Equity Financing profitable for developers

By Morris Aron

Twenty years of designing houses for clients was more than enough for Pete Muraya who six years ago quit practicing as an architect to become a property developer. Together with his wife Sue, they set out as property developers under the company Suraya Property Group. Little did they know of the challenges in housing industry.

George Laboso,Sales and Marketing Manager, S&L

"We intended to introduce middle-income gated housing concepts and price our houses very competitively," says Pete. "It wasn’t long before we realised our dream may never materialise due to the high cost of land in and around Nairobi."

Like several other property developers who dared to enter the real estate business after 2000, the Murayas soon realised they had entered the fray at a time when land prices in the capital city were sharply rising. The change of regime at the turn of the Century had ushered a stable political climate leading to an increase in the number of real estate investors. It also saw tremendous growth in the number of people taking up mortgage loans, leading to high demand for property and a subsequent price escalation.

In Kileleshwa, for example, a quarter acre of land is currently going for up to Sh15 million. Three years ago, one could buy the same acreage for Sh7.5 million.

"Land prices in the middle and upper income neighbourhoods have risen sharply in the last six years due to increased demand and speculation," says Wilberforce Oundo, chief executive of Regent Management, a property firm.

To beat the prices, developers began experimenting with financing models. That is when equity arrangements began popping up.

This is how equity financing works. Most landowners in and around Nairobi have huge parcels of land but lack the capital to construct houses. On the other hand, real estate investors have access to capital. Through an innovative financing arrangement crafted by property and finance experts, the two parties come together through a property developer.

Daniel Ojijo,CEO, Villa Care

Once an understanding is reached between the parties, the landowner is paid for the land at start of the project at a cost slightly less than the market rate using money raised through personal savings and a loan from the financial institution as part of the equity deal.

In addition, the landowner and the developer also share profits as the houses are off-loaded to the market and the financing institution benefits from a ready customer base. Such an arrangement ensures developers are able to price their properties competitively after beating the high cost of land.

High costs of land have also proved to be a major hindrance to the construction of affordable housing, leading to a rise in the number of informal settlements and aggravated housing shortage in the country. According to standard rules of real estate business, the cost of land is approximately 30-50 per cent of the total cost of a project, meaning any increase in land prices would automatically result in highly priced houses.

Players in the housing industry say while property firms continue to devise innovative ways of beating the high land prices, more still needs to be done by policy makers to make affordable housing a reality.

Villa Care was among the first property companies to explore such arrangements with landowners. Soon after, a number of developers joined the trail and it is approximated that three out of every five housing projects along Kiambu Road and the wider northern drift in Nairobi use equity financing.

Last year, Villa Care launched a multi-million residential property project by entering into an equity arrangement with a landowner along Ngong Road near The Junction, a retail chain outlet.

"We realised we needed to partner with landowners to come up with properties that are affordable to the target market," said Daniel Ojijo during the project’s ground breaking ceremony.

Recently, mortgage financier Housing Finance expressed interest in the financing model. Similarly, several other small-scale developers are actively exploring the model. The managing director of Housing Finance, Frank Ireri, says the company is looking at partnering with landowners to increase supply of affordable housing to over 10,000 a year targeted at middle-income earners.

One of the posh properties developed by the Suraya Group. Photo: Courtesy

However, it is the Suraya Property Group that birthed the first large-scale property project by launching a Sh6 billion housing project in Nairobi in partnership with Standard Chartered Bank as the financier.

Government’s Ability

"The State needs to come up with policies that will stifle the rise in land costs brought on by speculation," says Pete.

There are also concerns over the Government’s ability to provide basic amenities such as roads, water and sewerage facilities in order to open up virgin land. The good news is that the quest by property developers has been heard at high places.

The Ministry of Housing recently announced plans to partner with landowners within a radius of 70 kilometres from the CBD and other towns where the ministry will fund the development of basic amenities such as water and sewage lines.

The Cabinet has also just given a nod to the draft land policy, which now moves to Parliament for debate before being made law. Key among the proposals is hefty taxation to any owners of idle land, which is a move meant to encourage development instead of speculation.

In addition, the policy will make it compulsory for the Government to set aside land in designated areas for property development. "We believe these new measures will encourage property development and at the same time open up virgin land in peri-urban areas in the process reducing the cost of land," says Tirop Kosgey, the Permanent Secretary in the Ministry of Housing.