Analysis of Inflation, Interest Rate, Exchange Rate and Real Estate Residential Property Prices, Kenya

Abstract

Real estate as an investment has continued to form an important part of investments held by both retail and institutional investors over the years. This has been attributed to its ability to generate continuous income streams and capital appreciation of the underlying asset. The Kenyan population is expected to hit 60 Million in 2030, with more than 50% expected to reside in urban areas. This, compounded by the higher-than-average returns experienced in the real estate sector, makes real estate an important investment for investors' portfolios. For instance, one Million invested in 2017 in the real estate sector would have been worth 9.61 Million in 2021, which is higher than that for bonds and equities. Notwithstanding this impressive return component, real estate investments in Kenya have faced challenges such as increased cost of credit through fluctuating interest rates owing to residential real estate being mostly financed by debt. Hence, unstable interest rates affect their market prices. Real estate residential investment has been susceptible to booms and busts and erratic exchange rates, which affect the value of investments made by both local investors and remittances from abroad from time to time which results in either inflated property prices which get out of reach of common retail investors or lack of demand for investors in a market facing a glut. Over the years, inflation has been rising steadily, with each investor becoming more interested in how this might affect their real return. Real estate, which is heavily leveraged, has also been prone to changes in the interest regime in the economy, which affects the cost of borrowing. The study concentrated on inflation, the interest rate regime, and the state of the exchange rate and drew conclusions while referencing finance and economic theory. The study established that a percentage increase in inflation results in a 2.248% increase in real estate residential property prices. On the other hand, a percentage increase in interest rate results in a 9.630% increase in real estate residential property prices. The study also establishes that real estate residential property prices have a negative relationship with exchange rates. Whereby a percentage increase in exchange rate results in a -1.995% decrease in real estate residential property prices in the long run. The study, therefore, recommends the inclusion of real estate investments in investors' portfolios to hedge against inflation and, at the same time, ensures that investors limit interest-sensitive asset classes such as fixed-income securities in portfolios containing residential real estate exposures. Lastly, the study recommends that investors use derivative securities such as futures contracts to hedge against adverse exchange rate movements in real estate residential properties that have exposures .in the foreign exchange markets either through foreign-denominated leases or rental contracts.