Low rental income removes the shine from residential property

Static rents and the continued climb in house prices has eroded rental earnings for new landlords, causing a market shift that may slow down investments in real estate.

The latest property index data indicates that at current rental yields - being the return in rent on the capital tied up in a property - any new landlord buying property to rent out is set to earn less income than the interest costs on their mortgage.

The HassConsult property index data that was released on Wednesday indicates that rental yields have now crept downwards to a low of 5.62 per cent a year.

The returns, however, still compare well with other investment options such as the bonds market for investors buying houses with cash, but are down substantially from the 2007 rental yield peak of 7.3 per cent.

The Hass survey on the residential housing market shows that property prices have risen 55 per cent in the past three years while rents have risen by about 18 per cent over the same period thinning out returns on investment.

The depressed rental yield are being attributed to increased supply of apartments and townhouses in the past couple of years as developers rushed to provide high density housing to maximize returns while buyers’ preference shifted to stand alone units.

Composers of the property index said that current lifestyle desires are fuelling demand for stand-alone houses that have reported the highest gains on both value appreciation and rent income since 2009.

“We would like to signal all developers to take great care when deciding to develop more apartments and maisonettes, particularly in the outer areas of Nairobi,” said Ms Farhanna Hassanali, the property market analyst at HassConsult.

The near-stagnation in rental incomes come at a time when lenders have stepped up activity in the real estate market targeting young professionals who cannot buy property on cash basis.

New demand for purchased homes has, for instance, seen the price of a three-bedroom residential house in Buru Buru estate – a middle income area – double over the last five years, from Sh3.5 million in 2006 to Sh7.4 million, while the monthly rent has only climbed by a quarter to Sh25,000.

That means a buyer, who took out a 15-year mortgage in 2006 and paid a 10 per cent down payment currently needs a Sh19,000 top up to the rental income to settle a monthly repayment of Sh44,000.

Any buyer taking a similar home loan today would need at least Sh65,000 to top up to the rental income to settle the monthly repayments even after placing a 10 per cent down-payment.

An investor who bought a similar home cash to live in would however have grown their wealth by 94 per cent.

A similar house that cost Sh2 million in Mlolongo in 2006 is now selling for Sh5.5 million, while generating Sh15,000 as monthly rental income compared to Sh8,000 then.

In South C, selling agents say that a similar house cost about Sh5 million in 2006 and attract a monthly rental income of Sh23,000 but is currently selling for about Sh9.5 million while attracting about Sh35,000 in rent.

These developments have turned property into an important asset class among high net-worth institutional and individual investors, pretty much like stocks and bonds, able to offer attractive returns.

A study by Stanbic Investment Management Services revealed that property outperformed all other asset classes in the 10-year period to 2010, with residential property appreciating by more than 3.5 times.

Investors who put their money into equity at the Nairobi Stock Exchange reported only 2.8 times appreciation and have been unable to recover to the pre-credit crunch levels.

Development

In the more recent past, surging property value has sucked in companies, whose core business was not in property development but have now committed billions to the development of mega housing projects.

Among them is British-American Investment that has announced plans to diversify into residential property development using proceeds of a planned initial public offering later in the year.

Others include Centum, a listed investment company that is investing more than Sh2.5 billion on two separate developments and UAP Insurance.

The situation points to how the strong growth in property prices has made mortgage financing a less attractive means to acquire a residential property with the anticipation to rent it out and make a decent return.

Pamela Onyambu, a co-director at Easy Properties, a private development firm says rental yields are bound to decline even further since prospective home buyers are currently tenants.

She said that the demand is currently strongest in the middle income segment, individuals who are likely to acquire their homes through mortgage financing, at least according to the statistics from the first phase of a 712-unit estate her firm is building.

“The first phase of our estate was sold out mostly to young families who bought to live in,” she said adding that “the rental income here cannot sustain a mortgage repayment.”

Developers are however able to finance their developments using bank loans since the turn-around period is much short as they are able to recoup their investment once the units are sold, which she says are fully paid up for at the time of completion.

Ms Onyambu says that there exists an opportunity for investors who want to buy homes with the intention of selling them since excess demand for housing is set continue pushing property prices.

New developments in middle income estate like Donholm are already taking the steam off the soaring rents, with the developers asking the same prices as the older apartments, an indication that the stagnated rents are infiltrating into middle income settlements.

Ms Hassanali said that the local property market is likely to generate much lower growth rate in rental incomes because the Kenyan market is more expensive than most markets in the developed economies considering the income levels.

“What we are experiencing is a correction since the rents in this market are generally higher than in most developed markets relative to the average income levels,” said Ms Hassanali.

The survey covers properties in upper middle to the higher end segments of the housing market showed that the selling prices rose more gradually in the first quarter of the year compared to the preceding one, a pointer to a slowing down of asking prices.

Sharp gains in property values were reported on stand-alone houses especially in the middle income segment which now cost up to 18.8 per cent more as compared to the first quarter of last when where rents have appreciated by about 10.5 per cent.

But even as the stand alone houses recorded the strongest performance across the property classes, the price appreciation still overshadows the growth in rental income.

HassConsult estimates that the stand-alone houses will attract strong growth as individuals adopt to new lifestyles that offering more privacy than the apartments and marionettes.

Nathan Luesby, the managing director of Property Leo said that the rising cost of land will continue to propel property prices, and more-so for stand alone houses, predicting that this factor will pile more pressure on their pricing going forward.

“Developers will have to recoup the higher cost of land by passing through the increased cost to the end buyer and this is expected to keep prices rising,” said Mr Luesby who added that should land prices continue spiraling upwards, it might be unsustainable to buy it for development of housing.

The worst performing property type in the quarter to March are town houses  which despite their prices going up by an average of 2.1 per cent, the attracted diminished rents- a situation that had been reported in apartments last year.

Investment managers at the ICEA asset management attribute the low rentals to increased supply of units in the middle and high-end housing market over the past decade that has outstripped the rate of expansion of the country’s middle class.

While rentals have slowed down, property value has continued to climb, implying that one is better off targeting capital gains though one has to be careful on the type of property, as apartments have shown weak demand both on sales and rentals.

“Investors are better of buying homes to sell than to let since there is still strong demand for ownership which will propel their value,” said Susan Mbatia, an investment manager in a recent interview.

Analysts say that the decline in rents is a global correction trend that comes in the wake of a long-running bull run in property development but increasing prices will be supported by the excess demand.