Why real estate industry has fallen on lean times

The reluctance of Ugandans to purchase real estate properties has prompted commercial banks to make it difficult for borrowers in this sector to obtain credit in the face of rising non-performing loans.

The Bank of Uganda (BoU) fourth quarter bank lending survey, released on September 2023, shows that commercial banks made it more difficult to process loans for the building, mortgage, construction, and real estate sector. The survey also shows that lenders made it easier for the other economic sectors as they anticipated an increase in loan defaults in the quarter to September 2023.

The expected increase in default rates on loans to enterprises and households has been attributed to recent parliamentary legislation. 
The commercial banks, in turn, fear that the legislation could result in suspension of international organisation funding for some non-governmental organisations or NGOs, increasing the level of non-performing loans due to job losses.

Without warning, Uganda’s government announced in August 2021 that 54 civil society organisations (CSOs), including those that monitor elections and advance human rights, had their operations suspended due to the country’s lack of oversight of their financial transactions.

Along with the closure of the UN High Commissioner for Human Rights (OHCHR), the Democratic Governance Facility (DGF), with estimated investment funds of about Shs393.3 billion (€100m), was one of the largest funders of the majority of NGOs in the country. DGF provided funding for numerous projects across the nation that employed hundreds of people. Following its closure, many people lost their jobs and had no other way to cover their debt obligations, including their rent and loan payments.

The BoU survey notes that “the tightening in the building, mortgage and real estate sector was mainly attributed to the low property rates and decreasing occupancy levels.”
The occupancy rate is the ratio of used or rented space to the total amount of available space.

Gloomy picture
Different commercial banks made it tougher with stringent conditions for acquisition of a real estate or a mortgage to the point that most of the high end borrowers in commercial real estate establishments have tremendously reduced, according to Mr Michael Mugabi, the managing director of Housing Finance Bank, a government-owned financial institution that mainly finances mortgages.

“However, we are working to address the income segment level where we have created packages for different income earners, from low to high income earners, and this has allowed us to increase traction primarily from low income earners, which has also reduced the pace of non-performing loans,” he continued.

Several commercial banks have been forced to handle the challenging task of having to sell properties whose owners have not paid their loan obligations, in addition to the additional burden of incurring additional costs to hire property auctioning companies.
Due to concerns about slowing economic growth, Uganda’s commercial banks saw their ratio of non-performing loans (NPLs) to total gross loans rise from 5.32 percent in June 2022 to 5.36 percent in June 2023, according to official latest figures from the central bank.

Even though gross loans and advances to the private sector increased to Shs19.4 trillion ($5.15 billion) in the year to June 2023, there was a 7.5 percent decline in credit issuance to the sector a year earlier, resulting in an increase in bad loans registered by tier one financial institutions.

For instance, Bank of Baroda reported an increase in bad debts written off from Shs7.98 million in the six months to June 2022 to Shs759.25 million in the six months to June 2023. Its NPLs increased from Shs1.6 billion to Shs18.8 billion during the same period.
Stanbic Bank, another impacted financial institution, reported in its half-year financial fillings that its customer credit loss ratio increased from 1.0 percent to 1.8 percent in 2023 from 2022.

Consequences
While Uganda has a shortage of at least 2.4 million housing units, the tightening of real estate borrowing has made it worse because National Housing and Construction Company, a partially government-owned real estate and construction company, is being overrun by the rising demand for housing as the population of Kampala’s slums increases.
With this increasing demand, many real estate companies—like Knight Frank, Crane management, Wilken Properties, among others— have mushroomed.

The lack of a government-run organisation to construct homes for the populace in Uganda has prompted various real estate agencies to fill the housing gap. 
However, because they lack the funding to do so, they are heavily reliant on commercial banks.

When times are tough economically, tenants are less likely to occupy their properties as they struggle to cope up with the high cost of living. As a result, sold homes sit empty and tenants are forced to share small spaces because they are unable to pay the ‘expensive’ rent.

“Uganda has a 2.4 million housing deficit and most people are investing in the real estate sector to close that gap. It is estimated that approximately 900,000 housing units in Uganda are substandard and in desperate need of replacement or upgrading. So definitely this will worsen the country’s housing deficit and the unemployment rate as well,” Mr Lazarus Mugabi, a board member of Association of Real Estate Agents Uganda, said.

In addition, the country’s monetary authority has increased its benchmark interest rate, known as the Central Bank Rate (CBR) to influence the overall interest rates in the economy.

Due to the frequent defaults in the private sector, this has caused the government to borrow more money from commercial banks through the issuance of government bonds and other debt instruments.

“Government has of late increased domestic borrowing, which has pushed up interest rates on loans from commercial banks. These banks are now giving priority of lending to the government because of its guarantee in terms of payment. If you have the government as a client, the increased interest rates spillover to the private sector, which can only be lowered when BoU lowers the CBR,” Mr Mugabi said.

Uganda’s CBR has averaged 9.89 percent in the first nine months of 2023, as opposed to 7.39 percent in the same period of 2022.
The slowdown in the economy combined with the severe inflationary pressures on consumption that ravaged the country and reached highs of 10 percent in October 2022, drove up the “buying market.” As a result, there was an increase in loan defaults in the building and construction sector because many property owners were unable to make enough money to satisfy their debts to financial institutions.

“Some people are even now mortgaging their properties, like houses, to get school fees for their children. […] And it becomes even worse for commercial banks because it’s hard to get a quick buyer and value for money as well,” Mr Mugabi said.

Source of money
The real estate industry has come under fire for using funds that are not part of the real economy. Experts say this enables property owners to build multi-million dollar homes in a nation where the majority of the population has lower disposable incomes.

Industry insiders, however, assert that they choose offshore borrowing due to the alluringly low interest rates that come with it.
“If you borrow in the domestic market, the best you can get is an 18 percent interest rate on loans, and yet you can get offshore money at five percent interest rates. There are some foreign countries where you can source the money at even free rates. Then you come back to the country and you outcompete everybody in the market by pricing well your property competitively,” Mr Mugabi said.

The fact that occupiers are still actively haggling for discounts and taking advantage of the rising supply of space is significant. As a result, there is ongoing pressure for rental rates to decline in the long run, according to Knight Frank, a real estate advisory firm, in its 2023 half-year review.

Uganda’s landlords are negotiating with the taxman to lower property and rental rates in order to maximise the return on their investments. They currently pay property tax and rental tax on properties that generate income for the owner to the Uganda Revenue Authority (URA) and local governments, respectively.

Fire sales
A recent study by this newspaper revealed that at least 750 buildings have been sold at auction in the last three months as banks try to recover their defaulted loans.

“If the general economy is performing well, a fraction of people put investments in acquiring homes, which shoots up the occupancy rate. However, an economy like ours, which saw high headwinds, prompts people to eventually remove homes off their priority lists and fight the cost of living,” Mr Mugabi added.

For example, some of the country’s five-star hotels, including the Pearl of Africa Hotel (pictured), have been put up for auction to recover sizeable accumulated debts from various contractors. As a result, creditors have filed for its insolvency because the hotel failed to recover to repay its accumulated Shs600 billion ($159.3 million) debts.

After operating in the country for over a decade at Nakasero in central Kampala, the hotel had failed to generate a significant return on investment in its 23 floors and 296 rooms.