Impact of Global Financial Crisis on Real Estate Market in Kenya Essay

IMPACT OF 2007-2008 GLOBAL FINANCIAL CRISIS ON KENYA’S REAL ESTATE MARKET; A CASE STUDY OF NAIROBI CHAPTER 1: INTRODUCTION 1. 1 Background Real estate sector is one of the critical pillars in a country’s economic growth and development. Property makes up 5. 3% of Kenya’s GDP and has shown positive growth since 2001 (Keeler, 2009). It spurs investment in both Formal and informal sectors. The sector provides employment to a big percentage of Kenyans in mortgage companies, consultant firms, construction firms, and brokerage firms.

Real Estate refers to fixed real property such as land, buildings, minerals etc.

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It includes piece of land, the air above it, the ground below it, any buildings or structures on it and its natural assets (Brueggeman W. & Fisher J. , 2008). Real estate market is an over the counter market that deals with buy and sell of real estate, financing for real estate acquisition and renting of office spaces, apartments, houses and land. It is also concerned with leases. The situation of real estate market is determined by fundamental variables of the market.

These variables are: (1) House prices, house inventories and sales of new and old houses (2) rents, and vacancy rates (3) mortgage amounts, mortgage Interest rates and mortgage default rates. The term financial crisis is applied to a broad variety of situation in which some financial institutions or assets loose a large part of their value, thus causing an economic meltdown (Read, 1959). It is a collapse of the world financial system, where there is a widespread failure of financial institutions or freezing up of capital markets that can substantially reduce the supply of capital to the real economy (Acharya V. Philippon T. , Richardson M. , and Roubini N. ,  2009). The United States of America recently experienced this crises; “The global financial crises of 2007-2009. ”  There is almost universal agreement that the fundamental cause of the crisis was the combination of a credit boom and a housing bubble (Acharya V. et al. 2009). This led to a wave of defaults, world over, with many more expected to come, in the mortgage sector (Acharya V. et al. 2009). Its effects were felt all over the world.

While developed countries are experiencing some of the sharpest contractions, households in developing countries are much more vulnerable and likely to experience acute negative consequences in the short- and long-term (Cord L. et al. ). Louise C. , Marijn V. , Blomquist C. , and Rijkers  argue that declining growth rates combined with high levels of initial poverty leave many households in developing countries highly exposed to the crisis. This means that vulnerability is heightened if, at the same time, governments are constrained in cushioning the impacts due limited institutional capacity and fiscal resources.

Kenya’s economy is characterized by recovery from post election crises, political instability and global economic recession. This makes the real estate market in Kenya to be more vulnerable. 1. 2 Problem Statement This paper will study the impact of Global financial crisis real estate market in Nairobi. The commercial real property market is a critical sector to the economy and its performance is directly and indirectly affected by the prevailing economic, political and social conditions of the country (Regent management ltd market research report, 2010).

Vulnerability is heightened if, at the same time, governments are constrained in cushioning the impacts due limited institutional capacity and fiscal resources (Louise C. , Marijn V. , Blomquist C. , & Rijkers B. ). Kenya’s economy is characterized by recovery from post election crises, political instability and global economic recession. This makes the real estate market in Kenya to be more vulnerable. A number of studies have been done on Kenya’s real estate market and also how it is impacted by the global financial crisis.

The study by Kaptich (2008) revealed that Property companies in the east Africa are still enjoying an economic boom despite the global credit turmoil. This study covered a scope of the whole East Africa region. It therefore does not reflect the specific conditions real estate market in Nairobi. . The Hass consult property price index which is the latest studies on house prices in Nairobi. It studies on the house prices, their percentage change and their trend. The scope of the studies is limited to Nairobi region and it has only included upper and middle income housing.

Also, the studies don’t include all the fundamental variables of real estate market in Kenya. Also, price indices are not universally accepted. There are no other better property price indices. These inadequacies limit the study from accurately and generally reflecting the real estate market condition. There is a need for a current study on the impact of global economic crisis on the fundamental variables of Kenya’s real estate market, which reflects the condition in countrywide real estate market.

There is a knowledge gap in the literature on impact of global economic crises on Kenya’s real estate market. There is need for studies to be done to reflect the most recent condition in Kenya’s real estate market To address the knowledge gap on the literature on impact of global economic crises on Kenya’s real estate market, there is need for a study that covers a countrywide scope of Kenya’s real estate market and considers all the fundamental variables of real estate market. This study will addresses this problem by surveying the impact of global economic crises on real estate market.

However, it does not cover a countrywide scope due to financial and time limitation. It therefore will takes a case study of Nairobi. It considered the fundamental variables of Kenya’s real estate market. These variables are: (1) House prices, house inventories and sales of new and old houses (2) rents, and vacancy rates (3) mortgage amounts, mortgage Interest rates and mortgage default rates. 1. 3 Purpose of the Study The purpose of this study will be to determine the impact of global financial crises on real estate market in Nairobi.

The determination of Kenya’s real estate market variables and comparing them with those in the United States of America, and the base year established the exact impact of global financial crises on Kenya’s real estate market and the exact market situation. 1. 4 Benefits of the Study The research will be useful to scholars and academics, for it would add to the body of knowledge and provide a basis for further research on the impact of global economic financial crisis on real estate market in Kenya.

The findings of this study will address the knowledge gap in the literature of the impact of global financial crises on real estate market in Kenya’s real estate market and a wider scope study on the impact of the current global economic crises on Kenya’s real estate market. Also, this study will be useful to investors and various stakeholders in terms of providing current and timely information necessary to predict future performance of the real estate sector and thereby be in a position to make rational nvestment decisions. Speculators in the market will have this study as a useful reference to make informed decisions. This study will stimulate and direct the necessary industrial and government response to restore or maintain equilibrium in the real estate market. The policies and regulations developed can play an important role in helping the government control and monitor the operations of different players in this sector. CHAPTER 2:  LITERATURE REVIEW 2. 0 Introduction

Nikolson (2008) recognized that financial crisis which initiated in USA between 2006 and 2007 has now become a global phenomenon. It is clear that the USA house bubbles  of between 1994 and 2006 led to credit crunch in USA between the peak of the house bubble in July 2006 and 2009 (DeBoer). The mechanical phenomena behind the global economic crisis of 2007 are domino effects and psychological contagions as many institutions had financial links (Kilonzo, 2008). The effects and global nature of the crisis has attracted the attention of many scholars world over.

Various studies and work have been done on this phenomenon, thus building on the literature of global financial crisis, house bubble, credit crunch and other related concepts. 2. 1  Other Past Crises During the 20th century, the world experience two major financial crises. The first global financial crisis was seen during 1929-30, which affected the developed nations, Europe and America. The second crisis came in 1997 and remained till 1999 and was experienced by emerging economies of Asia Pacific (Ullah, S. , Malik, I. N. , Azam, K. & Marwat, A. K. , 2008). Kilonzo (2008), in her speech on the global financial crisis, its impact on Kenya and possible strategies to mitigate the effects, she reviewed previous economic crises since 1920 to 2007. First, there was “The Wall Street Stock market crash which occurred during a period of declining real estate values in America (which peaked in 1925). A precursor to the Crash was a time of prosperity and excesses (high price levels) in USA, despite warnings against speculation. Then, there came “The Global Financial Crises of 1987”.

The 1987 market crash in USA was caused by sales through program trading, overvaluation, illiquidity and market psychology. In 1997, there was “The Asian Crisis of 1997”. It was triggered by the devaluation of the Thai currency in July 1997 which prompted attacks on East Asian stocks and currencies. Other causes are widening current account deficit resulting from falling export performance due to exchange rate appreciation, rising capital inflows encouraging excessive imports, exchange rates pegged to the US dollar and Increased financial liberalization. 2. Effects of Global Economic Crisis Since the start of the crisis, the Institute of International Finance estimates that the global financial system has suffered worldwide write downs and credit losses of over US$ 1. 5 trillion as of the end of June 2009. These losses are concentrated in the Americas (around US$ 1 trillion) and Europe (over US$ 450 billion), while Asia has been minimally affected (around US$ 50 billion). In a series of influential papers, Carmen, & Rogoff (2008) have studied the historical record of countries experiencing severe financial crises.

They report that real housing price declines average 35 percent stretched out over six years from peak to trough, while equity price collapses average 55 percent over a downturn of about three and a half years. The unemployment rate rose by an average of 7 percentage points over the down phase of the cycle and output falls by an average of over 9 percent. The real value of government debt tends to explode, rising an average 86 percent, because of lost tax revenues. The effects of financial crisis have been felt greatly by the different sectors in the real estate market.

According to Matt (February 20, 2010), the financial crisis marked the end of the very high valuations of the real estate markets and sudden decrease in prices. investors who had put their money in high valued real estate not only lose the money invested in the real estate market but also the money borrowed against it. The huge number of foreclosed homes is just one of the many sad effects of the financial crisis in the real estate market. The effects of this financial crisis have been very real after the big banks and real estate firms started reducing their operation and filling for bankruptcy.

This finally led to lose of million jobs throughout the world. There was a decrease in rents up to twenty percent and increase in office vacancies up to 5 to 7 percent in USA due to companies going bankrupt or being acquired. Builders were more cautious, and they tend to build less since less money is available. In some areas, building almost came to a standstill since there were already more homes on the market than buyers. The recession also affected banking institutions in the sense that they were forced to either charge higher interest rates, reject everything except the safest loans, or both.

Loan applications reduced due to lack or income sources for some people and the high credit score expected. Out of the few loan applications, only a small fraction was underwritten (Buzzle. com). 2. 3 Causes of Global Economic Crisis About the cause of current crisis Bartlett (2008) said that crisis was started with the downfall of US sub-prime mortgage industry , the intensity of this collapse was significant; “Mark-to-market losses on mortgage backed securities, collateralized debt obligations, and related assets through March 2008 were approximate $945 billion. He further stated that it is “The largest financial loss in history”, as compared to Japan’s banking crisis in 1990 about $780 billion, losses stemming from the Asian crisis of 1997-98 approx $420 billion and the $380 billion savings and loan crisis of U. S itself in 1986-95. Y? lmaz (2008) charged U. S subprime mortgage industry to be the major reason of current global financial crisis, he also stated that the total loses estimated initially up to $300 to $600 billion are now considered to be around $1 trillion. It is argued that the current global financial crisis stemmed from a confluence of several factors and events.

The broad underlying causes of the crisis are grouped into three main categories: macroeconomic or market factors, risk management failures, and inadequate regulations or policies (Archarya, & Richardson, 2009; Brunnermeier, 2009; Financial Services Authority, 2009; IMF, 2008). The study done by Archarya, & Richardson (2009), Brunnermeier (2009), Financial Services Authority (2009) and IMF (2008) revealed that macroeconomic or market factors for the crisis are macro financial complacency brought about by a long period of expansion in credit and leverage, combined with rapid innovation.

The crisis was preceded by more than a decade of booming economic conditions, manifested by low interest rates, low volatility, and abundant liquidity. This period was also characterized by increased appetite for risk and leverage by both creditors and investors. At the same time, there was a growth of innovated, complex structured financial products, which made it easier to trade credit risk and thereby increased the perceived liquidity of these products. Bundling of mortgages into an ABS, which is then traded rather than held, created an impression that the risk of such asset was minimal for an institution.

As a result, there was an unprecedented expansion of mortgages and credits in the United States. The study also revealed that the financial crisis is also due to multiple risk management failures that left the financial system vulnerable to excessive risk taking. It is evident that market discipline – which is supposed to check excesses – had failed. Misaligned compensations and incentives for executives and traders, as well as for bankers, underwriters, and rating agencies, encouraged the weakening of underwriting and credit standards in favour of promoting volume expansions.

Credit rating agencies’ due diligence might have been compromised by incentives for fee income as well as inadequate methodologies, while institutional investors’ search for yield may have undermined their own due diligence, putting excessive reliance on rating agencies. Finally, banks may have underestimated the liquidity risk in their funding models due to the misperception of counterparty risk of complicated derivative instruments such as credit default swaps, as well as misunderstanding of extreme ‘‘black swan’’ events (Taleb, 2007).

In some instances, banks set up off-balance sheet entities to facilitate rapid growth and generate fee income. However, this implied poor disclosure of material corporate risk, which further weakened the efficacy of corporate risk management. Policy frameworks have also been identified in the study as inadequate to prevent the crisis. Regulatory and prudential norms, along with supervising oversight, have lagged behind financial innovation.

Supervisors lacked a macro prudential perspective, failed to monitor off-balance sheet entities and liquidity buffers, relied too heavily on ratings for capital charges, and failed to take countervailing actions. In addition, central bank liquidity frameworks were not flexible enough to cope with unexpected liquidity shocks. In some cases, crisis management and deposit-insurance schemes proved to be outdated, and various regulatory agencies were compartmentalized without sufficient regard to the interdependencies of different financial institutions and markets.

Further, valuation, disclosure and accounting inadequacies seem to have exacerbated the situation. Weaknesses in the application of accounting standards and gaps associated with the valuation and financial reporting of structured products have been mentioned as a key contributing factor for the crisis. Other explanations for subprime crisis were presented in the study by Kallis, G. , Martinez-Alier, J. , & Norgaard, R. B. (2009). He argued that the finance sphere grew far too fast and too large to be supported by the real economy beneath.

Also, Soddy (1926) noticed that the financial system can be prone to increase debts (both private and public) and then mistake the expansion of credit for the creation of real wealth. Brenner (2006) showed how asset bubbles – first technology shares and then houses – contributed to maintaining the perception of a buoyant economy and consumption growth, but only at the cost of building up personal and corporate indebtedness (Wong, 2009,) While enlightening the factors that why this US sub-prime mortgage crisis turn into global banking crisis, Khatiwada, & McGirr (2008) stated “Many of these sub-prime mortgages ctually never made it on the balance sheets of the lending institutions that originated them”; and they were made attractive to foreign banks by high investment grading, “when sub-prime borrowers failed to repay their mortgages, the originating institution needed to finance the foreclosure with their own money, bringing the asset back on its balance sheet. This left many banks in a financially unviable situation, in a rather short, unmanageable timeframe”. However Hyun-Soo (2008) argues that it was the “Trust Crisis” which caused this global predicament.

DeBoer (2008) believes that it was series of events which caused the crisis; it begins with the collapse of currencies in East Asia in 1997 and became edgy due to the financial crisis of Russia in 1998. Next, in USA was the “dot-com” stock collapse in 2001, and the final stroke was again in USA, when after a swift decline in housing prices and “rapid contraction in credit, it fell into recession. Rasmus (2008) has the same thoughts; he, while discussing the reasons of economic recession of U.

S said “The ‘real’ ailments afflicting the US economy for more than a quarter-century now include sharply rising income inequality, a decades-long real pay freeze for 91 million non-supervisory workers, the accelerating collapse of the US post-war retirement and healthcare systems, the export of the US economy’s manufacturing base, the near-demise of its labour unions, the lack of full time permanent employment for 40 per cent of the workforce, the diversion of massive amounts of tax revenues to offshore shelters, the growing ineffectiveness of traditional monetary and fiscal policy, and the progressive decline of the US dollar in international markets. ” 2. 4 Conceptual Framework of Global Economic Crisis 2. 4. 1 House bubble. Throughout this decade, many people expressed concern about the rapid pace of growth in housing prices. Between 1994 and 2006, the average price of a single family home increased by almost 200 percent (Case-Shiller Housing Price Index, cited in DeBoer). Many scholars concentrated in explaining this paradox. DeBoer presents a clear view on the concepts behind the house bubble of USA in the years between 1994 and 2006.

According to DeBoer fuel for this growth was (1) inexpensive mortgage rates, averaging 5. 7 percent between 2003 and 2005, (2) reduced adherence to banking rules in the mortgage industry, and (3) changes in consumer expectations. He explains the connection between low mortgage interest rate and high house prices using the concept of demand and supply. In most cases, purchasing a house is a joint purchase (involving a purchase of both house and a mortgage). This is complementary purchase. Economic theory shows that when the price of one good in the pair falls, hence increase in its demand, the demand for the other good also increases. Therefore, the fall in mortgage rates led to high demand of houses and consequently high prices.

When illustrating the factor of deregulation of banks and change in banking practices DeBoer identifies that this is what led to widespread movement to branch banking and bank consolidation. These banking systems had great impact on banking practices. He presented a historical scenario where the neighborhood banker was the primary source for credit. Further, that banker personally knew many of his customers. This offered a casual information channel by which a banker could assess risk. The introduction of larger branch banking institutions removed this information channel. He argued that, as the casual information channel was being cleared, the incentive structure within the financial sector further changed in such a way that increased mortgage turnover.

He compared a historical mortgage mechanism where the issuer of a mortgage was likely to maintain an equity stake in that mortgage with the existing mortgage mechanism where deregulations have changed that constraint. Banks and other financial institutions introduced numerous financial derivatives. These are Collaterised Backed securities (CBSs), Security Investment Vehicles (SIVs) and Collateralized Debt Obligations (CDOs). These derivatives allowed mortgages (and other types of debt) to be packaged and re-sold (and as time went by, re-sold again). DeBoer argued that this reduced the need for lenders to practice quality oversight. In essence, if a loan was defaulted, it would no longer belong to the issuer.

DeBoer identifies that with the growth in foreign savings in the United States and too much domestic money, lenders found many ready buyers of this repackaged debt. Mortgage turnover therefore increased as lending practices became increasingly weak. Another factor identified by DeBoer is the factor of subprime mortgages. As mortgage debt became more easily available, new buyers of housing entered the market – the “subprime” borrower. The influx of these new borrowers who would traditionally not have had access to loans, further spurred housing demand. Finally, he also argues that consumer expectations changed as housing prices rose. Consumers came to expect housing prices to continue to appreciate at a high rate. This encouraged the entrance of new real estate speculators into the market.

In this way, the new buyers again drove up housing demand and continued to propel the upsurge in housing prices. This final speculative demand – when piled onto the other forces driving an upsurge in housing prices – formed a housing price bubble. If asset price bubbles never burst, they would not be of concern. Unfortunately, they always do. The cause of this downturn tied to the notable decline in the international confidence in the U. S. economy starting in 2006 (DeBoer). The fall in confidence dried up some of the foreign savings and pushed some foreign buyers out of the housing market, which put upward pressure on mortgage interest rates and likely started the downturn in the housing market. 2. 4. 2 Credit crisis.

The credit crisis was caused by the fall in housing prices that began in July 2006 in USA (DeBoer). DeBoer explains the channels and events through which the housing prices enter the financial sector. DeBoer identifies that core connection was the requirement for capital asset backed loans. Every bank or other financial entity in the United States is required to have capital assets backing its loans. In his illustrations, the introduction of financial derivatives contributed by encouraging financial entities to widely used mortgage-backed securities as a share of the capital backing their operations. As housing prices declined, the value of mortgage-backed securities also declined.

This led to banks’ capital assets decline in value. Banks were then forced to issue fewer loans. The tightening of credit conditions necessitated by this logic started a downward spiral. First, he DeBoer explains how tighter credit narrowed the market for housing. The fall in demand pushed housing prices further down. Recent buyers of houses found they owe more on a house than the house is worth (negative equity). This encourages them to default mortgage obligations and foreclosures increased. As foreclosures increased, the value of properties next to foreclosed houses declined. This pushed more homeowners into a situation of negative equity. Second, ccording to DeBoer, the continued decline in housing prices further reduced the value of mortgage-backed financial derivatives. As they declined, credit conditions further tighten. This became an increasing problem as variable rate mortgages begin to reset. Those who were planning to refinance prior to the interest rate reset were unable to do so. Some also found that they were unable to afford the now higher payments. This led to another round of foreclosures. Further, DeBoer explains what would happen when the contractionary cycle was not resolved. This cycle would continue until the capital assets are fully re-priced, stopping the continued contraction in lending. This contractionary cycle would be made more severe by requirements to “mark-to-market. With mortgage-backed derivatives falling in value, the market for these assets will have effectively disappeared; as such, the market value of these assets would be close to zero (though they can realistically be expected to rebound in value within five years). . Despite focusing on the housing market and mortgage-backed derivatives, which were the early locus of the problem, DeBoer also explains how the house bubble connected to other sectors of the economy. As credit conditions tightened, consumer loans, loans for business operating expenses, and loans for corporate expansion became increasingly difficult to obtain. This drove down the sales of many items and forced many otherwise well-functioning firms into failure.

He identified that the effects of this broader downturn are currently being seen in markedly higher rates of unemployment. The concept of credit crunch is represented in figure 1 which was adopted from Wikipedia. As illustrated in this figure ,after the bursting of the United States housing bubble high default rates on “subprime and adjustable rate mortgages (ARM) began to increase rapidly. Once interest rates began to rise and housing prices started to drop moderately in 2006-2007 in many parts of the U. S. , refinancing mortgages became more difficult. Defaults and foreclosure activity increased dramatically as easy initial 2. 5 Real Estate Market in Kenya 2. 5. 1 General economic condition.

Kenyan economy has been growing steadily in the past three years after several decades of low growth rates. In 2007, Kenya recorded an economic growth rate of 7. 1% and 1. 7 % in 2008 (KASNEB News line, 2009). The high GDP growth rate in 2007 reflects a good performance of real estate sector of the economy. The significant drop in growth rate in 2008 is partly attributed to global economic slowdown and financial crunch. Other contributors include; post election violence, a rise in fuel prices, high food prices, global economic slowdown and financial crunch. (KASNEB News line, 2009). Economic experts project an economic growth rate of 4. 5 percent and World Bank project a GDP growth rate of 3. percent in 2009, following the implementation of economic stimulus package (Kenya times, 2010). 2. 5. 2 General real estate market conditions. A number of studies have been done on Kenya’s real estate market and also how it is impacted by the global financial crisis. The study by Kaptich F. , (2008) revealed that Property companies in the east Africa are still enjoying an economic boom despite the global credit turmoil. It identified that there is demand for property probably due to increase in population and stability in the region. The study also identified reluctance by banks in lending and predicted a slowdown in the real estate investments across the region as a result of this.

Markets in the study revealed that East African region are amongst the most robust, and will continue to be interesting for investors. The market appears to be more insulated from the slowdown more than others              Between the month of August and September, the online real estate search in East Africa region grew by 58%, although, there was a slowdown between the month of July and August; a drop of 1. 75%. Online real estate search has grown on average by 27% since it started monitoring online property search. The data suggests that there is high demand for East African real estate (Propertyzote, October 22, 2008, cited in Kaptich F. , 2008). 2. . 3 House prices and rents in Nairobi. The Hass Consult property price index gave another reflection of Kenya’s real estate market. It covered the trend in housing prices for the city’s upper and middle income town houses. Hass Consult Real Estate attributed the drop to the 2007 post election violence coupled with the global economic downturn. The Composite Index developed by Hass Consult indicates that house prices increased constantly from mid 2006 to 2008 and started levelling off heading towards 2009. The Composite Index and Hass Property Index are the most recent studies and reflect the most current scenario in Kenya’s real estate market.

As the property index report continues to have a ripple effect, real estate firms insist the houses in stock have all sold at a record speed, meaning the thirst and demand for houses is still there. According to Mentor Group director, Daniel Ojijo, demand for houses remains high following the housing shortage that outstrips supply (Ayodo, May 6, 2010). According to Homes Kenya marketing executive, Louis Agili, houses in Nairobi’s Kilimani, Lavington, Riara, Ngong Road and Kileleshwa areas on high demand. He attaches this to an inadequate supply of housing units, which has led to the increase of prices. Hass Consult report released in 2007 and 2008 indicated that prices appreciated by four per cent every quarter, translating to a 30 per cent appreciation annually. (Ayodo, May 6, 2010).

Hass Consult report released last year showed that prices of palatial homes fell by between 1. 4 per cent and 2. 2 percent in the second and third quarter respectively. Real estate  firms say that prospective clients who had pledged to purchase shieded away after the release of the report, expecting prices to fall further (Ayodo, May 6, 2010). The fall in price was attributed to recession, high inflation and falling remittances from the Diaspora were among possible reasons for the decline in prices (Ayodo, May 6, 2010). According to Ayodo (May 6, 2010), a demand-supply mismatch resulting in over supply of property 9particularly apartments) coupled with excessive speculation could also be factors.

The general property transaction trends in the high-end market are on a sluggish demand path with a rise of 1. 8 per cent compared to the previous quarter. Some property sellers continue to quote high asking prices for their residential and commercial property in up-market areas (Ayodo, May 6, 2010). According to the Hass Property Index, the asking price of sellers rose by 7. 8 per cent in the first quarter of this year. The increase was mainly driven by upmarket prices by some short-term owners seeking profits through price hikes on apartments bought for speculative investment (Ayodo, May 6, 2010). Rent in Nairobi’s Real estate market have shown an interesting pattern.

Findings by the Hass Property Index report for the first quarter of 2010, released in mid April, indicated that rents for the market has stagnated over the last three years (Hass Property Index, cited in Morris, April 27, 2010). In the latest list of growing indices of Hass Letting Index (which tracks rental trends) rent for residential apartments stagnated in the last three years, dipped in the second quarter of 2009 and rose again marginally in the first quarter of this year (Hass Letting Index, cited in Morris, April 27, 2010). The Index showed that asking rents (what property managers ask tenants to pay when they advertise) at the close of last year was at the exact same level as they were at the start of 2007.

Arum says rent in up market areas continue to increase as investors require high rent yields to pay high mortgage rates (Ayodo, May 6, 2010). According to Ayodo (May 6, 2010) a sample of the Nairobi residents were reported to have resided in areas and houses lower than their preferences. Someone who targeted Kileleshwa or Riverside ended up in South B, South C or Imara Daima. However, following a market correction experienced recently, this group of Nairobi residents are contemplating to pursue their dream homes and places of residence. For the last three years, high-end apartment prices have more than doubled, while rental prices have stagnated, meaning that rental yields are falling.

This is according to Jenny Luesby, a consultant who is behind the Hass Property Index (Morris, April 27, 2010). According to property experts, Kenya’s high-end apartment rental yields are now adjusting to international standards. In 2007 for example, rental yields from apartments stood at 15 per cent to 20 per cent. Latest figures indicate that it is now below 10 per cent against most markets averaging two per cent to six per cent (Morris, April 27, 2010). Real estate analysts say the trend in Nairobi’s REM is good news to middle income earners, as developers are likely to shift tact and focus on providing fairly priced middle class housing units (Morris, April 27, 2010).

Demand for fairly priced middle income residential units may pick up again, as the year unfolds, the economy recovers and more people save and invest in long term projects such as housing and developers look at middle class housing where there is demand (Morris, April 27, 2010). 2. 5. 4 Mortgages and interest rates. Interest rates, also, have some effects on the REM. In the first quarter of 2010, most banks have been reducing their interest rates so as to encourage borrowing and boost economic activities. For example, Kenya Commercial Bank (KCB) chief executive officer Martin Oduor-Otieno recently announced a reduction from 15 per cent to 13. 5 per cent. (Ayodo, May 6, 2010). Economists say prospective investors may take mortgage and invest in real estate, possibly reducing rent further.

However, there could be a general boom in real estate especially if the current demand for cement is anything to go by (Ayodo, May 6, 2010). Cement production rose by 18. 1 per cent in January compared to the same month last year reaching 292,769 metric tonnes and growth in cement production has been gradual but steady through the years, reflecting increased economic activity (Central Bank’s Monthly Economic Review, February, 2010, cited in Ayodo, May 6, 2010). Mortgage financing is on the rise because commercial banks now offer facilities of up to 100%, and new regulations from the Retirement Benefits Authority (RBA) allow pensioners to leverage up to 60% of their benefits as mortgage security (Ratio Magazine, November 23, 2009).

Ratio Magazine, November 23, 2009, identifies that real estate investment inflow from the diasporas that had increased by 80% from 2004 to 2008 and driven property values up have since declined as a result of the global crisis. It also recognises that Somali pirate cash has contributed to the boom in Real estate market in Nairobi. Land price now amount to an often prohibitive 50% of development costs and  cost of building materials is up, for example  steel by 110% since 2002 (Ratio Magazine, 23 November 2009). According to ratio Magazine, 23 November 2009 issue, despite input cost challenges, demand continues to far outpace supply in most real estate sectors, increasing market stability and potential returns for investors.

The stringent measures adopted by mortgage financiers could have played a role in the twist of events in Nairobi’s REM (Ayodo, May 6, 2010). The standards ensured that prospective investors seeking loans to buy houses were screened to reduce incidences of loan defaults, thus affecting financing. 2. 6 Kenya’s Real Estate Market Debate Some local estate agents and property managers deny evidence that a boom exists while many of the country’s property speculators are talking up all the evidence they can find to prove to the wider world that the Kenyan property sector is actually the place to be right now for maximum gains and profits (Property Kenya, 2005). In Nairobi demand for property is intense, causing a mismatch between property demand and supply.

Upmarket areas of the city have seen property prices increase by up to fifty per cent in the last two years alone (The Hass Consult Property Price Index, 2009). Marketers are using this fact to prove their argument. Property in Kenya is booming – price growth is intense and the rental figures being charged for some of these properties in the most desirable areas are on a par with major cities around the world (Property Kenya, 2005). A contrary argument is that because the increase in property prices is limited to certain areas of the country and is only benefiting the higher income sectors of society, it is being argued that this cannot constitute a boom.

A true boom would positively affect the lower, middle and upper end of the market investments made into certain parts of Kenya and Nairobi will net their owner impressive rental yields and a good level of annual growth. However, investment made into real estate in some parts of Kenya and Nairobi may not be affected by the boom’s wave and not yield maximum profit. Therefore, real estate investment rental yield and capital growth returns (as with any emerging real estate sector in the world) depend on the investor’s due diligence on which areas of the country actually have the necessary demand to sustain profitability (Property Kenya, 2005). CHAPTER 3: RESEARCH METHODOLOGY 3. 0 Introduction

A research design is simply the framework or plan for a study used to guide in collecting, analyzing and interpreting the data, (Mouly, 1978). It ensures that the study will be relevant to the problem and that it will use economical procedures. There is never a single standard correct method of carrying out research but rather there are many research designs frameworks which can be designed into some basic types. One useful classification is in terms of the fundamental objective of the research e. g. exploratory, descriptive or causal. 3. 1 Research design This study was a descriptive study that researches the impact of global financial crisis on real estate market in Nairobi.

The descriptive study was also longitudinal study, so as to capture the trend in the real estate market. The trend considered was that of fundamental variables of real estate market. The variables are: (1) House prices, house inventories and sales of new and old houses (2) rents and vacancy rates (3) mortgage applications, mortgage amounts, mortgage Interest rates and mortgage default rates. 3. 2 Population The population of interest for this study comprised of all mortgage firms and banks operating within Nairobi. Nairobi was selected as the case study because it has the most vibrant real estate market in the country’ and therefore it clearly captures how real estate is dependent on the global financial condition.

Also, this made it possible dealing with the challenge of accessibility and limitation of research resources such as time and finances. These real estate firms and commercial banks were first selected through judgmental sampling which yielded a sample of 27 real estate firms and 20 banks. These samples were further sampled through simple random sampling in order to come up with representative sample used in the study. The sample consisted of 15 real estate firms and 10 commercial banks. Residential property information as opposed to commercial property information is the data that was collected with respect to house prices, house inventories and sales of new and old houses.

At this point, properties that are not typical and may distort the series were also removed from the data set collected. The most significant exclusion is of properties where ‘development potential’ is factored into the pricing, being older properties with land of more than half an acre where zoning permits further development. The property index excludes properties where prices contain a development potential premium. However, this was an issue with Lettings which include all property types. 3. 3 Data collection The study made use of both primary and secondary data. Primary data was collected using both open ended and close ended questions, which were first pre-tested.

The questionnaires were self administered questionnaires. The questionnaires were in two sets; one set was designed for real estate firms while the other was designed for commercial banks. The questionnaires consisted of four sections. Section one helped to gather bio-data of respondents. Section two captured data about house prices, house inventories and sales of new and old houses. Section three captured data about rents and vacancy rates. Section four captured data about mortgage applications, mortgage amounts, mortgage Interest rates and mortgage default rates. The questionnaires were administered through “drop off and pick later” method.

This method allowed the respondents to complete the questionnaires on their own free time and allowed the researcher to build up initial commitments and “check-up” on the responses. They were administered to the head of quality and assurance department of the firms under consideration to ensure that respondents interpreted the questions correctly, leading to more accurate information. Data collected was on the fundamental variables in the real estate market. The variables are: (1) House prices, house inventories and sales of new and old houses (2) rents and vacancy rates (3) mortgage applications, mortgage amounts, mortgage Interest rates and mortgage default rates. So as to collect data on house prices, house inventories and sales of new and old houses, the houses were categorized in to three categories.

These are bungalow/ maisonettes/ flats, medium size houses and small size houses. Location of the houses was also categorized into up end market, middle end market, low end market and the Central Business District (CBD). Secondary data was sourced from the internet, books, newspapers, journals and economic reviews. The questionnaires were tested for completeness and consistency and later coded to classify responses into meaningful categories to enable the data to be analyzed. 3. 4 Data analysis The fundamental real estate market variables were then analyzed through a comparison of their quantitative results in the years 2007, 2008 and 2009 with the data results in the year 2006 (the base year).

The variables were also analyzed through a comparison with the respective USA’s real estate market variables. REFERENCES Acharya V. et al. (2009). The Financial Crisis of 2007-2009: Causes and Remedies. Archarya, V. V. , & Richardson, M. (2009). Restoring financial stability: How to       repair a            failed system. New York: Wiley Finance. Barro, R. J. (February,  2009). Stock-Market crashes and depressions. NBER Working Paper No. 14760. Bartlett, D. (April 2, 2008). Fallout of the global financial crisis. Brenner, R. (2006). The economics of global turbulence: The advanced capitalist economies            from long boom to long downturn, 1945-2005. London: Verso. Brueggeman W. , & Fisher J. (2008).

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New York, NY:            Random House Inc. The Hass Consult Property Price Index. (2009). Property sale prices stabilize, as asking            prices correct to lower level. Ullah, S. , Malik, I. N. , Azam, K. , & Marwat, A. K. (2008). The impact of recent       global            financial crisis on the financial institutions in the developing countries: The need for           global solutions. Wikipedia. (n. d. ). Subprime mortgage crisis. Wong, L. (2009). The crisis: A return to political economy? Critical perspectives on            international business. Vol. 5 Nos 1/2, pp. 56-77. Y? lmaz, K. (2008). Global financial crisis and the volatility spillovers across stock markets.

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