Beware, the property bubble is about to burst

Property investors in Nairobi and other cities are blowing large bubbles but the burst won’t be long.

Having learnt from the recent real estate market crash in the US where I lost millions of shillings in equity, I am now investing in emerging markets.

My advice is, buyer beware.

In Nairobi’s commercial real estate, if your capitalisation rate is less than 12 per cent, you are losing.

If for example, your Net Operating Income on a rental property cannot add up to Ksh300 million ($3.726 million) in 15 years on say an apartment complex that cost say Ksh180 million ($2.23 million) to build, you are in the wrong business.

If your Debt Service Coverage Ratio is less than 1.5, you are slowly strangling your financial prowess.

And if your equity build up is more than 15 per cent annually in an economy with a 40 per cent unemployment rate, the bubble is about to burst.

A market bubble is created when demand exceeds supply and suppliers become greedy.

This is already happening in Kenya.

Real estate goes through four cycles— buyers’ market phase one, buyers’ market phase two, sellers’ market phase one and sellers’ market phase two.

The buyers’ market phase one is when property is so cheap that anybody with a little saved up can afford one.

There is a huge supply while demand is sluggish.

Rent becomes higher than the mortgage hence properties have tremendous cash flow.

However, it is expensive to borrow as lenders follow stringent rules.

In buyers’ market phase two, rents shoot as demand for rentals rises. These two phases are the best to invest in real estate.