Real estate market shifts in favour of office space owners

The Green House, which is one of the new buildings offering space for businesses at Adams Arcade in Nairobi. A square foot costs Sh40,000 per month. File
The Green House, which is one of the new buildings offering space for businesses at Adams Arcade in Nairobi. A square foot costs Sh40,000 per month. File 

Rising demand for retail business space has left commercial property developers with higher returns on investments than their counterparts in the residential market, the latest industry data shows.

Yields — the difference between the value of a property and the rental income — have dropped across the board, but investors in residential property have been hit hardest because of the high rate at which residential property prices rose in the past compared to rents.

Though rents have been equally sticky in the commercial property market peaking at an average of Sh100 per square feet in the past five years, sale price inflation has been much lower, leaving investors with an average yield of nine per cent compared with six per cent for residential properties.

Ben Woodhams, the managing director of Knight Frank — a real estate management firm — said high office space rents had made buying more attractive to many businesses, keeping the pace of yields erosion in check.

“Rents of about Sh100 per square foot translate to a return of about nine per cent – a great saving for small businesses that want to get away from paying rent,” said Mr Woodhams.

A nine per cent rate of return means investors who are buying office space to let can recover their costs in 11 years or sooner if the rental prices rise.

Industry statistics show that 15 million square feet of commercial property space is available in the local market – nearly the same as the level of demand – meaning rents and ultimately yields are likely to remain stable or increase in that segment of the market in the medium term.

Real estate managers expect a build-up of upward pressure on commercial rents as fast-growing medium-sized companies look for bigger space in key towns such a Nairobi and Mombasa.

Mwenda Makathimo, the managing director at Vidmerck, a property management firm, said demand for retail space has outrun supply especially in Nairobi’s Central Business District, a development he attributes to the rapid growth in the number of small businesses that have converted previous office spaces into stalls.

“Retail space is in short supply especially within the city centre and the imbalance is likely to remain because new enterprises are entering the market every day”.

Average monthly rents for such spaces stand at Sh70 per square foot.

Nairobi’s continued growth as East Africa’s commercial hub is also expected to continue, attracting multinational corporations — raising demand for commercial space and pushing up rental prices.

Knight Frank expects rental yields on commercial property, which have dropped from 10 per cent two years ago, to hold steady at current levels because both valuations and rents have stabilised.

Real estate market insiders said the exodus of businesses from the city centre has created an even pricier ring of commercial space in the upcoming business districts of Upper Hill and Westlands.

Peter Kimeu, the head of projects administration at Housing Finance and a supporter of the Kenya Property Index, said location has emerged as the key determinant on pricing in the commercial property market.

“Commercial space in new office blocks outside the city centre is more costly on average because many businesses are opting to move their premises to quiet locations,” said Mr Kimeu.

Rentals within the CBD have remained nearly static with going rates averaging at Sh90 per square foot, while tenants the office parks have been paying as much as Sh140, he said.

PDM Holdings, which manages IPS and the Nation Centre among other office blocks in the city centre, charges rental prices of between Sh90 to Sh120 per square foot.

Letting price at the International Life House, also in the CBD, stands at Sh85 per square foot but with a minimum tenancy of six years, exclusive of service charge. The same cannot be said of the residential property market where prices started cooling in the last quarter of last year after a dramatic six year rise that nearly tripled values, according to housing surveys.

In the 10-year period to December 2010, rents rose too but at a far much slower pace leaving those who bought homes to let with minimal returns.

Price correction

High interest rates on bank loans and rising inflationary pressure have dealt residential property buyers an even heavier blow, taking real returns to the negative territory.

Sue Muraya, a director at Suraya Property, a real estate developer, said she expected a major price correction in the homes market, saying developers had been overly ambitious in their pricing.

“Most developers have been very optimistic on the pricing of homes but it is clear that a price correction is on the cards.”
Mrs Muraya, terming the Sh25 million price for a four-bedroom apartment in some areas as ridiculous.

Rental prices on such an apartment stand at between Sh100,000 to Sh120,000, meaning that even in the best of times, and assuming full-year occupancy, yields on such property are below six per cent. Buyers of such property must therefore wait for more than 17 years to recoup their investment.

Farhanna Hassanali, the property development manager at real estate firm HassConsult expects residential property yields to flatten out after declining in the past five consecutive quarters.

HassConsult publishes the quarterly property index covering the high and upper middle segments of the housing market, and is expected to release the Quarter Three results in the first week of November.

Mr Woodhams said availability of mortgage facilities had enabled small companies to finance property acquisition without straining their cash flows and positioning them to benefit from capital gains.

Main drivers

“Owner-occupiers benefit from capital appreciation instead of just handing over rent to landlords. They have an asset whose value continues to rise,” he said.

The higher returns on commercial property are seen to be main drivers of the ongoing rapid growth in office blocks and shopping malls in Nairobi.

Prices have risen to as high as Sh40,000 per square foot at the newly completed Green House commercial complex along Ngong Road.