Runaway property prices recipe for disaster

By Moris Aron

Real estate players are calling on the Government to provide direction in property development by formulating a mortgage policy that will tame errant practices in pricing and valuation of property, which is threatening to reverse gains made in the sector in the last five years.

Housing industry players say there is need for the adoption of a law that will best be captured through a mortgage policy, which requires all developers to disclose construction costs and profit margins. This will rein in unscrupulous developers and streamline property pricing in the country.

"It is crazy out there," says Justus Munene, the managing director of Dayton Valuers, a property firm. "Properties which are valued at Sh3.5 million or less are being sold at Sh10 million and above due to the absence of a Bill of Quantities and very high profit margins. I pity individuals who have bought such property. Banks may be sitting on overvalued property, which would not recover loans advanced if they are sold."

According to property players, the absence of such a law requiring developers to show their customers a Bill of Quantities is distorting market prices and undermining professionalism in the real estate sector.

Currently, there is no provision in law that compels developers to disclose such information to buyers as is common in developed real estate markets. The practice, if anchored into law as it is in developed countries, will make it compulsory for developers to show any buyer a Bill of Quantities, which is a document prepared by a quantity surveyor that shows the quantity and cost of materials used to construct a house before selling it.

The practice, originally rampant in sales transactions in the upper-middle income areas, is slowly spreading to the lower-middle income category where demand for housing is picking up.

Documents seen by Home & Away indicate developers are making up to 200 per cent profit by pricing their houses without disclosing to a buyer the Bill of Quantities. Industry-allowed margins are between 20 per cent and 25 per cent.

Widespread trend

In one case, a three-bedroom bungalow in Athi River built at a cost of Sh2 million was recently offloaded to the market at a cost of Sh4.8 million. In another case, a housing unit that cost Sh2.5 million to construct is being sold for Sh6 million along Mombasa Road.

In yet another case in Langata, a four-bedroom apartment, which cost Sh4 million to put up has a market price tag of Sh8 million.

The trend is widespread in the real estate business and it is feared if left unchecked, it could tear the credibility of some mortgage loan providers, valuers and the Institution of Surveyors of Kenya.

"I can confirm to you that this practice is prevalent between the developers, valuers and banks," says a real estate professional who asked not to be quoted citing his reputation.

Analysts say that with reports of over-valuation rampant in the market, the development could lead to a scenario where many individuals end up paying mortgage loans that are not commensurate with the actual value of the houses they bought.

Overvalued property

Banks on the other hand could find themselves holding overvalued property as collateral, making the real estate and the financial system vulnerable to any changes in the economy. This is not safe in case of an economic downturn.

At the highest risk include financial institutions that give out mortgage loans of up to 100 per cent of the value of the collateral, which are mainly land and property.

The worst hit by the development, however, are individuals who have already taken up mortgages to buy homes. With the exaggerated prices, industry players say buyers will end up servicing loans valued much higher than the houses they were advanced against.

The development is threatening to split the real estate industry as valuers point accusing fingers at each other for ‘distorting the market’ in the quest for profits.

According to recent real estate industry reports, valuers are currently divided over the best way to value a property with some saying valuation should be based on the cost of construction while others argue sales figures should be driven by the price at which a similar property was sold.

It is, however, well known that during the real estate boom coursing the last three years but which is now bottoming out, many valuers arrived at values of properties based on what similar adjacent properties were sold for and ignored the cost of construction.

Such differences in valuation recently played out during the valuation of Grand Regency (now Laico Regency) where different valuation firms gave highly varied figures of the cost of the five-star hotel.

On the spot over this mess is the Ministry of Housing and the Institution of Surveyors of Kenya who have been blamed for letting the practice take root. According to industry players, the practice has been going on for a while and it has seen thousands of home buyers lose millions of shillings in shoddy deals between developers and banks right under the nose of the ministry, which should regulate the market.

Fingers are also being pointed at valuers for going against industry practices and not being totally fair in their valuation of property. There is growing consensus that there is need to control greedy developers on the prowl who are capitalising on the growing demand for urban property to make a quick buck.

Even as this debate rages on, property developers have stuck their ground saying property prices reflect high demand in the market while others claim it is a delicate balancing act between profitability and providing a basic need.

"Private developers go into real estate to make profits just like in any other business in a liberalised economy," says Daniel Ojijo of Mentor Group, a real estate company.

According to Reginald Okumu, a property consultant with Arc Consultants, as long as private developers continue to dominate housing supply without proper Government incentives, profit will always be a motive.

Government incentives

"It all boils down to the forces of demand and supply," says Okumu. "To the private sector, real estate is a business that one goes in to make profits."

Nonetheless, there is growing concern on the need to tame errant pricing practices, which may have catastrophic effects on the local financial system.

"We are constantly looking for ways to make sure housing is as affordable as possible through the facilitation of incentives to developers," says Tirop Kosgey, the permanent secretary Ministry of Housing.

"We may need to review these incentives in order to pass the advantages to the end consumers."