Loans can be traced as far back as the days of Christopher Columbus, the man who discovered America in the 14th century.
Columbus made his voyage towards the Indies after he got a loan with backing of Queen Isabella of Spain in the form of royal jewels to finance the trip.
In 2008, America experienced its most painful financial markets turmoil after the housing bubble-bust alongside an energy crisis, sending the economy into a recession.
The housing bubble grew in the wake of President Bush’s tax cuts that were introduced to increase disposable incomes of households.
The Bush government, under the stewardship of Allan Greenspan at the Federal Bank, also kept interest rates low to rescue the US economy from the threat of recession that it was facing.
Mortgage lenders dished out money to the point that they were no longer interested in the borrower’s ability to pay, sending the market into a crash.
Since then a slight property boom in any economy has always caused jitters of an impending bust. In Kenya, many analysts have warned of an imminent housing bust, which actually is erroneous to say the least.
Kenya’s property market is the third most developed in Sub- Saharan Africa behind Namibia and South Africa. The mortgage market is said to have increased from 7,600 accounts in 2006 to 20,000 homes in 2012, a figure that remains upstanding to date.
Since 2012, Kenya has experienced an economic slowdown in the housing market, a reduction of home purchases and an increase in home loan default rates attributed to an increase in interest rates in 2011.
To understand the economic dynamics in this market, one has to separate the short run and long run segments of the market.
The short run prognosis is that our housing market is facing a slow-down and not a bubble with an imminent bust.
High interest rates and low disposable incomes have been mentioned as the main bottlenecks to home loan affordability.
The long term predication is that the property market promises increasing return to scale despite its decreasing returns in the short run.
According to a 2011 World Bank survey, only about 11 per cent of Kenya’s population earns enough to support a mortgage meaning most middle income earners are out of the mortgage market.
A survey by The Mortgage Company in 2014 established that only a fifth of Kenyans living in urban areas can afford a home loan priced of Sh1 million and above.
The study also found that at least a quarter of Kenyans living in urban areas can afford a Sh2 million mortgage out of the country’s nine million households.
The current economic slowdown in the housing market is not because houses are unaffordable due to high interest rates but is because of lack of demand — the majority of the middle class prefers instead to rent houses.
Many analysts have incorporated the short run and long run demand into one entity as forces that are driving growth in the market.
Demand drivers in the short run are the potential home loan borrowers with the ability to service their loans through a sustainable disposable income and not anyone with a pay slip who wishes to own a home.
Majority of the urban middle class has a constraining disposable income not solid enough to service a home loan in the long term.
Even if interest rates are lowered many will still not meet the affordability threshold. The reason mainstream mortgage lenders have maintained high interest rate margins is to maximize profits in the absence of slow demand growth.
So to increase demand of home loans, household incomes must increase and interest rates stay where they are or go down.
If interest rates are to come down without an increase in households’ disposable income, the possibility is that prices of rental homes will sharply come down.
As long as the price of homes exceeds the marginal cost of building, developers still have an incentive to keep on building new housing units.
Building new houses
But the developers will still not be able to sell their units because only a few of the middle class will qualify for home loans when interest rates go down, forcing them to convert their units on sale into rental homes.
The real estate sector boom will persist, home developers will make profit with the existing demand as they await a market take-off where majority of the middle class will be able to afford home loans.
The housing boom will come to an end when returns on property investment diminish to the point where there will be no profit in building new houses.
A market bubble does happen from the demand side of the market where investors stampede in a scramble to tap into the future. That future must be characterised by a steady rise in prices.
The dot.com bubble-bust is an example but let us use the US housing market.
Mortgage banks decided to put the prices of home loans on steroids when they realised that default rates were robustly growing after issuing loans without checking borrowers’ ability to pay.
They created an artificial demand by slicing up mortgages and glueing them back together into structured products called “Residential Mortgage-Backed Securities” before selling to other financial institutions that often had no idea what it contained.
The dynamics driving investment changed, prices were out of the markets’ control and home owners now depended on the prices going up forever so as to pay their mortgage.
That way they could either sell and plow the profit into a new property or refinance at a higher price and pull “equity” from their home to make ends meet.
We will have a housing bubble in Kenya when the majority of urban middle class will have sustainable disposable income to service home loans, but for now we will continue to have a housing boom with slow growth.
If we are to say we are experiencing a housing bubble then basically everything in life is a bubble-bust.