Commercial/Office Sector
Office rents in Nairobi are expected to be static in the short to medium term amid harsh economic times that have led to currency depreciation and a decrease in GDP growth rate.
This contrasts prime real estate properties in Kenya that have remained resilient to market shocks. According to real estate consultancy firm Knight Frank, exclusive high-end office, retail, and residential developments continue enjoying prime rents, and above market occupancy rates.
Occupancy levels in Nairobi nevertheless fell by 3.9 per cent in H1 2023 to 71.5 per cent. This is in tandem with an 18.72% drop in absorption rates in H1 2023, from H2 2022.
The discrepancy between demand and supply has made investors holding out on above market rents to ultimately give in and accept at least what the market is willing to pay for.
The first half of 2023, similar to previous periods, have prime office rents remaining static at $1.2 (about Sh179 at current exchange rates) per square foot, per month.
Key Economic Data
Data by Kenya National Bureau of Statistics indicates the following:
- The construction sector recorded a decelerated growth of 3.1 per cent in the first quarter of 2023 compared to 6.0 per cent growth in the first quarter of 2022.
- This decelerated growth was reflected in the volume of cement consumption, which declined by 7.7 per cent during the period.
- Credit advanced to the construction sector increased from Sh397.8 billion in 2022 to Sh414.6 billion in the same quarter of 2023.
- The overall economic growth slowed to 5.3 per cent compared to 6.2 per cent growth in the corresponding quarter of 2022.
Rising Loan Defaults
The current economic situation has seen a significant rise in loan defaults amid high interest rates, with the real estate sector among those affected. The Central Bank of Kenya reported that the ratio of gross non-performing loans (NPLs) to gross loans stood at 15.0 per cent in August 2023, compared to 14.2 per cent in August 2022. Additionally, borrowers have now defaulted on more than Sh596 billion in loans.
According to Knight Frank, the increasing cost of capital amidst struggle by developers to service their loans has made financial institutions "very conservative" in supporting large real estate developments, hence the subdued real estate activities.
Dollar-Denominated Rentals
On another note, a growing trend is a preference from landlords for dollar denominated rentals which has proven beneficial for tenants whose earnings are in dollars, while posing a drawback for those whose income is in shillings. This preference has arisen due to the continuous devaluation of the Kenyan shilling against the US dollar, leading to forex losses, and also allows the alignment of revenue and cost currencies as most commercial debt is dollar denominated.
Supply Pipeline
The fall in occupancy levels in H1 2023 is attributed to the introduction of more than 600,000 sq. ft. of grade A office space in 2022, combined with non-renewals of some leases as more companies take up remote working and working from home to reduce recurrent expenses. The pipeline supply for 2023 remains subdued compared to previous years, as very few office developments are expected to be completed.
Our View
In the short and medium term, the office space will remain a tenant's market attributed to the oversupply in office spaces as well as the ongoing company trend of working from home and integration of co-working spaces. The imbalance between demand and supply will continue to push investors to adjust and accept rents closer to market rates.
Additionally, developments for office spaces are bound to decline as investors are discouraged by the increase in cost of capital as well as lower returns, given that rental rates are at the discretion of tenants and lower occupancy due to companies cutting down on office spaces.
Going forward, developers and investors may look into integration of hybrid office spaces as well as the integration of sustainable or ESG initiatives in the wake of growing awareness on green buildings and certification such as Leadership in Energy and Environmental Design (LEED) and Excellence in Design for Greater Efficiencies (EDGE) to match demand in the market.
Source: The Star and Sterling Real Estate Advisory