The cyclical nature of property markets

Judy R. Kyanda

Subsequent to the release of the Knight Frank H2 Market outlook report a few weeks ago, we have been inundated with inquiries from concerned members of the public, asking and wondering when the market will pick up again, if it is the right time to invest in the property market or put a hold to their development projects. Any prudent investor would ask such questions and we are glad that the market is becoming more aware of the consequences of speculative development.
Cycles (upwards or downwards) are an integral part of most markets and are recognised as a common occurrence across property sectors. They happen at different times and for different reasons, and a greater understanding of the property cycle may hold the key for investors seeking to overcome upcoming headwinds.

Additionally, aside from the cyclical nature of the property markets, there is also a life cycle to the underlying assets, and a prudent investor should understand both. Property sectors can be countercyclical, and retail property, for example, may not necessarily perform the same way office property does at any one time.
The drivers behind retail sector performance are different (though not totally unrelated) to those of the office sector. Retail tenants have different requirements to office occupiers. In fact, as we speak, the prime retail sector of Kampala is performing better than offices in terms of rents, returns and demand from foreign property funds and investment companies.

Whilst we cannot control the real estate market, we can control our investment decisions and strategies. There are many factors underlying the cyclical nature of property markets, but I will address in simplest terms only a few in this instance.

  1. Economic performance – This is generally measured by economic indicators such as GDP, employment data, manufacturing activity, the prices of goods, etc. Broadly speaking, when the economy is sluggish, so is the real estate market. A weak economy constrains tenants financially, thereby limiting their ability not only to pay their rent, but absorb rental increases. Average prime net rentals for offices have decreased from $18/sq.m in 2014/15 to $15/sq.m currently. Occupancy rates have dropped by 10 per cent to 30 per cent across office properties for the same period.Tenant risk has increased as we can see from the number of defaulting tenants, downsizing and restructuring within the oil and gas, financial and telecoms sector, and many businesses being wound down.
  2. Supply and demand – Demand is one of the elements that creates value for real estate. The element of demand is present when someone wants a property and has the financial ability to purchase it. Supply refers to the amount of properties for sale in the market at a given price during a given time period. Some factors that affect supply in the real estate markets include the labour force, construction costs, government controls and financial policies.
  3. Infrastructure – As a general rule, property developers tend to buy land and develop in areas where infrastructure is in place. Infrastructure refers to a good road network, electricity and water supply, etc. The recent boom in the development activity of Greater Kampala Metropolitan area is as a result of the increased infrastructure development that has taken place therein.
  4. Interest Rates – Interest rates have an impact on real estate markets. Changes in interest rates can greatly influence a person’s ability to purchase a residential property for example. Reason being, the lower the interest rates, the lower the cost of a mortgage, which creates higher demand for real estate, which again drives prices up.
  5. Demographics describe the composition of a population, such as age, race, gender, income, migration patterns and population growth. These statistics are a significant factor that affect how real estate is priced and what types of properties are in demand. Major shifts in the demographics of a nation can have a large impact on real estate trends for several decades.

Whilst it is not easy to accurately predict when or how long our property cycles will happen or last, I am glad to say that they have a beginning and an end, and are not an insurmountable crisis. It is in times of uncertainty and bearish markets that you need to seek professional advice before you make that investment and avoid speculation which is highly risky and can be futile.

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