Building Economics: Getting into Real Estate

Why The Rental Market Rates Have Gone Up

Building Economics: Getting into Real Estate | Foreclosure 1 | Pinned Directory Kenya
A typical signage of a property that is under foreclosure. Normally to be auctioned by banks in order to recoup the construction development loans funds.

Real-Estate is the business of owning and managing property. Nowhere is real-estate more glorified than in English-Speaking countries. The adage is that real-estate investment is the safest, timeless, tried-and-tested investment option; you can never go wrong, so they say.  The major challenge of real-estate, though, is the barrier-to-entry. You need at least one of the following to get started: capital, tenants, knowledge or land. As such, real-estate business is not an entry-level career; you got to start somewhere else, either in banking/finance/business, politics/civic mobilization, education, architecture, engineering and construction or land development.

The motive of business is indeed profit, that is, the financial-output has to be more than the initial-investment-input. This means that if you want to reap big in real-estate, you have to source for cheap-land, employ the best talent and skills, explore low-cost construction techniques and efficient management procedures and strategic marketing of your product to a group of selected or identifies clientele. In other words, you don’t get into real-estate business blindly, without research, without professionals, without necessary support, the right ideas and knowledge. You have to be wise and smart.

Building Economics: Getting into Real Estate | Foreclosure 12 | Pinned Directory Kenya
A graph showing the historical interest rates o mortgages for homes in UK. Note that the interest rates are less than 10%..

In Kenya, disappointment is a common occurrence for new entrants into real-estate development. Some of the reasons include: lack of buying-clients or paying-tenants, excessive construction-loans, stalled-projects, mismanagement, fraud and theft, project located in inaccessible locality, lack of willing partners in permanent financing or mortgages, general low-wages or income across the country and many more. Nearly all the development that were finished after the 1990’s have resulted into very high rental values that have been out of reach of many Kenyans at large. Why has the rent values gone up the roof lately, is it the construction-cost that is too high?

An entry-development project may typically be 2-to-4-units of one or two bedroom units. A one-bedroom apartment is about 500 sft and a two-bedroom apartment is about 800 sft. With a conservative construction estimate cost of 2000/=psft, a 4-unit development may cost between 4 to 6.4 million shillings. This is the start-up capital for an entry-level developer. Sometimes the desire of owning a home/property can be so much overwhelming such that people are willing to take extraordinary risks and consider taking up construction-loans. With prevailing low-wages and income-levels, most of the development from the 1990’s onward were probably funded by construction-loans.

Building Economics: Getting into Real Estate | Foreclosure 16 Lavington Nairobi For Rent Lease 300000 KES B | Pinned Directory Kenya
Waterfront Estate at Kangemi, Nairobi, Kenya. One of the Housing Finance Development Projects.

The beauty with construction-loans is that there is a grace-period, usually 6 to 12 months, within which the borrower is not required to make any repayment nor charged interest. But there is where also the challenge lies. It is key that, as an investor in real-estate, you step into this position with validated research and feasibility study, project-plan and schedule of activities from ground-breaking to marketing and sale-out. Otherwise the end of the grace-period might as well be the genesis of newer challenges.

If projects are not completed after the grace period, the bank still demands repayment. Therefore, stalled-projects are actually useless projects. If projects are finished late, then the probability is that they would have incurred more costs and the investor is likely to stay behind in payment or otherwise charge exorbitant rental prices or sales values to catch-up with their account balances. Essentially, a construction loan is a “time-bomb” that need “bomb-experts” and the experts are called Construction or Project Managers. Without proper analysis and management of risks and benefits, challenges and opportunities that arise from a construction project, the whole thing may spiral out of control into a “nuclear-explosion or chain-reaction.” That is, incomplete or stalled-projects, late-payments, default on loans and mortgages, very high rental and sales values, high vacancy rates, and sometimes delinquency or bankruptcy and even personal health problems like depression and so on.

Building Economics: Getting into Real Estate | Foreclosure 3 | Pinned Directory Kenya
A typical bill statement issued by a financial institution showing “Past Due” Balances.

Recently, the Central Bank of Kenya capped interest rates at 4% above the base-interest-rate which stands at 10% at the moment (2017). This means that for a 5 million construction loan, for a period of 5 years, with simple-interest calculation, will accumulate a total debt of 8.5 million shillings. If an investor, so wishes to recoup his/her investment after 5-years, then a 4-unit real-estate property (say a one or two bedrooms each), shall need to be charged 35,500/= monthly-rent. In the 1990’s, house-rents were more comparable and competitive with the municipal provided housing. Rent ranged from 3000/= to 15,000/=, with slight up or down variations, depending on locality and from city to city.

Building Economics: Getting into Real Estate | Foreclosure 13 | Pinned Directory Kenya
A graph showing the historical interest rates of mortgages for homes in USA.

But suddenly things changed, everything became upside down and rent rose to an average of 35,000/= to 50,000/= or even more on monthly-basis, in our major urban centers. Reason: construction loans undercut all the economic and social realities relevant to the various location. That is why you go to Kisumu and Mombasa today and you see rent values are almost comparable to those in Nairobi. And the trend is catching on and spreading to other towns as well.

You see, the beauty with statistics is that statistics don’t lie. Numbers do not know your ethnicity or religion, neither do they recognize your race or gender. It is important that we base a major decision on available data and statistics.

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