property bubble could be developing in Kenya.

“There is a growing concern about the possibility of a bubble burst in the Kenyan property market today, but no clear answer has so far been given because information is lacking,” Cheruiyot was quoted by the Sunday Nation last week as saying.

He added that housing bubbles normally develop when property prices rise faster than rental levels in a market driven by over-optimistic buyers who often borrow more than what their incomes can support.

But not everyone agrees that Kenya’s property sector could be headed for a crisis because of a possible glut.

While addressing the subject of whether the country could be on the cusp of a property burst on October 12, Alister Murimi, a managing director at Ark Consultants Limited, a Nairobi-based real estate consultancy firm, said the likelihood of such a crisis was too remote to consider.

“To me, a property crash in Kenya is a mirage,” Murimi, who is also poised to become the chairman of the yet-to-be established Kenya Real Estate Index (Krex), told pension scheme managers, developers and real estate professionals who had attended the first annual real estate investment conference in Nairobi.

He said the current property boom would continue because demand still outstrips supply by far. “Everything is looking up,” he summed up his presentation.

So what next now? Our advice is simple: Be careful where you put in your shillings.