Testing for bubbles in the commercial real estate rental market in Nairobi, Kenya

Abstract

This study tests for a bubble in the commercial rental market in Nairobi by examining the movements of commercial rental prices within Nairobi between Q1 2010 and Q2 2020 and whether they are driven by economic fundamentals. The study sought to construct a commercial rental price index using index numbers with a base period of Q1 2010. This index was used to test the relationship between the movements in price and the selected macroeconomic variables through the use of correlation and regression analysis. The study found strong positive correlation between the commercial rental price index and GDP as well as building cost index while weak negative correlation with lending rates, inflation rates and the Nairobi stock exchange index. The study proceeded to drop lending rate and inflation rate from the model as they were seen to have no linear relationship with the commercial rental price index. The study adopted the Johansen cointegration test as a bubble detection method to test for the existence of a long run relationship between the commercial rental price index and the remaining variables, this was found to be present with GDP and the Nairobi stock exchange index seen as having a negative impact on the commercial rental price index while the building cost index having a positive impact. The existence of a long run relationship between the variables was seen as a rejection of the existence of a bubble within the rental price market. Granger causality test was also used to detect for the existence of a bubble and the results were that two, unidirectional causality existed between the commercial rental price index and GDP as well as with the Nairobi stock exchange index while no causality relationship existed with the building cost index; this was seen as affirmation that a bubble exists. Accordingly, the remaining macroeconomic variables were seen not to precede the commercial rental price index and couldn’t therefore be used to predict it. Despite the mixed findings as regards the cointegration and Granger, the study concluded that the movements in the commercial rental price was part of the cyclic behavior of the market and not evidence of the existence of a bubble. The study suggested use of longer study period and development of a more robust index to further test for a bubble.