Otieno Odhiambo
The decline in the prices of houses is bad news for the financial
sector, more so if the majority of the...
houses are mortgage-financed.
The evidence of the loss in asset value is deduced from the high number
of assets that are facing the auctioneer’s hammer as announced in the
daily newspapers, specifically in the property and transport sectors.
The first decline in asset prices was witnessed at the Nairobi
Securities Exchange (NSE), where share prices tumbled significantly a
few years back.
SEE ALSO :Housing Finance shuts down loss-making investment unit
In 2018, nearly all the shares in the NSE-20 share index were hit hard.
The securities that lost significantly included shares in big companies
such as Kenya Power, Nation Media Group, Centum Investment, NSE and the
now-suspended ARM cement.
This trend is worrying because companies exist to create wealth for
shareholders and as such, a change in share prices indicates changes in
shareholder wealth.
Last year, moving from lower share prices the previous year,
the NSE experienced marginal improvements in returns for shareholders
from some shares.
Several companies also reported huge declines in annual share returns,
as large as 45 per cent in the case of Bamburi Cement, CIC (26 per
cent), Barclays Bank Group (31 per cent), Uchumi (67 per cent), Kenya
Power (48 per cent) and Nation Media Group (44 per cent).
SEE ALSO :Why 2019 is a year real estate would like to forget
While
the preceding firms have posted a negative decline in share prices,
firms in the financial sector reported a huge improvement in share
returns - Barclays 13 per cent, Equity 27 per cent, KCB 30 per cent and
I&M 21 per cent.
In the financial sector, the expectation is that the earnings of those
firms will respond positively to the liberalisation of interest rates.
For those who use shares as collateral when borrowing, this suggests
that a fall in share price might not adversely impact the balance sheets
of financial institutions.
However, the worry is the undesirable impact of the expected decline in
real property, specifically house prices on the balance sheets of
financial institutions.
If this happens, it will hurt the economy and reduce the quality of life.
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Rent increase
Research shows that house prices are indicators of changes in the
economy. In other words, the change in house prices passes information
about the pending state of the economy.
The value of a house depends on the rent that the tenant pays to the landlord.
In finance, we discount rent in house values, such that when rent
increases, the value of the house must also increase because additional
income is being generated and vice versa.
This means that it is only in unsound economies that tenants are unable
to pay rent thus opening a window for the decline in house prices.
SEE ALSO :How to switch up a boring house
An effective way of monitoring the economy is monitoring house prices.
One researcher wrote: “House prices also clearly influence consumer
expenditure, as housing provides the least-cost route for consumers to
obtain loans through a mortgage on the property, thus enabling to
consume out of their wealth.”
At times, we are forced to think of where to sleep ahead of what to eat.
When house prices decline substantially, and if such houses were
financed by bank loans, the lending bank(s) can fail. This is what
happened in the US between 2007 and 2009.
During the period, the US economy experienced the worst financial crisis
since the Great Depression because there were massive defaults in
subprime residential mortgages.
During that period, major financial institutions collapsed. Let us hope we do not go in that direction.
In Kenya until recently, houses were seen to be safe investments, but this appears to be no longer the case.
In Nairobi only, Housing Finance is auctioning Sh2 billion worth of houses, including commercial buildings.
Is it that mortgage holders are unable to service their loans?
Simply put, if a mortgage is for Sh10 million, but the house has
declined in value to say Sh7 million, the logical thing to do is to
default.
The default will lead to more losses in asset values and low-quality financial institutions.
This explains why debt is largely an option. The debate then is between
the interest rate and collateral rates - the rate at which houses are
financed with debt - which is the most important to the economy?
Could we be more focused on the amount a homeowner takes as a loan when
acquiring a house or should we be more worried about the interest rate?
Which of the two variables should be of particular concern to the Central Bank of Kenya?
We might be elaborate about interest rates after removing the interest
cap but less unclear about leveraging the amount to be borrowed.
The amount borrowed can impact the capacity to service the loan regardless of the level of the interest rate.
-The writer teaches at the University of Nairobi
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