Is Kenya in the midst of an asset bubble?

An asset bubble is defined as a price level at which an asset's value is completely unrelated to its real value e.g. the price of a house being 4/5 times cost of building the house or a forward PE ratio of 40 times the company's profitability in the case of shares. An asset bubble can also be ascertained by comparing the price trend in a particular location with similar sized locations in other countries (in the case of house prices) and comparing company PEs where they are in the same sector. This article reviews the Kenyan experience of an asset bubble in its real estate and the stock market.

In real estate, although there is no data that is currently centrally corrected on movement in house prices (one is being planned), anecdotally, it can be shown that the house prices in all the areas lying between Garden Estate and South B have in the last four years increased four-fold (evidence of 50% growth in last 2 years here http://www.propertykenya.com/articles/kenya_real_estate_boom.phpm and here http://www.globalpropertyguide.com/country.php?id=100&cid=af&cat=5). 1/2/ acre plot that would have cost an average of ksh750k in 2003, now starts at ksh2.5m; the equivalent in the above places cost ksh1m in 2003 and now costs ksh4.5m plus. For a family home, these would have cost ksh3-10m but now range from ksh10m-40m+. In fact, all major towns in Kenya are now experiencing a housing boom driven by the increase in money supply; a more buoyant economic environment; huge increase in diaspora remittances and a move away from the big cities of Nairobi and Mombasa. However, the asset bubble in these areas of Nairobi has additionally been driven by some unique factors.

• Increased presence of NGOs with “phat” housing allowances for their staff thus a ready-made rental market increased population from the rural-urban migration and expatriates.
• Asymmetrical information i.e. there are very few real estate players who have a real idea of the comparative house prices in the areas they buy/sell. This has led to situations where sellers can call a price and be able offload their properties at those prices.

The evidence in the stock market is more mixed. The NSE index grew by 378% between Dec 2002 to June 2007. However, the drivers for this were in most cases supported by the underlying earnings growth of the shares. The additional factors such as more investors (domestic and diaspora) flowing into this market and more optimism about the direction of the economy are likely to remain in place. Inflation has grown by 50% in the economy as and will thus have had a bearing on company profits. Several counters are exhibiting bubble-like qualities even after the correction earlier this year, but are driven by speculative events specific to them. The evidence of a bubble in the stock market is patchy at best.

While there is something in the region of 500,000 stock market investors, those involved in the real estate are a much larger group. Thus the current real estate bubble is of concern because:

• It shows a dearth of similarly lucrative investment opportunities in other economic sectors.
• To the extent that asset inflation can have impacts on economic activity (those holding appreciating assets will use some of the equity to buy consumables or invest elsewhere), any bursting of this bubble would lead to negative multiplier impacts) will distort economic growth by focusing resources on sectors with low multiplier effects.

Options to slow down the bubble:

Monetary policy-one of the main drivers of current bubble was the reduction of banks' cash reserve to 6% from 10% and consequent reduction in yields from t-bills which meant that banks now had to go out and lend (BDA put growth in mortgage lending at ksh3bn in 2002 to ksh35bn in 2006). As such a tightening of this or other measures that would impact liquidity such as the proposed increase in capital requirements will reduce it

Fiscal-introduction of capital gains tax was muted last year by Kimunya who is clearly concerned about house prices.

Administrative: Planning permissions (as was done last year to allow utilities to catch up) and enforcing these rigorously would have the effect of spreading price growth to the whole city as opposed to particular areas of the city

Increased supply-will take time but is already having an effect in areas such as Kilimani and Kileleshwa.

Information: having an index that tracks prices and or a property price map would also allow real estate investors to make informed choices that would for example shift the burden from already densely built areas to other areas that require more housing. In NBI, making a economic case for building nicer houses in the slum areas would be a good result.