REAL ESTATE EXPERIENCED A TEMPORARY SLOW-DOWN IN 2017 MAINLY DUE TO POLITICAL UNCERTAINTY & INTEREST CAPS, BUT THE FUNDA...

3 January, 2017

Press Release

NAIROBI, KENYA, JANUARY 3, 2018-

SECTION I: OVERALL SECTOR PERFORMANCE

The real estate sector in 2017, experienced a slow-down due to political uncertainty brought about by the extended electioneering period and thus cautious investors postponed making purchase decisions. The sector was further constrained by oversupply in some segments such as the commercial office, and credit constrains due to the interest rate cap that resulted in slower credit to the private sector growth from a five year CAGR of 14.4% to a low of 2.4% as at October 2017. Development activity reduced evidenced by the 18.4% reduction in the value of building approvals in Nairobi between January and July 2017 to Kshs 149.5 bn from Kshs 183.2 bn during the same period in 2016.

On performance, according to Cytonn’s 2017 Real Estate Review, the sector recorded rental yields of 9.6% in retail, 9.2% in commercial office and 5.2% in residential sector, resulting to an average rental yield for the real estate market of 8.0%, compared to 7.8% in 2016. Capital appreciation in Nairobi and its metropolis averaged at 6.5% in 2017 from 18.0% in 2016 and thus the real estate sector recorded a total return of 14.5% in 2017 compared to returns of 25.8% in 2016, showing a slow-down in real estate operators’ performance.

“The slowdown in performance was as a result of a steep decline in capital appreciation brought about by stagnated land and property prices indicating slowed demand in 2017,” said Elizabeth N. Nkukuu, CFA, Cytonn’s Chief Investment Officer. “Developer returns, however, remain high at an average of more than 25.0% given that real estate is a long-term investment, with a capital appreciation of 17.4% over the last 6 years,” added Elizabeth.

According to Cytonn’s Report, real estate will recover in 2018 given the i) high housing demand and the large housing deficit at 200,000 units annually ii) improving infrastructure iii) the growing middle class with higher purchasing power iv) government incentives to spur affordable housing development and v) growing businesses and SMEs creating demand for office and retail space. Investors, however, have to conduct research to identify the niches in the market given the increased focus by institutional developers, which, while clearly an indication of growth, will result in stiff competition as clients and investors demand quality developments.

SECTION II: PERFORMANCE BY SECTOR

RESIDENTIAL SECTOR PEFORMANCE: In the residential market, rental yields increased marginally to 5.2% in 2017 from 4.9% in 2016, attributable to a slight increase in occupancy rates showing sustained demand for rental properties while total returns to investors declined by 2.6% points to 10.3% from last year’s average of 12.9%, attributable to slow price appreciation rates in 2017 as a result of buyers’ wariness which resulted in slower demand. ‘’Despite the setback in 2017, we expect the residential market to pick up in 2018 especially in the mid and low mid end segments as investor appetite for the same continues in a bid to curtail the housing deficit while also gaining impetus from the expected government’s affordable housing initiative and probable increase in credit to the private sector, if the interest rates cap law is revised, which is set to encourage more activity from the developers’ side,” said Johnson Denge, Cytonn’s Real Estate Manager. “We expect a drastic turn around for the high end market especially with the proposed review of zoning regulations for some of the exclusive Nairobi suburbs such as Spring Valley, Kyuna, Loresho, Lavington and Dagoretti, to make them high density areas, a factor that is bound to lead to the said regions experiencing increased development and thus, immediate land price hikes,” he added.

COMMERCIAL OFFICE SECTOR PERFORMANCE: The commercial office sector recorded softening of rental yields by 0.2% points to 9.2% in 2017 from 9.4% in 2016 and reduced occupancy to 84.6% on average from 86.0% in 2016. “The low performance in the office sector can be attributed to reduced economic activities during the electioneering period and an oversupply of 3.2 mn SQFT in Nairobi that is expected to grow to 3.9 mn SQFT in 2018,” said Mr Denge. According to the report, Karen, Parklands and Westlands were the best performing sub-markets with yields of 10.3%,9.8% and 9.5%, respectively due to superior locations, enabling them to charge a premium on rentals. “The opportunity in the sector lies in Grade A office space, with 10.0% yields, as it accounts for only 10.0% of office space in Nairobi and in serviced offices which have high yields of 13.4% compared to conventional office space at 9.2%,” added Mr Denge.

RETAIL SECTOR PERFORMANCE: The retail sector in Nairobi similarly recorded reduced yields to 9.6% in 2017 from 10.0% in 2016 while occupancy rates declined to 80.3% from 89.3% in 2016 attributed to increased supply of retail space in Nairobi alone through the opening of malls such as Two Rivers and a tough operating environment characterised by reduced credit supply. “Notably, the sector, in 2017, witnessed paradigm shifts with the closure of several Nakumatt branches due to insolvency and cash-flow challenges leading to increased foothold of international retailers such as Carrefour and Souk Bazaar and local retailers such as Tuskys and Naivas taking up space previously occupied by former leading retailer,” said Nancy Murule, a research analyst at Cytonn.

“The retail segment has grown in other regions such as Mt Kenya and Kisumu as seen through increased mall space supply in these areas,” said Nancy. “With occupancy at 75.0% and rent at Kshs 150.2 per square foot, Kisumu was among the best performing retail markets, with a 9.1% yield’’, she added.

HOSPITALITY SECTOR PERFORMANCE: The hospitality sector had initially shown signs of recovery following the slump between 2011 and 2015 that was caused by insecurity and terrorist attacks. However, during the year, the sector struggled due to concerns over security during the electioneering period and thus the average daily rate of 3,4 and 5-star hotels in Nairobi declined by 3.9% to Kshs 11,789.0 in 2017 from Kshs 12,270.0 in 2016 while room occupancy declined by 4.6% points to 50.7% from 55.3% in 2016. “We expect the sector to recover in 2018, supported by the growth of business and tourism travel, domestic tourism and increased government incentives and continued marketing efforts which have restored confidence from key international markets,” said Patricia Wachira, a research analyst at Cytonn.

LAND SECTOR PERFORMANCE: In 2017, land continued to attract developers and investors, informed by the positive performance recorded across various locations despite the political uncertainty during the year. The Nairobi Metropolitan area recorded an appreciation of 6.5% in 2017 leading to a 6-year CAGR of 17.4%. Satellite Towns such as Utawala, Juja, Athi River, Ongata Rongai and Ruiru recorded the highest capital appreciation with a 6-year CAGR of 18.5% due to improvement of infrastructure opening up these areas for development.

LISTED REAL ESTATE SECTOR PERFORMANCE: In the listed real estate sector, Stanlib’s Fahari i-REIT, the only listed REIT in Kenya, had its price decline by 13.4% closing the market at Kshs 10.3 down from Kshs 11.9 at the beginning of the year and shedding 50.5% from its listing price of Kshs 20.8 in November 2015. The REIT is trading at a discount of 47.8% to its Net Asset Value per share, which stood at Kshs 19.75 as per H1’2017 reporting. According to Cytonn, the prices of the REIT have remained low largely due to opacity of exact returns from the underlying assets, poor dividend yields and negative market sentiments as it is the first REIT and has left investors with losses while the second REIT attempt, Fusion DREIT, failed. “REIT managers have to align their interests with those of investors to deliver higher returns, thus boost investor appetite for the REIT product,” said Elizabeth Nkukuu. “There is need for the industry to accept alternative financing to real estate such as REITs and other forms of structured products to reduce reliance on bank funding,” she added.

SECTION III: THE KEY AREAS OF OPPORTUNITIES BY SUB-SECTOR

Based on returns, factors such as supply, infrastructure, land prices and availability of social amenities the following are the ideal areas for investment;

Sector	Themes	Locations	Reasons
High-End Residential	Detached Units	Karen	Relatively low land price, available amenities and high returns
Upper Mid-End Residential	Apartments	Kileleshwa, Kilimani, Ridgeways	Proximity to Commercial hubs, good infrastructure and social amenities
Lower Mid-End Residential	Detached Units & Apartments	Komarock & Donholm Suburbs Athi River, Ruaka satellite towns	Relative affordability and infrastructural developments leading to easy accessibility
Commercial Offices	Grade A offices	Gigiri, Karen	Relatively low supply, proximity to commercial hubs and high yields of 10.3% and 9.8%, respectively
Commercial Offices	Serviced Offices	Westlands	Prime commercial hubs with high occupancy of 81.2% and yields of 15.3%
Retail Sector	Suburban Malls	Counties such as Kisumu & Mombasa	High supply in Nairobi leading to increasing vacancy rates. Retailers are increasingly moving to other counties
Land Sector	Site & Service Schemes	Ruiru,Kikuyu, Kabete, Wangige	High demand and infrastructural development in satellite towns
Hospitality Sector	4-star Business Hotels	Upperhill, Kiambu Rd	Prime commercial nodes with good infrastructure and have relatively low hotel supply
Hospitality Sector	Serviced Apartments	Upperhill, Kileleshwa/Lavington	Relatively low supply, proximity to commercial hubs and with security