INFLUENCE OF MACRO-ECONOMIC VARIABLES OFFICE PROPERTIES RENTAL RETURNS IN ENUGU
INFLUENCE OF MACRO-ECONOMIC VARIABLES OFFICE PROPERTIES RENTAL RETURNS IN ENUGU
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
According to Knight Frank’s Africa report (2013), Africa is in the midst of a period of dynamic economic expansion, having average GDP growth of more than 5% per annum over the last decade. This strong growth is expected to continue and is creating wealthier populations, particularly in the largest and most rapidly growing urban centers. Africa’s “mega-cities” such as Lagos, Accra, Lusaka and Nairobi are increasingly becoming the drivers of its economic growth and as a result are attracting growing interest from occupiers, developers and investors. It noted that, the increasing wealth and sophistication of African consumers is leading to rising demand for modern retail formats and western-style shopping centers. However, in the office sector, many key African cities have severe shortages of high quality space built to the specifications expected by international companies. This scarcity of supply has lead to extremely high rents in some cities, particularly where there is strong demand for office space from international occupiers from the oil and gas sector. (Knight Frank, 2013).
The aim of every rational investor is to maximize profits on investments while trying as much as possible to reduce the risks involved (Tenigbade, 2011). Commercial real estate occupies a prime place in the property market as it commands a sizeable chunk of property investment either as direct or indirect investment into real property (Dugeri, 2011). According to Wyatt (2007), about 52% of the total investment into real estate in the UK is in the commercial property sector. It is worth mentioning that international direct investment into real estate is significantly made into the commercial property sector.
Generally, there are certain variables that influences consumer behavior especially as it has to do with their purchasing power and the way it reflects on the demand for commercial property. Consumer purchasing power is usually affected by the general economic outlook and the supply of cash in the economy (Tenigbade, 2011). Opening up of a new town also has its effect on demand for commercial property (Osagie, 2012). As it is being experienced in the city of Enugu, most areas are changing from residential property use to commercial largely because they command high rental and a property owner is always inclined to that use that will command highest and best use.
Over the years, investment in real estate has been professed to offer a hedge against inflation (Amidu and Aluko, 2006). This in simple term means that it has the power to protect the investor’s funds against the eroding power of inflation. With the current inflation rate at 8% and bank lending rates at 12% (CBN, 2014), an investor needs to be sure that investing in real estate will cover not only current but also future risks. However, despite the fact that most investors are risk-averse and will prefer more return and less risk, the Nigerian property market has frequently been characterized by naïve decisions (Olaleye, 2008).
Developers, financers and investors in commercial properties are faced with dearth of data on what level of rental income a development project could reasonably be expected to realize in a transaction involving willing and able parties (Ayodedle, 2011). The overall impact of risks and uncertainty in the property market calls for tools to predict future trend in commercial property market with some measure of accuracy. This is to ensure that income which is a given commercial property generates in the nearest future will be sufficient to recoup the capital outlay and be sustained subsequently.
1.2 Statement of the Problem
Real estate prices are limited in how far they can rise by the incomes of potential buyers which is determined by the present economic situation in the country as at that time, and also fluctuations of some of the key fundamentals in an economy as effects on every market economy (Begg, 1994).
Alteration in the government’s budget through aggregate expenditure will influence the behavior of the whole economy. a rise in government expenditure on goods and services or transfer of payments will increase demand in the economy. this will have beneficial impact because it will increase total output and employments which will in-turn affect price in different sector of the economy, real property inclusive.
In Nigeria today, price control occurs in situations where the political system indiscriminately interferes with the normal markets operation by fixing prices instead of allowing prices to be determined freely in the market by the micro and macro factors of the economy.
1.3 Aim and Objectives of the study
The study is aimed at establishing the extent of influence of macro-economic variables on the returns of commercial properties in prime locations of Enugu State. to achieve this aim, the following objectives are set: These are to;
- examine the characteristics of office property market in Enugu metropolis;
- ascertain the level of returns from office properties in the study area;
- identify the factors that influence the rate of returns from office properties in the study area; and
- analyze the effect of macro-economic factors on the rate of returns.
1.4 Research Questions
- What are the characteristics of office property market in Enugu metropolis?
- What is the level of returns from office properties?
- What are the factors that influence the rate of returns from office properties?
- What is the effect of macro-economic factors on the rate of returns?
1.5 Significance of the Study
McCue and Kling (1991) explored the relationship between the macro-economy and real estate returns. Equity REIT data were used as a proxy for real estate returns, the equity REIT returns were regressed against returns from the Standard and Poors 500 stock index, saving the residuals. These residuals are known as extra-market covariance between equity REIT returns and overall stock market. The residuals represent pure industry effects. The residuals are then employed in an unrestricted vector autoregressive model with the macroeconomic variables to test for relationships. The results show that prices, nominal rates, output and investment all directly influence the real estate chain. Quingping (2008) concluded that the housing sector plays an important role in Taiwan’s economy as it is able to hedge against inflation in the long-run. In Singapore, commercial properties establish not only a perfect one-to-one correspondence relationship with the inflation rate, but they also increase at a faster rate than the increase in the inflation rate. Kofoed-phil (2009) used an error correction regression model, to econometrically analyze the macroeconomic determinants of the quarterly real estate total returns from 1984-2008. It discovered that unemployment and the long term interest rate are negatively influencing the total return of the US real estate market, while the gross domestic product over time heavily influences the total return positively. The fourth analyzed variable inflation was found not to have any noticeable influence on the return.
Chan (2011) examined the forecasting return of commercial properties in South Africa using macro-economic factors. In this research, both direct property returns (IPD) and indirect property returns (J255 and J256) were investigated. The macroeconomic factors that are identified to have some influence on commercial property return are term structure, gilt equity ratio, employment index, building plan passed and changing inflation rate (CPIX index). Four different types of models were investigated, namely the univariant ARMA model, the univariant GARCH model, the VAR model and MLP neural network model. The optimal model for each type is identified using AICs and BIC information criterion techniques. The ARMA model and the neural network were identified to best predict indirect and direct property returns, respectively.
Bello (2005), while studying the Inflation Hedging Characteristics of Residential Property Investment in Nigeria between 1996 and 2000, established that real estate investment in Nigeria is not an all time hedge against inflation. Tenigbade (2011) empirically established the inflation hedging properties of commercial properties in prime locations of Enugu State. The Ordinary Least Square model as proposed by Fama and Schwert (1977) was used to regress real estate rates of returns actual, expected and unexpected inflation rates. The results show that, for prime locations around Enugu metropolis, commercial properties provide a perverse hedge against actual inflation. Whereas, commercial properties within Enugu and environs have been seen to present a complete hedge against actual inflation. Osagie, Gambo, Anyakora and Idowu (2012) looked at the inflation hedging capacity of office and shop property in Enugu metropolis from 1998-2008. Using data gotten from registered Estate Surveyors and Valuers who have properties such under their management. The study used descriptive analysis and line diagrams to show the trend of returns on commercial real estate investments in percentage against the change of inflation over the period under review. The results revealed that on the short run, office property does not provide a good hedge against inflation but does so on the long run, while shop property does not provide a good hedge either on the long or short run. Ojetunde (2013) the paper revisits the interaction between the Nigerian macro-economy and the operation of its residential property market using econometric analysis. By employing a larger sample and different data analysis approaches (pair wise correlations, co-integration, granger causality and vector auto regression) the objective is to provide further evidence on the extent to which the property market is integrated or linked to macro-economy. The evidence suggests that macroeconomic variables (real gross domestic product, inflation, exchange and interest rates) have long term relationship with residential property rents in Nigeria. The results of the granger causality shows that both exchange and interest rates have useful information for predicting residential property rents over and above the past values of other macroeconomic variables. The result of the variance decomposition within the vector autoregressive model further confirmed that real GDP and exchange rate combined forecast 31.4% of the variance in residential property rents. The study concluded that the response of the residential property market to macro-economic shocks of interest rate, real GDP, and exchange rate implies a relatively slow adjustment of the property market to the ever changing macro-economic events in Nigeria making long run equilibrium elusive.
As closely related as the various researches are, they have all produced different results. This disparity can be attributed to various factors including varying timeframes areas, fluctuating economic conditions and differences in microeconomic and macroeconomic indicators among other issues. The commercial property class in Enugu has also become an attractive investment commodity owing to its increase in demand; hence, this research proposes to assess the impact of macro-economic variables on the returns in commercial properties in prime in Enugu State.
1.6 Scope and Limitation of the Study
The scope of this research will be limited to Enugu State and its macro-economy because of the relative vibrancy of the property market in the city compared to other cities of the Federation. James (2008) defined a prime area as a location that is first in excellence, quality and value. Based on this, Enugu will be adopted for the study. Also the class of commercial properties to be investigated by this study is the purpose built office properties as it constitutes the highest in terms of demand and concentration. Based on the fact that the research focuses on commercial real estate, locations where there are high presences of commercial activities are of prime importance to this study.
The following are the problems I encountered when carrying out the research work:
(a) Financial constraints
(b) Limited Time
(c) Lack of cooperation attitude from respondents
1.7 Operational Definition of Terms
MACROECONOMICS: this is the branch of economics that studies the behavior and performance of an economy as a whole. It focuses on the aggregate changes in the economy such as unemployment, growth rate, gross domestic product and inflation.
INFLATION: this is the rate a price rises, and essentially how much the dollar is worth at a given moment with regards to purchasing. The idea behind inflation being a force for good in the economy is that a manageable enough rate can spur economic growth without devaluing the currency so much that it becomes nearly worthless.
, AN EXCHANGE RATE: is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency.
UNEMPLOYMENT RATE : this is a measure of the prevalence of unemployment and it is calculated as a percentage by dividing the number of unemployed individuals by all individuals currently in the labor force.
INTEREST RATE: this is the amount of interest due per period, as a proportion of the amount lent, deposited or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, the compounding frequency, and the length of time over which it is lent, deposited or borrowed.
REAL GROSS DOMESTIC PRODUCT: This is a measurement of economic output that accounts for the effects of inflation or deflation. It provides a more realistic assessment of growth than nominal GDP. Without real GDP, it could seem like a country is producing more when it’s only that prices have gone up.
PROPERTY: this is anything that a person or business has legal title over. Property can be either tangible or intangible, and having legal title to it grants the owner certain enforceable rights. Typical examples of a tangible property include real estate, also known as real property, vehicles, furniture, and equipment.
OFFICE: Its a location, usually a building or portion of a building, where a company conducts its business. A company can have just one office, known as its home office, or a main office and a variety of field offices or branch offices. All of these offices are involved in some way in the business of the company.
A RETURN: also known as a financial return, in its simplest terms, is the money made or lost on an investment. A return can be expressed nominally as the change in dollar value of an investment over time. A return can be expressed as a percentage derived from the ratio of profit to investment.
RENT: This is the Compensation paid by a tenant (or lessee) to the property owner (or lessor) for use or occupancy of a property.
1.8 The Study Area
Enugu State is one of the thirty-six States constituting the Nigerian Federation. It came into being on August 27, 1991 when the administration of President Ibrahim Babangida finally acquiesced to the long agitations of Waawa people for a State they could truly call their own. Enugu State derives its name from the capital city, ENUGU (top of the hill) which is regarded as the oldest urban area in the Igbo speaking area of Southeast Nigeria.
Enugu State is an inland state in southeastern Nigeria. Its capital is Enugu where the state derives its name.
It shares boundaries with Anambra on the West, Abia State on the South, Kogi on the North while Benue and Eboyin on the East. Enugu and Nsukka are its major towns. Enugu was the headquarters of the former East Central State and Eastern Nigeria.
Enugu State is in the South East geo-political Zone of Nigeria. It is located at 6o30′ North of Equator, and 7o30′ East of Latitude. It covers an area of 7,161 km2 (2,765sq mi), and ranks 29th out of the 36 States of Nigeria in terms of land area. Enugu State has a good climatic condition all the year round. The hottest month is February with about 87.16oF (30.64oC), while the lowest temperature is recorded in November/December, reaching about 60.54 oF (15.86oC). Lowest rainfall of about 0.16 cubic centimeters (0.0098 cu in) is recorded in February, while the highest rainfall is recorded in July at about 35.7 cubic centimeters (2.18 cu in).
Enugu State is also densely populated, and is rated at 460/km2 (1,200/sq mi). This is regarded as one of the highest in Africa. Demographers have however, continually put the realistic population figure of Enugu State at six million. The State’s area code is 042, while its ISO 3166 code is NG-EN. Official website is Enugustate.gov.ng.
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