Tuesday,June 02,2020 17:27 PM

Real estate has pronounced medium risks

By Admin

Added 30th June 2017 11:09 AM

Contrary to the long term recoverability of real estate, over 60% of the cumulative private investments are in buildings and structures.

Real estate has pronounced medium risks

Contrary to the long term recoverability of real estate, over 60% of the cumulative private investments are in buildings and structures.

'Real estate sector sound but has pronounced medium risks especially for urban areas'

By Enock Nyorekwa Twinoburyo

Three years ago, a colleague as old as Uganda's life expectancy (63 years) approached me for advice on his rental units business that was fetching him about sh30m in monthly revenue.

However, according to him the occupancy levels were averagely 10 months per year.  I then advised him to sell his property and at a price 10 times his annual rent revenue. He eventually sold at sh3b. I further advised that he invests in government securities (bonds and bills) as the rates were bound to increase since government domestic borrowing was on the rife.

In fact nearly sh5 trillion of government securities have been issued in the last three years and nearly sh1 trillion to be issued in FY 2017/18. Also owing to upward periodic surge in inflation, the Central Bank usually reacts by increasing the Central Bank Rate thus fostering an increase in other short term interest rates including the treasury bills and bond rates. Long story short, his annual his net annual return has averaged between sh360m - sh400m.

Looking at the rental units buyer's perspective, it will take them about 20 years to have a breakeven. With an assumed annual income of sh300m-sh360m, it will take new owner about  10 years to recover the current face value of UGX 3bn which then will be will be of much less value.  Contrary to the long term recoverability of real estate, over 60% of the cumulative private investments are in buildings and structures.

One of the obvious reasons is that the return on real estate (inflation) will remain favourable. Contrary also to the law of demand, when real estate prices increase, the demand tends to also increase in anticipation that prices will rise in near future.

The vibrancy of real estate activities has been backstopped by the notable increase in share of private sector credit allocated to Building, Mortgage, Construction and Real Estate from 17% in 2009 to 22% in 2016, surpassing trade as the largest share of the private sector credit.

The foreign currency loans to construction sector continued rose at a faster rate - accounting for 28% all total foreign currency loans.

However, the recent trends are indicative of slowing economic activity. Over the last 6 years, economic growth the leading indicator of economic vibrancy has been short of its historical average rate by 2-3 percentage points.  Growth is expected to reach to be 3.9% in FY 2016/17 (the second lowest growth rate since the early 1990s).

Slow growth trends mean subdued demand and have implications on some segments of the economy particularly the real estate sector. 

The real estate activities have remained stagnant at 5.2% of GDP over the 2009-2015 period implying  that its growth has been commensurate the slowing growth rate of the economy. However, the construction sector growth has slowed from over 11% in 2009 to just 4% in 2015 despite the increased government infrastructure expenditure. The latter illustrates the weak local activity in the large infrastructural projects.

In 2016, the size of non-performing loans on the commercial banks books enlarged rapidly reaching 10% of gross loans - with largest share (21%) recorded in the building and construction sector.  The risks were more pronounced for foreign exchange denominated loans largely underpinned by the   depreciation of the shilling against the USD that has averaged 8% p.a since 2010. 

In principle, when the real estate prices grow faster than economic growth, it becomes hard to sustain the bubble. The Bank of Uganda compiled real estate indicators for greater Kampala (Land Price Index and Rental Property Index) though not recently updated -  indicate that the prices have increased and rapidly except for Kampala Central where they reduced. 

The bubble has seemingly burst for commercial properties, as the commercial property index show that the prices have reduced by 25% points between December 2012 and September 2015.

In conclusion, the real estate remains largely informal, unregulated, over priced in urban centres  and marred with information asymmetry which factors underscore structural challenges and long term risks to sector.

Regulatory reforms especially in land subsector are expeditiously warranted. Remember land is a primary factor of production.

The writer is an economist and a PhD Research Fellow - University of South Africa


Related articles

More From The Author

More From The Author