CHAPTER ONE - INTRODUCTION1.1 Background of the StudyThe real estate market plays a very important role in any economy. It is known to have adramatic multiplier effect and is a key economic indicator. The business dictionary definesreal estate as land and anything fixed, immovable, or permanently attached to it such asappurtenances, buildings, fences, improvements, roads, shrubs and trees (but not growingcrops), sewers, structures, utility systems and walls. Title to real estate normally includestitle to air rights, and surface rights which can be bought, leased, sold, or transferredtogether or separately. It includes improvements, natural resources and structures bothabove and below.The real estate market has experienced significant growth in the last decade. Theoretically,the condition of a market is driven by forces of demand and supply. Demand refers to howmuch (quantity) of a product or service is desired by buyers . When demand is high, pricesof a commodity go up. Higher prices on the other hand decrease the demand of a particulargood and service (Baumol & Bunder, 2011). Aggregate supply is the relationship betweenthe economy’s price level and the amount that the output firms are willing and able tosupply. Therefore Residential Real Estate prices are guided by the relationship betweensupply and demand.Many countries have in the past experienced house price fluctuations. This has beenassociated with economic instability. In many countries, like the U.S., price fluctuationshave led to accelerated housing defaults with millions of residential properties having2negative equity mortgages with outstanding loan balances being greater than the propertyvalues (Burnside et al, 2011). House prices are a significant indicator of the real estatemarket because prices are driven by the demand in the market. Demand on the other handis determined by a number of macro and micro economic factors in an economy. Thus tofully understand the changes and developments in a real estate market, it is important tofully understand the forces behind price fluctuations. Higher property prices also tend tostimulate the economic activity through wealth effects, thereby encouraging investment andconsumption spending.1.1.1 Residential Real Estate PricesReal estate markets are heterogenous, with a series of geographical and sectoral submarketsthat lack a central trading market. Every property is usually unique and information on themarket transactions is often not available. The pricing process is usually negotiated and themarket is characterized by large transaction costs. The prices of an existing property shouldtheoretically be equal to discounted present value of the expected stream of future income(rents), which depend on expected growth in income, anticipated real interest rates, taxesand other structural factors. The price should equilibrate demand and supply in a wellfunctioning market. The fundamental equilibrium price is the price at which the stock ofexisting real estate equals the replacement cost (Hilbers et al 2001). Therefore in theory agrowth in prices indicates growth in demand and hence a growth in the market. Severalfactors drive the demand of the real estate market.There are two ways to measure real estate demand and these involve an evaluation of realestate investments and real estate prices. As demand for real estate increases, real estate3prices rise and therefore real estate investors will increase their in real estate to meet thedemand and therefore it can be said that real estate prices and real estate investments aredirectly proportional to real estate demand.The real estate market is a key contributor to the Socio- economic development of nationsthrough creation of employment in construction and other areas. It is also a key contributor

to the GDP. For many families, the house is their one major investment representing over30% of their wealth. Thus house pricing is of utmost importance to them. House prices arealso of great interest to real estate developers, banks and policy makers in general.1.1.2 Determinants of Residential Real Estate PricesThe size and scale of the real estate market makes it attractive and lucrative sector for manyinvestors. House prices are a good indicator of the size of a real estate market. Severalfactors affect residential real estate prices and hence the growth of the market. Theseinclude: interest rates, GDP, level of money supply, and Inflation rate (Mak, Choy, & Ho,2012).1.1.3 How the Factors affect Residential Real Estate PricesInterest rates have a major impact on the real estate markets. Changes in interest rates cangreatly influence a person's ability to purchase a residential property. That is because as theinterest rates fall, the cost to obtain a mortgage to buy a home decreases, which creates ahigher demand for real estate, which pushes prices up. Conversely, as interest rates rise, thecost to obtain a mortgage increases, thus lowering demand and prices of real estate. When4interest rates are low, buyers can afford more homes for their money because less of themortgage payment goes toward interest charges to the lender. This scenario could drawmore buyers into the market, which could lead to multiple bids on houses and an uptick inoverall prices. Because the influence of interest rates on an individual's ability to purchaseresidential properties (by increasing or decreasing the cost of mortgage capital) is soprofound, many people incorrectly assume that the only deciding factor in real estatevaluation is the mortgage rate. However, mortgage rates are only one interest-related factorinfluencing property values. Because interest rates also affect capital flows, the supply anddemand for capital and investors' required rates of return on investment, interest rates willdrive property prices in a variety of ways (Liow, Ibrahim & Huang, 2005).Another key factor that affects the value of real estate is the overall health of the economy.This is generally measured by economic indicators such as the GDP, employment data,manufacturing activity, the prices of goods, etc. The GDP is the market value of allofficially recognized final goods and services produced within a country in a given periodof time. GDP per capita is often considered an indicator of a country’s standard of living.Under economic theory, GDP per capita exactly equals the Gross Domestic Income percapita. When the GDP is low it means that the people’s purchasing power is also low hencethe demand for real estate and consequently the house prices will decrease. Conversely,when the GDP increases, the purchasing power also increases hence increasing the demandof Real estate and house prices go up. Broadly speaking, when the economy is sluggish, sois real estate. However, the cyclicality of the economy can have varying effects on differenttypes of real estate. For example, an investment in hotels would typically be more affected5by an economic downturn than one in office buildings. Hotels are a form of property that isvery sensitive to economic activity due to the type of lease structure inherent in thebusiness. Renting a hotel room can be thought of as a form of short-term lease that can beeasily avoided by hotel customers should the economy be doing poorly. On the other hand,office tenants generally have longer-term leases that can't be changed in the middle of aneconomic downturn (Case et al, 2005).Money Supply is a broad measure of money in an economy. Increase in money supplygives rise to greater inflation uncertainty and this has an adverse impact on the real estatemarket. Excessive growth in money supply may lead to an inflationary environment andmight affect the investments because of higher discount rate (Liow, Ibrahim & Huang,2005).

Inflation is often defined as a sustained increase in prices for a broad range of prices(Gallagher, 2011). Inflation rates affect the purchasing power of money. Inflation ismeasured by the changes in the Consumer price index (CPI) which measures the retailprices of goods and services purchased by households (Liow, Ibrahim and Huang, 2005). Itis theoretically expected that the higher the inflation rate the higher the house prices.1.1.4 Real Estate Market in KenyaThe Kenyan real estate market has been experiencing a boom in the past ten years and thelatest findings have shown that the trend will continue into the foreseeable future. In areport published by Knight Frank and Citi Private Bank, it was found that luxury homes in6Nairobi, Mombasa, Malindi, and Lamu were ranked among the top-notch residentialproperty markets in the world for attaining the highest rise in prices among propertiessurveyed globally in 2011. Nairobi was reported to have had the highest growth rate with25% price increase for top-notch residential properties, followed by Kenyan coastalproperties in Mombasa, Malindi and Lamu with 20% price growth. Properties in Miami,Bali, Jakarta, London, Vancouver, Moscow, Toronto, Beijing and Cape Town were ratedon the price increase index with 19.1%, 15%, 14.3%, 12.1%, 10.4%, 9.8%, 8.1% and 2.4%in that order (Knight Frank & Citi Private Bank, 2011).In 2010, growth was higher than expected at 5.6 percent, and this rate is expected to bemaintained over the medium term. If growth accelerated to 6 percent, Kenya could reachMiddle Income Country status by 2019.This means Kenya is at the threshold of a majordemographic transition and is urbanizing rapidly. Each year, Kenya will continue to growby more than one million people, who will live longer, be better educated, and increasinglylive in cities. This social and economic transformation needs to be managed well tocatalyze its development impact (World Bank, 2011). This increase in urbanization willaffect the demand for housing significantly.According to UN Habitat Statistics, E.A is the fastest urbanizing region in the world withits urban population expected to double between 2007 and 2017 (UN Habitat, 2013).Nairobi is one of the fastest growing cities in the world. Recent report by the KenyaNational Bureau of Statistics, shows that demand for real estate in the urban areas in thelast ten years, exceeded supply by more than five times.7Another reason to anticipate significant growth in the real estate market in the year 2013 isthe dropping interest rates. Lower rates have spurred an uptake of mortgages which have inturn fueled the impending housing market boom. In June 2013, the CBK lowered its rate to8.5%. Statistics show however that despite lower interest rates, less that 200,000 Kenyanshave mortgage facilities. Only 6% of Kenyans own their own homes. Mortgage lending isstill accessible to only a minority. In 2012, only 1.1% of the top 60% income earners inKenya have a mortgage (Knight Frank, 2012). This means that there is still a huge deficit inthe housing market. Statistics indicate that the demand for housing, which has possibly ledto increase in house prices, has been on the rise at a faster rate than the number of housesavailable or under construction (National Housing Corporation, 2009). The estimatenumber of houses constructed annually is about 30,000 whereas the demand is estimate at150,000 (National Housing Survey, 2013).In Nairobi the demand for real estate is at an all time high. With improved infrastructurelike the Thika Superhighway, access to utilities, growth in information technology, theperformance of the sector continues to grow. A major innovation has been the multibillion– dollar gated communities and mini cities coming up. These include the Kihingo Village,Thika Greens Golf Estate, Fourway Junction, Tatu City, Konza City, Migaa Golf Estate,Roslyn Heights, and EdenVille Estate among others. This has spurred the growth of the

sector tremendously. These communities are preferred as they are perceived to present asense of higher security and provide access to high end facilities like swimming pools and8gyms at a lessor cost than if homeowners were to construct their own. Hence property inthese communities has increased in value.Another boost to the sector players is the introduction of Real Estate Investment Trusts(REITS) by the Capital Markets Authority (CMA). This will enable real estate companiesbe listed in the Nairobi Securities Exchange (NSE). It will also enable small investors tohave access to an otherwise prohibitive market (Julius, 2012).1.2 Research ProblemAs identified earlier the key determinants of residential real estate prices are interest rates,GDP, level of money supply and inflation rate. The factors may have a negative or apositive relationship with the house prices. The factors may also affect the market directlyor indirectly. For example interest rates affect house prices by raising the demand. Also, thedegree to which each factor impacts the house prices varies. Knowing the relativerelationship is of paramount importance in making investment decisions as well as policyformulations in a bid to boost the market even further.Studies have been conducted globally on house prices. Egert and Mihaljek (2007) studiedthe determinants of house prices dynamics. Selim (2008) studied the determinants of houseprices in Turkey for both urban and rural areas. Mak et al, 2012 studied the specificestimates of the determinants of real estate investments in China. Lieser & Groh (2011)studied the determinants of commercial real estate investments. Posedel & Vizek (2009)studied house price developments in six European countries. Alves et al (2011) conducted aresearch to test other dimensions of asset pricing other than the hedonic modeling.9In the Kenyan setting, studies done on the real estate sector include Muthee (2012) whosought to determine the relationship between economic growth and real estate prices inKenya. Jumbale 2012 sought to determine the relationship between house prices and realestate financing in Kenya. Muli (2011) studied the relationship between property prices andmortgage lending in Kenya. Julius (2012) studied the determinants of residential real estateprices in Nairobi.Though a similar research as this study had been conducted, Julius’ study was limited tothe city of Nairobi and studied the relationship of house prices with interest rates, level ofmoney supply, inflation rate, population and employment. Other studies have concentratedon the relationship between house prices and one particular variable without the relativecomparison of other factors. This study sought to extend and fill the research gap bywidening the scope to the whole country of Kenya. It also included economic growth as avariable.1.3 Research ObjectiveTo investigate the determinants of residential real estate prices in Kenya.101.4 Value of the StudyIt is expected that this study will add to the body of knowledge in existence in the realestate field which will be beneficial to academicians. It will also provide a basis for furtherresearch in the field. Thus it will make a contribution to the literature on determinants ofresidential real estate prices.Investors seeking to join or expand in the real estate sector will be able to make informedevaluation as to what is driving the changes in real estate prices and thus be able to makesound decisions. Individuals seeking to own their own homes will also benefit inunderstanding the market forces and make the best buy. Financing institutions will find this

study useful in regard to fluctuations in prices since this affects the long term evolution ofreal estate financing. The government and regulatory bodies will benefit in knowing howgovernment policies on issues like taxation affect the sector and hence formulateappropriate regulatory framework for enhancing the growth of the sector.

CHAPTER ONE: INTRODUCTION 1.1 Background of the Study Real estate investment plays the crucial role of providing employment opportunities, offering shelter to households, enhancing income distribution and poverty alleviation (Masika, 2010). Real estate industry in Kenya continues to fail to fulfil this fundamental role due to a number of unique factors that affect the sector. In the recent past, Kenya has witnessed an upsurge in real estate investment owing to increased quest for Kenyans to own homes coupled by an increased demand for residential homes due to increased rural urban migration, as well as demand for office space as more small and medium enterprises come into being (Nzalu, 2010). Wisniewski (2011) indicates that the processes occurring in real estate are subject to different impulses, and these impulses are different depending on the financial and economic situation of a given country. For example, different macro-economic factors vary over time and they influence economic processes, practices and outputs in an economy. Lynn (2007) states that since macro-economic factors often influence one another, and at times very correlated, when one factor changes, ripple effect occurs and the economy is affected much more. To this end, measuring the effect of macro-economic variables is usually a difficult endeavor. This paper examines the effect of interest rates, GDP/income, inflation, diaspora remittances - which affects the balance of payments and employment, economic growth hence affecting the various markets in the economy including the real estate market 2

(Barkham, 2012). Notably, the fluctuating rates of interest do fluctuate the interest charged by lending institutions on loans – cost of capital for investment. Also, the level of national output/income affects various aspects of the economy including investments. Also, an increase diaspora remittance represents an injection of capital for investment. On the other hand, an employment rate represents a capital addition in the economy which may be spent or invested. This study examines the effect of the selected macro-economic factors on real estate investments in Kenya. 1.1.1 Macro-Economic Variables Macro-economic variables refer to factors that are pertinent to the broad economy at the regional or national level and affect a large population rather than a few select individuals. Macroeconomic factors such as economic output, unemployment, inflation, savings and investment are key indicators of economic performance and are closely monitored by governments, businesses and consumers (Khalid et al., 2012). Fischer (1993) posits that the interplay or relationship between various macroeconomic factors is the subject of a great deal of study in the field of macroeconomics. While macroeconomics deals with the economy as a whole, microeconomics is concerned with the study of individual agents such as consumers and businesses and their economic decision-making. The macro-economic factors are; real GDP, the unemployment rate, the inflation rate, the interest rate, the level of the stock market, and the exchange rate (Khalid et al., 2012). The five common macro-economic factors; rate of inflation – affects prices for inputs and outputs in the short run and interest rates over the longer run in an economy, rates of 3

interest – affects cost of capital which is the interest expenses hence property values, rate of unemployment – affects available income and hence disposable income for investments since this is an important source of internal equity capital, rate of growth in GDP – affects the domestic demand for national outputs, and rate of foreign exchange – affects the value of the currency relative to international currency hence affecting property values where different currencies are involved as well as the export demand for outputs. 1.1.2 Real Estate Investment According to Cummings (2010), real estate investing involves the purchase, ownership, management, rental and/or sale of real estate for profit. Investment in real estate is undertaken for its ability to provide returns inform of capital, income and intangible benefits (Baum & Crosby 1988). However returns in commercial real estate are maximized when there is full occupancy, prompt and total rent collection, full market rent, good physical condition of building; minimal irrecoverable outgoings and low rate of tenant turn over. Studies by Ziening & McIntosh (1999) and Tonto, Wheaton & Southard (1998) have shown that the greater volatility in return in commercial real estate is not an appraisal problem but a structural problem of the property markets and real estate property as an investment vehicle. The most typical sources of investment properties include: market listing (through multiple listing service or commercial information exchange), real estate agents, wholesale (such as banks real estate owned department and public agencies), public auction (foreclosure sales ,estate sales ), and private sales. 4

As Lynn (2007) notes, the primary cause of investment failure for real estate is that the investor goes into negative cash flow for a period of time that is not sustainable, often forcing them to resell the property at a loss or go into insolvency. A similar practice known as flipping is another reason for failure as the nature of the investment is often associated with short term profit with less effort (Thalmann, 2006). Real estate markets in most countries are not as organized or efficient as market for other more liquid investment instruments. The individual’s properties are unique to themselves and not directly interchangeable, which presents a major challenge to an investor seeking to evaluate prices and investment opportunities (Renigier-Biłozor, 2011). For this reason, locating properties in which to invest can involve substantial work and competition among investors and to purchase individual properties may be highly variable depending on knowledge of availability. Information asymmetries are common place in real estate markets. This however, increases transaction risks, but also provide many opportunities for investors to obtain properties at bargain prices (Nzalu, 2012). Real estate investors typically use a variety of appraisal techniques to determine the value of properties prior to purchase. Real estate investment is measured through various approaches. One of the evident approaches is through indices mainly used in stock exchange market. Indices are frequently used as a benchmark against which to measure the performance of shares and fixed interest stock (Barkham, 2012). They are applied in the property industry but in a limited scope as compared to stock markets mainly because of difficulties associated with the free availability of data. Owing to the subjectiveness of property valuations, property index should ideally include a large sample, be independent of any of the institutional 5

investors, and should separate income, capital performance and total performance for each category of property. The market value can also be used to measure property performance in the market. The value placed on a property is a major determinant of its performance. The value may be either market value or fundamental value. The fundamental value is the value placed on the property by the owner and is not necessarily market related (Thalmann, 2006). On the other hand, market value is the value which the market at large places on the property. Ideally, property indices are produced by industry players such as established investment firms or government valuing agencies. In real estate sector, indices are produced by real estate investment firms. For example, HassConsult Real Estate Ltd comes up with real estate valuation indices. Specifically, the Hass composite Sales Index is a measure of asking property sales price, based on a Mixed Adjusted Methodology. This study use the Hass Composite Sales Index which will be retrieved from the Hass Property Index reports. 1.1.3 Effect of Macro-Economic Variables on Real Estate Investments Like any other sector of investment, real estate is affected by diverse factors including; fluctuations in exchange rate, interest rate, inflation rate, money supply, national output etc. O’Sullivan & Sheffrin (2003) indicate that an exchange rate between two currencies is the rate at which one currency will be exchanged for another. The Post Keynesian theory assumes that currency prices are determined in the market for financial capital and that trade flows do not tend toward balance. It is further assumed that income effects are more important in determining the current account than are price effects. 6

GDP (Gross domestic Product) is defined by OECD as "an aggregate measure of production equal to the sum of the gross values added of all resident institutional units engaged in production” (OECD, 2002). In Keynes's theory of determination of equilibrium real GDP, employment, and prices are affected the aggregate income and expenditure. According to Keynes, spending affects GDP. To this end national income affects the level of investment. According to Blanchard (2000), Inflation is the sustained increase in the general price level of goods and services in an economy over a period of time. Through the cost-push theory of inflation, raising wages can fuel inflation, which will further increase the price of property. Money supply or money stock is the total amount of monetary assets available in an economy at a specific time (Cummings, 2010). If Keynes’s theory is conceded, increases in money supply lead to a decrease in the velocity of circulation and that real income, the flow of money to the factors of production, increased, hence affecting the real estate market positively (Barkham, 2012). Therefore, velocity could change in response to changes in money supply. Barkham (2012) posits that diaspora remittances are the funds entering a country from foreign markets as gifts or support of friends and members of one’s family. Through the theory of price, the demand of property by investors in the diaspora can increase the prices of the property in the market receiving the remittances. Huge remittances from abroad can cause a surge in money supply hence price of goods. As Lynn (2007) notes, the primary cause of investment failure for real estate is that the investor goes into negative cash flow for a period of time that is not sustainable, often 7

forcing them to resell the property at a loss or go into insolvency. A similar practice known as flipping is another reason for failure as the nature of the investment is often associated with short term profit with less effort (Thalmann, 2006). Real estate markets in most countries are not as organised or efficient as market for other more liquid investment instruments. The individual’s properties are unique to themselves and not directly interchangeable, which presents a major challenge to an investor seeking to evaluate prices and investment opportunities (Renigier-Biłozor, 2011). 1.1.4 Real Estate Investments in Kenya According to Muchoki (2013) most people in Kenya prefer to invest in real estate. Real estate business in Kenya entails buying a house, and it is one of the safest ways to invest your money in Kenya. This is mostly due to the fact that assets like a land and houses in Kenya have tended to almost always appreciate. Also, real estate business in Kenya is fair well in the market because with growing population in Kenya, the demand for houses is on the rise. A Kenyan with the money to buy a house can prefer to buy a house and make use of the money used to pay rent for investment somewhere else in Kenya. Factors that Influence Real Estate real estate include demographic factors, rate of interest, inflation rate, performance of the economy among others. Demographics are the data that describes the composition of a population, such as age, race, gender, income, migration patterns and population growth. These statistics are an often overlooked but are significant factors 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. 8

According to Wallace (2013) population shifts and demographic changes in the population have an impact on the real estate market in Kenya as an increase in population causes demand, which further increases prices. In assessing the challenges affecting real estate development, Muchoki (2013) identified that poor planning was one of the challenges. Poor planning is partly contributed by lack of updated demographic reports. When interest rates decline, the value of a bond goes up because its coupon rate becomes more desirable, and when interest rates increase, the value of bonds decrease. Similarly, when the interest rate decreases in the market, REITs' high yields become more attractive and their value goes up. Real Estate Investment Trust - REIT' is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. When interest rates increase, the yield on an REIT becomes less attractive and it pushes their value down. Otwoma (2013) identified that property prices displayed a high inverse relationship with interest rates in the period December 2000 to May 2003 and November 2011 to June 2013 when interest rates were high. This inverse relationship reverses in the period June 2003 to October 2011, a period when interest rates were relatively low and stable. Another key factor that affects the value of real estate is the overall health of the economy. This is generally measured by economic indicators such as the Gross Domestic Product, employment data, manufacturing activity and the prices of goods, amongst others. In a research conducted by Muthee (2012), the results indicate that there is a relationship between the variables (GDP growth, inflation, and unemployment) revealing that a quarterly change in housing prices yields a quarterly change in GDP. The data 9

collected and analysed indicates that property is a strong asset class which has been under exploited in portfolios. 1.2 Research Problem The growth of real estate investment in any context is highly affected by a myriad of economic factors. The growth in real estate could be measured as the collective total investments (costs of investing in real estate) or the price index (the asking prices). In this sense, then different factors can cause growth. For example, the housing bubble is associable with; excessive desire for home ownership in an economy, buying for speculation rather than shelter, low interest rates, viewing residential real estate as a safe harbor, and bad lending practices. To this extent, variables that influence the above variables such as inflation, GDP, Money supply, including international remittances are bound to affect the growth of real estate and other sectors in the economy. As of 2012, the National Housing Corporation (NHC), the Vision 2030 estimates that the country requires 200,000 new units of housing per year, but the industry could only avail 35,000 units each year. A report from the Kenya National Bureau of Statistics (KNBS) shows that real estate investment has greatly contributed the growth of Kenya’s Gross Domestic Product. Kenya National Bureau of Statistics report (2012) shows that, in 2008, real estate contributed 107, 323, 000 shillings to the country's GDP. However, real estate prices in Kenya have been growing almost every year. Masika (2010) posits that demand for housing units continues to outstrip the supply. Makena (2012) postulates that level of money supply can influence the level of real estate 10

investments as well as real estate property prices. According to Otwoma (2013) property prices display a high inverse relationship with interest rates especially when interest rates are high. He adds that this inverse relationship reverses when interest rates are relatively low and stable. In his study, Muthee (2012) established a relationship between the variables (GDP growth, inflation, and unemployment) and a quarterly change in housing prices yields. In his study, Nzalu (2012) concluded that GDP, interest rates and inflation rates do greatly determine the real estate investments in Kenya. Elsewhere, Renigier-Bilozor & Wisniewski (2012) established total consumption expenditure, net income; unemployment and population growths are influential factors to the real estate investment. Also Golob, Bastic & Psuder (2012) affirmed the findings of Renigier-Bilozor & Wisniewski (2012). It is notable that while different researchers do agree that GDP, interest rates, inflation, unemployment, demographics, amongst others do affect the level of real estate investments, they do not conclude on the direction of the relationship or the strength of the relationship. Furthermore, findings from different authors are not consistent. The question of this study is; what is the effect of macro-economic Variables on real estate investments in Kenya? 1.3 Objective of the Study To determine the effect of macro-economic variables on real estate investment growth in Kenya 11

1.4 Value of the Study The study is of the following practical value: the study provides useful information to policy makers, market players and finance academicians on the extent to which macro-economic factors affect real estate development in the country. The outcome of this study provides insight to policy makers and real estate players as to whether macro-economic factors can be used as a useful tool in ensuring housing affordability in Kenya. The study adds value to theoretical discussion by testing the relationship of macro-economic factors and investment under an environment where demand outweighs supply. The findings of the study are useful resource base to students pursuing Finance and to researchers exploring the area of real estate. The study provides useful data for comparative study purposes in future researches on this topic. 12

CHAPTER TWO: LITERATURE REVIEW 2.1 Introduction This chapter provides literatures from past researchers and scholars on the effects of real estate investment. The chapter examines the concepts and theories on the topic with major focus on macro-economic variables; Exchange rate, inflation rate, money supply, real output – Real Gross Domestic Product and diaspora remittances. By considering literatures from diverse past authors, the chapter forms the theoretical and the conceptual framework of the study on the factors affecting real estate investment. 2.2 Theoretical Review Theoretical review refers to the theoretical foundation of a study. A theoretical research has its findings based on existing theories and hypothesis; there is no practical application in the research, while an empirical research has its findings based on the verification through experiments, experiences and observations.

CHAPTER ONE1.0 INTRODUCTIONReal estate investment plays crucial role in providing employment opportunities, offering shelterto households, enhancing income distribution and alleviating poverty. However, the real estateindustry in Kenya continues to fail to fulfil this fundamental role due to a number of uniquefactors that affect investment in the sector. In the recent past, Kenya has witnessed an upsurge inreal estate investment. This has been driven by a number of factors notably the quest forKenyans to own homes, rural urban migration, increased diaspora remittances among others. Asa result, property prices in the urban areas have taken an upward trend. The expansion ofMombasa road and the construction of Thika super highway have also contributed to the rise ofproperty prices in the adjacent areas. It’s therefore important to assess the factors that contributeto investment growth so as to sustain its the growth in future.Real estate is property consisting of land and the building on it along with its natural resourcessuch as crops minerals or water immovable property of its nature an interest vested thus an itemof real property building or housing in general. Real estate investing involves the purchase,ownership, management, rental land or sale of real estate for profit. Kenyan real estate propertycovers all property categories including single and multi-family residential dwellings,commercial and agricultural land, office space, go-dawns and warehouses, retail outlets andshopping complexes (Masika, 2010). Real estate is an asset form with limited liquidity relativeto other investment, it is also capital intensive (although capital may be gained through mortgageleverage) and is highly cash flow dependent. If the factors affecting the growth in the investmentare not well understood and managed by an investor, real estate becomes a risky investment.The primary cause of investment failure for real estate is that the investor goes into negative cashflow for a period of time that is not sustainable, often forcing them to resell the property at a lossor go into insolvency. A similar practice known as flipping is another reason for failure as thenature of the investment is often associated with short term profit with less effort. Real estatemarkets in most countries are not as organised or efficient as market for other more liquidinvestment instruments. The individual’s properties are unique to themselves and not directlyinterchangeable, which presents a major challenge to an investor seeking to evaluate prices and2investment opportunities. For this reason, locating properties in which to invest can involve

substantial work and competition among investors and to purchase individual properties may behighly variable depending on knowledge of availability. Information asymmetries are commonplace in real estate markets. This however, increases transaction risks, but also provide manyopportunities for investors to obtain properties at bargain prices. Real estate investors typicallyuse a variety of appraisal techniques to determine the value of properties prior to purchase.Investment in real estate is undertaken for its ability to provide returns inform of capital, incomeand intangible benefits (Baum & Crosby 1988). However returns in commercial real estate aremaximised when there is full occupancy, prompt and total rent collection ,full market rent , goodphysical condition of building, minimal irrecoverable outgoings and low rate of tenant turn over.Studies by Ziening & McIntosh (1999) and Tonto, Wheaton & Southard (1998) have shown thatthe greater volatility in return in commercial real estate is not an appraisal problem but astructural problem of the property markets and real estate property as an investment vehicle. Themost typical sources of investment properties include: market listing (through multiple listingservice or commercial information exchange), real estate agents, wholesale (such as banks realestate owned department and public agencies), public auction (foreclosure sales ,estate sales ),and private sales.1.2 Statement of The ProblemReal Estate comprises lands plus anything permanently fixed to it, including buildings and otheritems attached to the structure. Examples of real estate include undeveloped land, houses, townhomes, office, building, retails store and factories (Brown and Matysiak, 2000). According toSyagga (1987) the principal types of real estate property includes-: rural land use (which consistsof farmland, forestry and mineral land), urban land which consists of (commercial, industrial andresidential properties) and special type of property such as (petrol stations, recreational facilities,hotels and restaurants, halls and places of assembly and institutional property). The real estatemarket and industry covers land and improvements, their selling and rental prices, the economicrent of land and returns on buildings and other improvements, and the construction industry. Theinvestment represents a significant portion of people’s wealth, and this is especially true for3many real estate investors in Kenya. However commercial real estate in Kenya has been facedwith shrinking occupation demand and there exists disparities between expected and actualincome which may be either positive or negative (Murigu 2005). Real estate prices in Kenya hasdoubled, even tripled in the past few years (Majtenyi, 2010) and the government wants to knowthe cause. Demand for housing units continues to outstrip the supply (Masika, 2010). The sizeand scale of the real estate market makes it an attractive and lucrative sector for many investors.Nuri, E. & Frank Nothat,(2002) in a study found that the population of Kenya has steadilyincreased, resulting in an urban population in Nairobi of a record of 3 million people, wherebyall these people need shelter, hence the real estate industry is tremendously doing well andcontributing to the economy’s growth. Real estate investments and prices are good measures forreflecting expected real estate demand, and serve as good predictors of economic growth (KnightFrank, 2011). A survey conducted by Hass Consultants in association with CFC Stanbic bank inthe year 2010 revealed that the Kenyan real estate sector has been vibrant for the past decadebetween the years 2000 to 2010. For instance the report also indicated that capital gains fromKenyan properties far outstrips gains from US and UK properties. This has eventually made theKenya real estate market to be the winner in the international property investment amidst theindebtedness in the Western Countries (Mwithiga, 2010).According to a report by the National Housing Corporation (NHC), the Vision 2030 estimatesthat the country requires 200,000 new units of housing but only 35,000 units have been producedto date. That means we have a deficit of 165,000 housing units. Similarly, a report from theKenya National Bureau of Statistics (KNBS) indicates that real estate investment has contributeda lot to the growth of Kenya’s Gross Domestic Product. For instance data from Kenya NationalBureau of Statistics report (2012) shows that, in 2008, real estate contributed 107, 323, 000shillings to the country's GDP. In the subsequent year, 2009, the value of GDP attributable to

real estate reduced slightly to 116,657,000 Kenyan Shillings. In addition the value of GDPfurther rose in 2010 to 123,173,000 shillings and consequently the contribution to GDP from realestate rose further in 2011 to 134, 746, 000 Kenyan shillings. Real estate and renting businessservices play a crucial role in the Kenyan economy (statistical abstract 2011). For instance theinvestment grew at 3.5% in 2007 and rose slightly to 3.7% in 2008.4However, the growth declined sharply to 3.0% in 2009 due reduction in capital investment andthe poor performance of the economy as a result of the post-election violence that led todestruction of property and in the 2007 General elections. The growth picked up in thepreceding years at 3.2% and 3.6% respectively in 2010 and 2011 respectively as investmentclimate became conducive and by the of the end of the third quarter of 2012 the investment wasgrowing at 3.8% depicting an increasing trend. There has been a great appreciation of propertyprices and volatility across the different property markets in Kenya since the year 2006.According to Hass property consultants, in the first property index in Kenya, the prices for highend residential properties has doubled between 2005 and 2009 (Hass property index, 2009). Thecurrent rental yields that are the return on capital tied up in property is however much lower thanmortgage interest. The Hass consultant property index data for the first quarter in 2011 indicatedthat rental yield are down to 5.62 per cent per from a high of 7.3 percent per year in 2007. TheHass survey further revealed that property prices have risen to 55 per cent since the 2007 whilerental yields have appreciated with only 18 per cent. The main concern is that real estatecontribution to the economy of Kenya (as measured in relation to the economic growth) hasfaced a declining trend for the past years. For instance in 2008, it contributed to 5.1% of totalGDP, and in 2009 it reduced to 4.9% of GDP. Subsequently it slightly fell to 4.8% in 2010 andfurther declined to 4.5% in 2011. There is need therefore establish and assess the factors thatcontribute to the growth of the investment so as to sustain the investment growth in future.1.3 Research Questions(i) What is the impact of GDP on the growth in Real Estate Investment ?(ii) What is the contribution of interest rates to the growth in Real Estate Investment ?(iii) To what extend do changes in inflation rate affect the growth in Real Estate Investment ?(iv) What is the impact of population growth on Real Estate Investment ?1.4 Objectives of the studyThe general objective of the study is to determine the factors influencing investment in the realestate in Kenya.51.4.1 Specific ObjectivesThe study specific objectives are;(i) To examine the impact of GDP on the growth in real estate investment in Kenya.(ii) To determine the contribution of interest rates on the growth in real estate investment inKenya.(iii)To determine the extent to which inflation rates affect the growth in real estate investment.(iv) To examine the impact of population growth on the growth in real estate investment.1.5 Study HypothesisIt is hypothesized that the GDP growth is the main contributing factor to the growth in real estateinvestment in Kenya.1.6 Significance of the studyThe results and findings from this study will form a basis for policy formulations on ways ofcontrolling for the determinants of real estate so as to sustain the investment growth in future.1.7 Scope of the studyThe study investigated the factor affecting growth in real estate in Kenya with emphasis on theassessment of the various contributions of factors such as GDP growth, inflation rates,population growth rates and rate of interest. The study area involved private and publicdevelopers in real estate property. Data for the study was on time series covering real estate

renting business. The study covered a period of twelve years between 1998 to 2012.1.8 Organization of the studyThe study was organized into five chapters, chapters one to five. Chapter one discussed thebackground of the research, statement of the problem, objectives of the research, studyhypothesis, research questions, significance of the study and scope of the study. The nextchapter, chapter two, was on literature review where related literature from various scholars wasreviewed and an overview based on the literature given. The third chapter was on researchmethodology, which comprised sample design, research design, and the means of data collection6