How lucrative is the real estate sector?

BY LYDIA LIMBE

Real estate has always been considered lucrative, with everybody striving to cash in on the perceived massive profits, in one way or the other. But just how lucrative is real estate business?

“Like other businesses, real estate has its patterns. There are risks and gains. You have to know the factors that drive the real estate market in the area you would like to invest in,” says Michael Osewe, a land economist.

“Each market segment has its own dynamics. The high end wants excellent homes in a good neighbourhood, while the low-end wants pocket-friendly property. The high-end market is smaller than the low end, therefore, you have to be strategic in deciding which segment to invest in,” says Osewe.

Real estate business is demand-supply driven. Osewe says you have to be careful how you invest in real estate. That means you have to be clear where demand is: high-end or low-end?

Scenario

“I bought a plot on Riara Road, Nairobi, in the 1980s. I had been preparing to buy another one in Lang’ata, but changed my mind and bought the Riara Road one because it was near my house in Kileleshwa,” says Verkeys Hongo, who has since put up a 20-unit apartment block on the plot.

He bought the half-acre property at Sh5 million. It is now valued at Sh50 million. He spent about Sh160 million to put up apartment block, not to mention other incidental costs.

“I had to pay ten per cent of the construction cost to the professionals to draw up the plans, 0.05 per cent to National Environment Management Authority (Nema), and about Sh40,000 to the council for the relevant permits,” says Hongo, who is also a quantity surveyor.

An architect, structural, electrical and mechanical engineers have to be consulted during the planning and drawing stage of a new building.

The charges came to a total of Sh24.04 million — money he had to have upfront, because the construction loan he took only covered the actual building cost of the property. This is usually the bit about real estate that makes it a not-so-easy venture.

“Real estate needs a large capital outlay — it is not cheap. Lenders give construction loans for a maximum period of two years, and the interest rates charged are also high,” Osewe points out.

Rates

Interest rates change according to the Central Bank of Kenya base-lending rate. Due to this fluctuation, the period within which a real estate business venture breaks even can only be projected. It is mostly between four and seven years for rental real estate.

“When buying land, study the market trends within which you plan to invest, and see the best way you can maximise on your space. The common practice nowadays is building a multi-dwelling property, as this will allow more units on a small piece of land,” says Osewe.

You must also visit the council offices to find out the zoning plan of the area you would like to build on. This will inform you on the type of development permitted in that area.

But how do developers cushion themselves from the high cost of construction?

“Five of us came together and bought ten acres. We then contributed 30 per cent of the total cost of building 120 housing units on the land,” says Eric Ounga, the Managing Director of Ounga Commercial Agencies. The company is a real estate developer in Kisumu, and is currently putting up Sh120-million luxury homes on the ten-acre piece of land in Kisumu.

The bulk of the money is spent on construction work. Once construction is completed and people start buying the property, or leasing space, most often the money goes into repaying the construction loan.

When you do the appraisal, the discounted cash flow formula used to calculate the break-even point will inform the investor when his business will reach equilibrium.

Planning

In the event a development does not attract buyers as expected, and the loans still have to be serviced, what happens?

“First, I totalled up all the costs. And by total I mean the loan plus interests, the cost of land, construction cost as well as professional fees and divided them by the total number of housing units to get the selling price of each house,” says Hongo.

Each unit is going for Sh15 million at the moment. So far, he has managed to sell two units, and leased the rest at Sh75,000 per month. It is with these amounts paid that he services the loan.

“Another way of cushioning yourself from the high cost of loans, especially when the property is not making as much money as had been expected, is to have several properties that ‘mature’ at different times. This way, you are sure of cash flow at all times,” adds Osewe.

Lucky for Hongo, he has got other properties he had invested in earlier that have already ‘matured’.

One of the attractive factors of real estate is that it appreciates in value.

But even that, the total profit depends on whether or not the plot built on is serviced or not.

“As per our projections, we will make about 20 per cent profit because part of the money will go into building access roads, installing water and sewer lines,” says Ounga.

His sentiments are echoed by Charles Kibiru of Thika Greens. “If you get a fully-serviced piece of land, your profit margin is between 35 per cent and 40 per cent,” says Kibiru.

Once completed, some property investors prefer to take the headache of selling and leasing off their shoulders, and have property agents do it on their behalf. Of course, this additional cost claws onto the profit expected.

You will receive three per cent less on every unit you sell, minus the marketing fee charged by the agent. For properties leased out, an agent will charge about five per cent on the rent paid monthly.