Economic Factors, Property Supply, Rent Value, and Residential Real Estate Prices in Nairobi County

Abstract

Residential real estate is a key investment for both institutional and individual investors. Investors’ returns namely rental yield and capital gains is predicated on changes in house prices. As such, understanding the factors that influence house prices is central to the investment process. The problem is that there is no unified model for house pricing which is exacerbated by uniqueness of context. The focus was on the residential real estate market in Nairobi County, Kenya. Nairobi is a renters’ market dominated by individual investors with about 90.7% of households renting. House prices and rent value have been on the rise. The effect of rent on house prices is scarcely studied. There was a gap in understanding the interplay of demand drivers, property supply, house characteristics and rent value in determining house prices. There was also a gap in the way house prices and rent value have been characterised in past studies necessitating the construction of house and rent indices in this study. The study aimed at determining the relationship among economic factors, property supply, rent value and residential real estate prices. The study was anchored on the hedonic pricing model, stock flow model and efficient market hypothesis. It was also anchored on positivist philosophy and quantitative research design. Hypotheses were developed in keeping with the objectives of the study. Quarterly data was collected for the ten-year period under study and subjected to diagnostic tests. Autoregressive Distributed Lag model was adopted due to mixed stationarity. Real estate prices and rent value were operationalised by price index and rent index developed using hedonic model based on the data collected on actual selling price, rent paid and characteristics of a sample of houses in Nairobi spanning ten years. The study found out that GDP and inflation had significant positive long run effect on real estate prices. Property supply had a significant negative long run effect on real estate prices. However, interest rates did not have significant effect on house prices. In the short run however, GDP had a significant negative effect on prices. The speed of adjustments towards equilibrium relationship is 71.9%. Therefore, 71.9% of deviations from long run relationship in a particular quarter is corrected in the following quarter. The real estate market seems to be efficient despite its illiquid nature. The findings of the study indicate that rent value mediate partially the effect of inflation on real estate prices. As such, inflation has some residual direct effect. GDP and property supply have direct non-mediated effect on real estate prices. Also, the joint effect of economic factors, property supply and rent value on real estate prices was found to be significant. The study contributes to knowledge through its development of both price and rent indices. It adds to knowledge by finding that the effect of selected economic factors on real estate prices is partially direct and partially channelled through rent value. The findings also added to the mixed findings in literature in relation to the effect of interest and inflation rates on real estate prices. The finding relating to price and rent indices may inform property tax policy for county governments. Banks and mortgage providers will find the study outcome useful in pricing mortgages loans. Regulators such as IRA, RBA, CMA, CBK may tailor investment and prudential guidelines for their licensees to the study findings. Also, house price and rent indices can be used as benchmarks for portfolio performance attribution and creation of new products such as index funds. Future studies can focus on non-residential real estate markets, incorporate atheoretical models, include other variables such as investor characteristics guided by theory and practice in furthering understanding of the determinants of real estate prices.