Real Estate: Are Uganda’s Real Estate Prices Sustainable?

Published on 20th August 2012

AREA-U members in a function                                Photo courtesy

I recently went looking for a parcel of land to purchase with my peanut savings. The broker, on knowing the amount I had in mind, called his network of brokers to help me locate a cheap plot intimating “Ono sente tayina za CHOGM” (literally meaning, he does not have CHOGM funds). This arguably among other factors could explain the exponential rise in real estate prices in Uganda. It is against this backdrop that I try to explore the sustainability of Uganda’s real estate bubble that is characterized by rapid increases in valuations of real property.

Unlike the stock market, where most people understand and accept the risk that stock prices might fall, most people who buy a house don't ever think that the value of their house might decrease. The laws of physics state that when any object (which has a density greater than air) is propelled upward, it will return to earth because of the force of gravity acting upon it. The laws of finance say that markets that go through periods of rapid price appreciation or depreciation will, in time, revert to a price point that puts them in line with where their long-term average rates of appreciation indicate they should be. This is known as mean reversion.

Prices in the housing market follow this law of mean reversion too - after periods of rapid price appreciation (or depreciation), they revert to where their long-term average rates of appreciation indicate they should be. Home price mean reversion can be rapid or gradual. So yes, at some point property prices will come down. Since the when question is one that has not empirically been answered, therefore  the scope is this piece is limited to the key factors that cause the bubble as well pointers to why it might burst.

Prices are driven by demand and supply.When demand outstrips supply, the prices go high. The reverse is also true. To best understand the dynamics of real estate market, one ought to know the factors that affect both demand and supply of real estate. Assuming the supply is constant (same geographical stock of land), my analysis is limited to the key drivers of the demand side.

Land, real estate prices don’t follow the normal demand law, where the higher demand is driven by lower prices and vice versa. To the contrary, people buy more real estate when prices are high expecting them to rise further. This is primarily driven by speculation as well as lack of alternative investments in other sectors like agriculture. In Uganda, the speculation is further stimulated by the huge expectations from the oil sector where the estimates place the value of Uganda's oil assets at a minimum of $75 billion. A substantial amount of this money is to be spent on public expenditure, with a good amount trickling into the property industry. Also worth noting is that commercial exploitation of the reserves requires about US $10bn of investment which will also inevitably trickle down. However; Oil trend significant oil revenues (worth 5% GDP) won’t happen until 2030. During the peak period – which is estimated at 15 to 40 years at maximum – revenues will be around US$ 1.1 billion. Often resource extraction often entails little job creation, unemployment rises.

The rising debt levels will likely strain the future oil proceeds. Debt levels increasing simply mean more taxes in future. Currently, Uganda’s post HIPC and MDRI debt is growing at an average rate of 17% per annum in nominal terms, whilst projected to rise to 20% per annum in the medium term and long term frameworks. If we can take a leaf from Greece or any debt ridden country, austerity coupled with increased taxation only strains the demand levels with a trickledown effect on housing prices.

It is reasonable to expect that the number of houses built will increase at approximately the same rate as population growth. However as  much as there is growing demand for real estate and apparent huge housing deficits, the structure of the population demonstrates high levels of dependency with over 60% of  the population being below 18years. This coupled with the growing levels of youth unemployment will prospectively lead to a dwindling demand for non-consumables including land.

Real estate bubbles are seen as an example of credit bubbles (pejoratively, speculative bubbles), because property owners generally use borrowed money to purchase property, in the form of mortgages. This is probably the case in Uganda, as in FY 2011/ 12 when the central bank initiated an inflation targeting tool- by increasing interest rates to curb the runaway inflation (30% in November 2011), construction sector grew in real terms at 1.7% in FY 2011/12 compared to 7.8% in FY 2010/11. Real sector activities have continued to grow at 5.6% over the last 4 years.  Also notably, banks have consequently revised their mortgage valuations way below the market valuations. This move was prompted by the dip in housing prices in the center of town. This only points to fact that land and other real estates are wrongly priced primarily due to speculation. E.g. when will land of 1bn shillings in kololo ever pay back?

Speaking of inflation, arguably it could be here to stay primarily. There is an increasing shortage or scarcity of food inputs like land, energy, water etc. yet the demand globally is increasing due to increased population growth rate. Thus the structural changes around oil and food production may be here to stay. With persistent inflation, the consumption share of income of the already small formal sector (less than 10% of the economy) as well as others will increase reducing the available disposable income to clear mortgages or least buy off the overly priced properties.

Lastly corruption has a significant premium or call tax on the real estate pricing. Corruption which is estimated annually 10% of the national budget and about 2.2% of GDP has played a significant impact on the boom in real estate activities. Since the introduction of declaring the source of income for all properties above 50Million, the land and real estate activities have dwindled. Corruption if not curbed in the long run impedes investment, since it worsens the business indicators as well the global competitiveness index. Also notable, a strong fight against the vice will inevitably reduce demand leading to a price slump for real estate products.

Economic theory seems to suggest that the key drivers of real estate bubble such as corruption, private sector credit and remittances, among others like growth of an economy and expectations tend to be volatile in the long run. Given that real estate prices are growing faster than any macroeconomic variable, worryingly higher than real GDP growth which is a proxy for effective demand/ affordability, the bubble will inevitably burst unless the government regulates the real estate prices and controls corruption. Construction and housing bubble will burst faster in medium term (5-10 years) unless regulation happens.

By Enock Twinoburyo Nyorekwa
Economist.
[email protected]


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