The problem is that, most of the people would not admit the fact that they make lifetime decisions based on the above. This wrong strategy increases the risk exposure as it has very big chances of achieving negative results and possible losses. Unless we stay realistic and distinguish between what we really know from what we do not, it is not a matter of if but simply a matter of time to losses, getting ourselves in very difficult situations.
For almost three years now, working in Kenya, I have had the chance to discuss with hundreds of people from all the sectors of Kenya’s social classes. Every conversation about the Real Estate Market in Kenya, the answer would almost identical. “You cannot go wrong with real estate in Kenya”. “Kenya is different from the rest of the world, prices will only keep going up and nothing can change that.” It’s not that Kenya’s real estate market is not as good as the rest, but all markets around the world operate in cycles. All property markets, from Dubai to US, from Asia to Europe, all over the world, markets fluctuate.
A property cycle is a logical sequence of recurrent events reflected in factors such as fluctuating prices, vacancies, rentals and demand in the property market. Business and economic cycles typically last over a decade and they influence property cycles in different sectors. There are two different property cycles. The first is the physical cycle of demand and supply which determines vacancy, in turn driving rents and values. The second is the financial cycle where capital flows affects prices.
Property cycles are international global forces. Economic conditions affect the real estate market. Globalization of real estate markets has increased the impact of economic conditions on the market. Every cycle can be subdivided in four basic phases.
The boom phase, the slump phase, the stabilization phase and finally the upturn phase.
The boom phase
This phase usually tends to be the shortest phase of the cycle and its main characteristic is that, during the boom, real estate prices increase rapidly. The boom often begins slowly. Recognizing that property returns are increasing, investors come back into the market often at the same time as property owners push up demand for and this eventually leads to increasing property prices. During this period, Real estate offers the most desire of the world, quick and easy money. As the boom continues, a whole generation of new investors come into the market driven by the hype in the media, property seminars and rumors. Shortly, almost everybody tries to get involved with the market. Development and construction increase same as the prices. At this point greed starts to kick in, as is speculation. The market transforms itself to a monster that grows by all means. The market’s growth now is based on off plan sales that boost further cons. This was evident during Kenya’s property boom, when many investors bought properties off plan. They hoped to sell their properties at a profit. Many never really intending to settle on these, often they didn’t have the means to settle these properties. Although buying off plan should not be the first option during “The boom”, buyers rush to catch the momentum facing problems with quality, timeframes, delivery of the projects as well as negative price changes.
Psychology is one of the most important factors that influence the market. Fear drives property booms as investors see property prices going up all around them. They are worried that they may miss out on the profits delivered to other investors by the boom.
Not understanding the dynamics of a property cycle, many of these naive investors become overconfident at a time when they probably should be the most cautious. They are prepared to overpay just to get into the property market, pushing up property prices to levels that are (in the medium term at least) unsustainable and outside the affordability range of the demand.
At this stage of the market, properties often sell for more than their asking price as eager buyers compete with each other to snap up any property that comes on to the market. Vendors also become greedy pushing up asking prices and this just feeds the property boom. As the boom moves on, many builders and developers flood the market with new properties to meet the increasing demand from owner occupiers and investors. This excess supply is one of the factors that eventually brings the boom to an end.
At this point, I have to mention that people underestimate or misuse the rule of supply and demand. For example, the market can have a huge demand for affordable housing (ranging from KES 1,000,000 to KES 2,000,000) of 100,000 houses per year but the supply available in the market is targeting prices over KES 7 million. Although there is a real demand for more houses, targeting the wrong group of buyers creates an artificial oversupply.
In general the market is affected directly from local as well as international economic socks, changes in forex, rates, GDP, inflation, unemployment, foreign direct investment as well as several other important factors. Another reason property booms typically come to a halt is when, in an attempt to slow down the property markets and keep a lid on inflation, Central Banks increases interest rates and the banks limit credit.
This leads to the…
This is often characterized by an oversupply of dwellings due to over exuberant activity of builders and developers. Developing the wrong type of properties, targeting the wrong groups, misjudging the real affordability of the market is another reason. This causes increasing vacancy rates and decreasing investment returns. Property prices stop growing and eventually start to drop. If there has been a prolonged boom phase, this is usually followed by a longer and deeper slump phase with a greater likelihood of prices falling big.
During the slump, real estate is out of favor in the media and investors often struggle with decreased cash flows, higher interest rates and stalling values. They often consider selling up. When they do this in a falling market with few buyers they exacerbate the slump.
This is also the stage when some new buyers get into trouble. They’ve often overcommitted themselves during the boom by purchasing properties they could not afford and to interest payments that could just not afford. As interest rates rise, some find it very difficult to keep up payments. The only way out for them is to sell their properties at depressed prices. This often leaves them severely out of pocket and with a residual debt.
Usually in small to medium economies, in some cases bigger economies too, the Real Estate collapse has big effects on the whole economy of the country as unemployment rate increases, GDP growth slows down, bad loans increase, causing less consumption and serious cash flow problems. If this period comes as a surprise to individuals and governments, a recession would be expected, leading to economic catastrophes.
The positive thing is that this is part of the market’s cycle. This period could be determined by the fundamentals of the economy, the reserves in cash and other resources of the country. This will eventually proceed to the next phase which is the stabilization phase.
The stabilisation phase
Markets don’t usually jump from a period of negative sentiment to the next upturn.
There is usually a short phase where the various economic factors catch up with each other – they stabilize or get back into equilibrium. This period is very critical to the market as it regains its trust to the sector, creates the required environment to lead back to growth and the upturn phase.
The upturn phase
Finally, time to see some positive signs in the market. During the upturn, vacancy rates slowly fall, rents start to rise, and property values start to increase slowly but steadily. This phase creates great opportunities not easily recognized by most investors. At the beginning of the upturn phase of the property cycle, interest rates are usually lower than other periods and it is easier to get to access finance.
Real estate values generally start increasing in the inner ring, more affluent suburbs, suburbs close to the CBD and the beaches. This is initially driven by owner occupiers looking to upgrade their homes. Over the next few years, increasing values ripple out to the middle ring suburbs and eventually, to the outer ring suburbs. By the middle of the upturn, real estate is generally affordable and returns from property investment are attractive.
Investors begin to enter the market. In particular, professional investors take advantage of the opportunities of the upturn phase, with beginning investors often not yet convinced that real estate is a good investment. This is the time that many builders and developers commence developing projects to have them ready by the late upturn or boom phases of the cycle.
Property investors slowly get back into the market as conditions seem more favorable. They see home values rising and are concerned that they may miss out. This is also the time that many first home buyers enter the market.
Property values usually increase gently during this stage and do not rise sharply until the boom phase of the cycle. At the end of the upturn phase of the property cycle, real estate prices have risen substantially and property is becoming less affordable. As prices rise property investment returns decrease.
At this point, investors have to be ready as the cycle is about to start all over again… and again…
REValuer by Tegova
Civil Engineer Msc/DBM