I recently had a candid conversation with a close friend about a house he owns in Kampala and his frustration around the investment. The piece of real estate is in one of Kampala suburbs, famous for the middle-class residential demand, at a price of Shs295 million raking in rental income of Shs1.9 million. Almost 10 years later, a recent valuation placed the property at Shs290 million with a current rental income of Shs1.6 million. I need not pound out his bemusement to the fallacy surrounding the real estate capital gains in Kampala.
A big misconception about real estate is people calling it a ‘risk free investment’ – so let’s start here. Real estate on the spectrum of risky investments sits below investments like government bonds which are the blue-chip of local risk. The rental yield is not fixed (determined by demand and supply), principal investment is not protected and certainly the likelihood of the entire investment falling to ash is real and somewhat likely.
So now that we agree the investment is risky – why do we put all our hard-earned savings over decades of work into this risky asset? Society has an unwritten rule that a person having been employed for a given amount of time and upon achieving a given age should/must own the roof over his head. Well today I want us to check the premium we are paying because of this misinformed societal norm. For starters, the Kampala real estate market is somewhat lying belly up – rental yields are way below mortgage repayments for most if not all properties. A property worth Shs290 million yields Shs 1.6m per month and the mortgage repayment on that same property is Shs 3.8 million per month for 25 years at 15.0 per cent (this repayment would be Shs3.0million per month for 25years at 12.0 per cent). On the other end of it, the 20 year government bond pays a coupon of 15.75 per cent after tax. So we will now test the build option - if one built the same house including the cost of land to a grand total of Shs290 million, they will be saving on rental pay-outs to the tune of Shs1.6 million a month or 19.2m a year. However, if this investor had opted to invest this Shs290 million in a 20-year government bond they would walk away with a coupon of shs45.7 million after tax – I need not delve into the glaring opportunity here.
Again, I am not against real estate investments, I am simply an enthusiast of efficient flow of capital. African markets are extremely plagued by inefficient deployment of capital on account of societal norms like the one I have highlighted above and information asymmetry that leads investors to believe misconceptions like real estate being a risk-free investment. The work for regulators, private investment advisors and financial analysts is cut out – until we plug these holes, the inefficient flow of capital to low yielding assets will continue to hold back the aspiration to achieve middle-income status as investors continue to haemorrhage hard-earned funds into relatively inefficient investments to fulfil societal norms. So the question then begs – if there are 2.4 million units worth of housing shortage, why hasn’t this shortage driven up rental rates? Perhaps we need to delve further into the details of this shortage.
As a parting shot, I will try and summarise what we know now – a Shs290million house fetches Shs1.6m in rent but a mortgage on the same house paid over 25 years costs Shs3.8m, investing your capital in a risk-free asset for 20 years would return Shs3.8m after tax; enough to pay your rent and some change to spare. However, society demands that I own that house rather than rent it – what am I missing here?
Christopher Segawa Nantagya,