Kenya's construction sector to make a comeback after a period of slower economic activity

The domestic real estate environment in 2017 was shaped by slower economic growth as compared to 2016, stagnating prices and shifts in the retail scene. The Kenyan property market experienced strong performances in 2014-16, with high occupancy seen in the office segment, in particular. However, both commercial and residential real estate activity declined in 2017, with marginal performance rebounds seen in the first half of 2018. The slowdown was attributed in part to the high volume of new office buildings and shopping malls that were completed during the year, leading to an excess of available space for let and an uptake rate that was slower than expected at prevailing prices.

In the residential segment, the high-end market was affected by oversupply, which led to more bargaining power on behalf of renters, as well as multinational companies trimming budgets and professional expatriates – a large share of renters in this tier – relinquishing their units. Luxury high rises have continued to come on-line, but in December 2017 the government placed the spotlight on the affordable housing segment through its Big Four agenda. The plan lists four priorities laid out by President Uhuru Kenyatta for his second five-year term in office. These are affordable housing, food security and nutrition, expanding manufacturing and universal health care. The government has committed to building up to 500,000 affordable housing units by 2022, a goal that will require buy-in and investment from various private sector developers.

Market Structure 

Real estate players in Kenya are highly experienced and market volumes are dominated by affiliates of international players, including Knight Frank, Broll Africa and Axis Real Estate, formerly CB Richard Ellis. There are also a number of individuals operating as independent real estate agents. The industry is regulated by the Estate Agents Registration Board (EARB), a statutory body that enforces the Estate Agents Act (Chapter 533) of 1984. The EARB maintains a publicly accessible database of all individual registered agents and property valuers, providing the registration number, qualifications and address of each person.

While the real estate market as a whole saw a weaker performance in 2017 – largely due to excess supply, softening demand and, to a lesser extent, a prolonged election season that brought a wait-and-see approach – each segment was shaped by its own factors. The real estate market is divided into commercial retail, commercial industrial, office space and residential.

Commercial Retail

The retail scene in 2017 was marked by the opening of Kenya’s largest shopping complex, the 65,000-sq-metre Two Rivers Mall in the Runda suburb of Nairobi. The February 2017 addition is part of a KSh25bn ($244.9m) mixed-use development by the Two Rivers Lifestyle Company, a partnership between OMP Africa Investment Company, Centum Investment Company and the Aviation Industry Corporation of China. Two Rivers is just one of several shopping malls completed between 2014 and 2017, greatly increasing the retail space available in the country. A local media article published in October 2017 highlighted the fact that many newer, less-established complexes in the oversupplied environment are struggling to secure tenants, and malls were further being influenced by a slower economy and reduced consumer spending.

Another significant event of 2017 came when supermarkets Nakumatt and Uchumi began shuttering various locations due to liquidity issues. The closures, which have continued for both brands in 2018, have impacted commercial retail locations by leaving large spaces to be filled, particularly in malls. Recent entrants such as French supermarket giant Carrefour and South Africa’s Shoprite have stepped in to secure the space left by the brands at certain high-end Nairobi locations, such as Junction Mall, Sarit Centre, Westgate and Garden City. The gap at some lower-end sites, meanwhile, is being filled by other local grocer chains, such as Tuskys.

While Nakumatt and Uchumi are scaling down operations, other companies are either growing in or entering the Kenyan market. The first half of 2018 saw local expansion for South Africa’s Game market chain, while Japanese lifestyle brand Miniso opened its first Kenyan location at Nairobi’s upscale Village Mall in January 2018.

Industrial

The market for industrial real estate in Kenya is relatively small, and has historically comprised of mainly lower-specification warehousing sites. However, in recent years there has been higher demand for quality storage space, such as refrigerated facilities, and developers are expanding operations in this area.

Indeed, 2017 saw a rise in development activity for logistics parks, according to reports by Knight Frank, catering to industrial expansion. African Logistics Properties, for example, secured $35m in investment from the Commonwealth Development Corporation and the International Finance Corporation to begin a KSh6.2bn ($60.7m) project to construct 50,000 sq metres of grade “A” logistics space at Tatu City. Launched in June 2017, the facilities are part of an upcoming mixed-use project there that was designated as a special economic zone the month prior. Over 60% of the space was pre-let to businesses by mid-2018. Improvon of South Africa has stepped in to meet growing demand as well, agreeing to develop the 42-ha Northlands Commercial Park in September 2017. The space will serve growing warehousing and distribution needs, and is situated along the Eastern Bypass in Nairobi.

Office Space

While many companies seek logistics facilities, almost all need office space. The office segment’s performance is primarily shaped by activity around Nairobi, which has four main business districts: the old Central Business District; the Westlands, home to telecoms firms and many medium-sized companies; Upper Hill, the financial district where most banks and other financial service institutions are headquartered, including the local office of the World Bank; and Kilimani, which is dominated by multinational companies.

In general, office space in the city is greater than demand. According to a March 2018 report by Cytonn Real Estate titled “Constrained Performance as a Result of Oversupply”, over the course of 2017 some 325,000 sq metres of new offerings was completed in the capital. Available space that year was 585,300 sq metres against demand of 148,600 sq metres, with the low demand attributed to a slowing economy, multinationals downsizing and the prolonged election period. The uptake of new supply has been slow, and overall occupancy sat at 83.2% in 2017, compared to 88% in 2016.

Vacancy rates are particularly high in Upper Hill, according to Knight Frank, partially due to the area being poorly served by road networks, with the only major artery into and out of the area causing serious congestion during rush hour. Aware of this issue, in 2017 the government began the second phase of road upgrades in Upper Hill. Under this KSh3.5bn ($35.3m) initiative, several roads will be widened to become dual carriageways, facilitating traffic movement. The work is expected to be completed in December 2018.

Despite oversupply, construction of new office developments is continuing. In March 2018 work began on Garden City Business Park, the next phase of a mixed-use development built by UK private equity firm Actis on Thika Road. The park is a KSh54bn ($529.1m) development with 25,000 sq metres of grade “A” office space that is expected to be completed in 2019. Committed tenants include East African Breweries, which is set to take up 60% of the new office space.

Residential Market

When it comes to residential space such as apartments, semi-detached homes and detached houses, the market is divided into three broad segments: high-end, middle market, and low-income or affordable housing. The high-end segment experienced a downturn in occupancy in 2017 due to less demand from expatriates whose companies were scaling back operations, according to Knight Frank, which resulted in softening rents and sales prices as well. In the first half of 2018, however, rental and sales activity in the segment rebounded to some degree, with buyers and renters returning to the market after the elections. This includes heightened demand in areas of Nairobi such as Karen, parts of the Westlands and many northern suburbs where homes are valued between KSh100m ($980,000) and KSh150m ($1.5m). The middle market, meanwhile – homes priced between KSh15m ($147,000) and KSh25m ($245,000) – saw a general softening in occupancy rates in 2017 to as low as 80% in some areas, down from the 2015 peak of around 95%.

Affordable Housing

Affordable housing, for its part, is not defined by a specific sales value, but industry stakeholders and government officials provide a price range from KSh3m ($29,400) to KSh8m ($78,400). This segment of the market has historically been underserved by private developers, as it offers limited returns. However, the inclusion of affordable housing in the Big Four agenda and the state’s commitment to build 500,000 new low-cost homes over the coming years is expected to reorient developer behaviour. In launching its initiative, the government selected 35 private developers in early 2018 to undertake a pilot project to build over 8000 affordable units in Machakos County. “Public-private partnerships (PPPs) allow for innovation, efficiency gains, access to additional capital, and enables the government to undertake projects it would not necessarily have the funds or expertise to pursue on its own,” Stanley Kamau, managing director of the Public Private Partnership Unit, a body within the National Treasury, told OBG. “The key advantage of PPPs is that they enable critical projects to be built with the efficiency of the private sector and with the interest rates that come with government involvement.”

Tackling Costs

A key factor to meeting state goals is making affordable housing projects financially attractive to developers. The most expensive line item in developing housing is land. The government is the primary owner of undeveloped land suitable for housing, thus there is an opportunity for the state to stimulate the low-income housing segment by providing free land to private developers. Charles Hinga, principal secretary of the Ministry of Transport and Infrastructure, told local media in August 2018 that the government had set aside 3035 ha of serviced land on which developers would construct low-income units. To facilitate development, the government has also implemented systems to enable online land transactions as well as automated online payment for stamp duty.

Land use constraints imposed by local councils can also drive up development costs. These can include limiting the height of new buildings and the physical footprint of a building on a plot of land. “Globally, land accounts for between 20% and 30% of the total cost of a new development. However, in Kenya – and in Nairobi in particular – this can be up to between 70% and 80%,” Robert Gichohi, director of projects at developer MML Turner & Townsend, told OBG. “The high cost of land and zoning requirements therefore render many otherwise worthwhile projects commercially unviable, particularly in the construction of affordable housing.”

Beyond the issue of land, various incentives are in place to help private developers with overall costs and encourage their participation in the lower-income segment. These include the 2016 reduction of the corporate income tax rate from 30% to 15% for companies that build at least 400 affordable homes per year.

Party Financing

While the government releasing state-owned land and offering tax incentives has helped to ease the financial burden on developers, stakeholders have adopted other practices that limit real estate firms’ capital outlays. There is an increasing trend of joint ventures between landowners and property developers, were the landowner transfers title of the land to a special purpose vehicle (SPV) that is capitalised by the property developer. The developer is then responsible for building on the property, and sale and rental proceeds are distributed to both parties through the SPV. “The key benefit of these joint ventures is that you do not put a lot of capital into buying land, rather much of the capital can be spent on developing the property,” David Abuoro, project manager at development firm Home Afrika, told OBG.

The buyer, meanwhile, typically finances his or her purchase with a mortgage from a bank. According to a survey by the Central Bank of Kenya, the number of active mortgage loans in the country at the end of 2017 was 26,187, up 8.8% from 24,059 in December 2016. The value of such loans increased from Ksh219.9bn ($2.15bn) to Ksh223.2bn ($2.19bn) in the same period. Institutions surveyed by the central bank ranked various constraints on mortgage market development, with the top factors being the high cost of housing, expensive land for construction, high incidental costs and difficulties with property registration.

Outlook

The real estate sector experienced a slower year in 2017, with softening prices for prime residential and commercial properties. However, the outlook is brighter for the short-to-medium term, due to the government’s commitment to housing and the post-election resumption of normal commercial activity. Still, undertaking additional new projects will be contingent on developers seeing improvements in rental and sales returns, as well as access to more innovative financing options that offset the high cost of securing land.