Nigeria is a country with a population of over 200 million people, and a huge demand for housing and infrastructure. However, the Nigerian economy has been facing economic challenges such as inflation, recession, and currency devaluation, which have affected the real estate sector negatively. According to the National Bureau of Statistics, the real estate sector contracted by 9.22% in the third quarter of 2020, compared to a growth of 2.36% in the same period in 2019.
One of the major factors that have impacted the real estate sector is the devaluation of the naira against the US dollar. The naira has lost over 60% of its value since 2015, when it was trading at around N200 to $1. As of 25th January 2024, the official exchange rate was N900 to $1, while the parallel market rate was over N1,460 to $1. This implies that investors who initially purchased properties using the naira and saw gains in naira terms would suffer significant losses in terms of purchasing power and returns on investment, when the gains realized are converted from naira to dollars, reflecting the impact of a weaker naira against the dollar on their overall investment returns.
Case Study:
A property was purchased in 2010 for N5 million, equivalent to $32,000 at the time. Fast forward to the present day, the property’s value has appreciated to N30 million in local currency. However, when converted to dollars, the property’s worth has depreciated to $21,000. This situation underscores a stark reality for the investor, who is now contending with a substantial loss of approximately 37.5% on the initial investment when evaluated in dollar terms.
Furthermore, the high inflation rate, which was recorded at 24.5% as of December 2023, has significantly devalued the naira, consequently diminished the real income or gains (in naira terms) accrued from the initial investment.
Analysis:
The case study illustrates the dilemma faced by many investors in Nigerian real estate: Whether to hold or sell their properties in a depreciating currency environment.
On one hand, holding on to their properties may seem attractive, as they can benefit from the appreciation of their properties in naira terms. On the other hand, selling their properties may seem prudent, as they can convert their proceeds into dollars or other stable currencies, and avoid further losses from naira devaluation.
The answer to this question depends on several factors, such as the investor’s objectives, risk appetite, time horizon, liquidity needs, and alternative investment options. There is no one-size-fits-all solution for every investor. However, some general principles and strategies can be applied to help investors make informed decisions:
- Investors should consider the opportunity cost of holding or selling their properties. Opportunity cost is the value of the next best alternative that is forgone as a result of making a decision. For example, if an investor decides to hold on to his property worth N30 million ($21,000), he is foregoing the opportunity to invest that money elsewhere at a higher return or lower risk. Similarly, if an investor decides to sell his property worth N30 million ($21,000), he is foregoing the opportunity to enjoy future appreciation or rental income from that property. Therefore, investors should compare the expected returns and risks of holding or selling their properties with those of other available investment options. For instance, if an investor can find another investment option that offers a higher return or lower risk than holding his property in naira terms, he may be better off selling his property and investing the proceeds elsewhere. Conversely, if an investor cannot find another investment option that offers a higher return or lower risk than holding his property in dollar terms, he may be better off holding on to his property and enjoying its appreciation or rental income.
- Investors should consider the impact of inflation on their real returns from holding or selling their properties. Inflation is the general increase in the prices of goods and services over time. It reduces the purchasing power of local currencies and erodes the real value of assets denominated in that currency. Nigeria has been experiencing high inflation rates in recent years, averaging about 20% per annum since 2016. This means that a property worth N30 million ($21,000) today may be worth less in real terms tomorrow if inflation continues to rise. Therefore, investors should adjust their nominal returns from holding or selling their properties for inflation to get their real returns. For example, if an investor holds his property worth N30 million ($21,000) and expects it to appreciate by 10% per annum in naira terms, his nominal return would be N3 million ($2,100) per annum. However, if inflation is 15% per annum, his real return would be -5% per annum, meaning that he would lose money in real terms by holding his property. Similarly, if an investor sells his property worth N30 million ($20,000) and expects to invest the proceeds in a dollar-denominated asset that yields 5% per annum, his nominal return would be $1,000 per annum. However, if inflation is 15% per annum, his real return would be -10% per annum, meaning that he would lose money in real terms by selling his property.
Therefore, investors should seek to invest in assets that can generate positive real returns after adjusting for inflation. This may require diversifying their portfolios across different asset classes, currencies, and markets, to hedge against inflation and currency risks.
Conclusion:
Investing in the Nigerian real estate market amidst the naira devaluation vis-à-vis the US dollar is a complex and challenging decision that requires careful analysis and planning. Investors should consider the opportunity cost, inflation impact, and tax implications of holding or selling their properties, as well as their objectives, risk appetite, time horizon, liquidity needs, and alternative investment options. Investors should also seek professional advice from financial planners, real estate agents, tax consultants, and legal experts to help them make informed decisions.
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