The Time Bomb at the Heart of the Kenyan Economy

For a number of years now, we have been warning that Kenya’s real estate (land and housing prices) are overblown – out of all proportion to the underlying value of the land, and increasing at a rate that cannot be explained by rational economics. While, indeed, the economy has grown – and with it demand for housing and land for commercial and industrial activity – the rate of increase in real estate prices is at many multiples of this growth, meaning that it has become unmoored from any reality. For being Jeremiahs in an industry that has made many lots of money, we have been called names and told to stick to our lanes. However, I have realised that our jeremiads were not alarming enough, and we were looking at this issue very narrowly. It is much, much more serious than I first thought, and the implications to the economy could be very grave; much more serious than any election-related downturn.

You see, I have been discussing this issue from a purely retail level (see http://unquietafrican.blogspot.co.ke/2014/09/have-shoeshineand-350-million-bob.html and http://unquietafrican.blogspot.co.ke/2016/07/kenyas-property-market-is-bubble-and-it.html). But zoom out from the rejareja to the macroeconomic level, and you can see the massive time bomb sitting at the very heart of the Kenyan economy.

Nearly every large collective fund in Kenya (pension scheme, insurance investment, bank holdings, saccos) has land and real estate as a significant portion of their asset mix. Partly because land and real estate have been increasing in price so rapidly, and because these are tangible assets (a sacco can show members the buildings it owns, or a piece of land that they can subdivide to members), they tend to be a preferred investment and store of value.

There is nothing intrinsically wrong with this, except for one thing: most of these regulated funds are legally obliged to re-value these holdings every year, and for these values to be included in their books. Land valuers, in turn, go ahead and issue values that inexorably rise (sometimes at double digits), regardless of whether these new values are anchored in actual, realisable transaction values. I know many pension schemes and insurance companies which have land holdings which have tripled in value just, in effect, sitting there. The problem is that these values, which are only book values and many times unconnected to realisable prices for these land holdings, are then used to generate actual transactions. Saccos will calculate their returns based on revaluations and pay dividends to members; banks will issue real money in loans on the basis of the stated value of a parcel of land; pension schemes will pay out to retiring members based on the rise in a member’s pension holding, which includes the valuation of land held by the scheme. At the centre of this, though, is a value that is often only arbitrarily decided, and which will not be realised because it has no relation to reality.

This is not theoretical. At a conference I was at recently, an industry regulator told us of a piece of land valued at 600 million shillings an acre that had sat on the market for more than three years. Every year, the valuation of this land would go up (and, presumably, its price) while there had been no buyer willing to purchase it at this (inflated) value. Yet the fund manager continues to reflect this inflated value on its books, and undertake all sorts of real transactions with real money based on it. In effect, hard cash is changing hands based on valuations which might as well have been pulled out of thin air.

This is a potentially catastrophic issue for the economy. If the value of land holdings on many institutions' books is inflated (and to what level, I’m not sure anyone knows), then is there sanctity and solidity to these books? This includes, as we said, banks, pension funds, insurance companies and saccos. Basically, the entire financial industry may be sitting on assets whose true value is unknown, but is making tangible decisions based on these stated values.

Can anything be done about it? Yes (because I am an eternal optimist). First, the overheated real estate market needs to be cooled down. It will be difficult to do, socially, economically and politically. Proper bases for real estate valuation exist and should apply in Kenya. Second, it may actually be prudent to legally understate the value of land holdings on one’s books (a corollary to the ‘underpromise and overdeliver’ adage). Perhaps only reflect asset prices in one’s books if there is proof that these prices can be realised. It does require a change in mindset (sacco members will not be very happy when their dividends are lowered because the value of their holdings are treading water). Ultimately, though, the ball is in the court of regulators and the government – if this is indeed a bubble, and it bursts, there will be lots of blood on the floor of the Kenyan economy.