Interest rate cap laws pushes Kenya real estate developers to alternative financing models

A section of apartments and office blocks in Westlands (PHOTO:WILBERFORCE OKWIRI)

NAIROBI, KENYA: For years, property developers have had to contend with high land costs (grew by 19.4 per cent over the last five years), high construction costs (normally 70 per cent of total project costs), and lack of requisite infrastructure.

They have had to rely on financial institutions and their own resources to meet such costs. But the past two years have seen traditional lines of credit decline. The interest rate cap law that came into effect in 2016 ostensibly to spur credit growth has had the opposite effects. In any case, such funding only catered for 70 per cent of development costs.

According to real estate development and investment firm Cytonn, lack of cheap credit resulted in incomplete and delayed projects.

“The constraints have made developers seek alternative funding methods. They want cheaper, easier-to-access, and more reliable means to fund their development activities,” says the firm in a recent report.

According to the Kenya Bankers Association, the interest rate cap has worsened the slowdown in credit to the private sector, with disbursement of credit concentrated in four sectors, namely household, trade, manufacturing, and building and construction: “However, in all these sectors, there was a dramatic decline following the enactment of the capping on loan and deposit rates.”

“Why can’t the government set up a housing fund that can be modelled after such statutory funds as the National Social Security Fund (NSSF)? Why has the government sat on idle land for decades while this can be released to pre-qualified developers with specific terms and conditions?” asks Mwenda Thuranira, CEO of MySpace Properties, a Mombasa-based real estate development and management firm.

Thuranira, who began his real estate journey in the United States, says Kenya can pattern such funds in the lines of Freddie Mac and Fannie Mae, federal entities created in 1970s to expand the secondary market for mortgages in America.

Freddie Mac, for example, would buy mortgages on the secondary market, pool them together and sell them as mortgage-backed security to investors on the open market. The model increased the supply of funding available for mortgage lending and new home purchases.

“The success of a developer depends on the end user’s ability to either rent or purchase the units developed. This hinges on the developer’s ability to secure affordable funding,” says Thuranira.

Francis Kihanya, CEO of Manyatta Real Estate says Kenya has no choice but to embrace alternative financing models. Like Thuranira, Kihanya has had experience dealing with diaspora investors who rely on personal savings to buy property back in Kenya. Some of them have invested in land where companies are currently developing alternative financing options such as staggered payment methods.

“Some land companies are exploring options where you can pay for your property within two to three years. This means the piece of land cannot be charged or handed over to someone else. This gives the buyer peace of mind as there are no banks breathing down his neck,” says Kihanya.

Some developers have used similar models where a prospective owner pays over the long-term. Among them is Superior Homes, developers of Green Park Estate in Athi River, through their model called BOLT (Buy Over the Long Term).

Here are some of the most common alternative funding methods for real estate in Kenya:

Global institutional funds

Lately, a number of foreign investors have been investmenting in the country’s real estate sector due to an improved legal environment, high returns, high demand, especially for residential units, and a stable economy.

The most notable ones are UK-based Actis, which has invested billions in projects such as Garden City; Taaleri from Finland that has invested over Sh4 billion in firms such as Cytonn Investments and Fusion Capital; Chinese engineering services company Avic with a 38.9 per cent stake in Two Rivers; Helios that recently partnered with a local real estate firm Acorn to develop hostels in Nairobi; and China Africa Development (CADFund) that partnered with Suraya Property Group and China Civil Engineering Construction Company to fund redevelopment of 20,000 units in Nairobi.

Local institutional investors

These include insurance companies and pension funds that focus more on members’ contributed capital. These include NSSF, which has invested over 22 per cent of its funds in properties like Hazina Trade Centre and Nyayo Housing Estates; Kenya Power Pension Fund with properties in Nairobi such as Loresho Ridge; and Safaricom Staff Pension Scheme (SSPS) with the Crystal Rivers Mall.  

Structured products

These are funds tailored by and for high-net-worth individuals as alternative investments. They include project notes issued to finance a single or multiple projects and guaranteed by the real estate assets. For example, Cytonn Project Note offers returns of up to 21 per cent annually to high-net-worth individuals and institutional investors.

Saccos and investment societies

These involve a pool of people constantly contributing funds for purposes of investment often in the property sector. Norwich Union Properties, Home Afrika and Transcentury Limited are some of the notable investment societies. Saccos include Uriithi Housing Cooperative and Stima Sacco. Kenya Association of Investment Groups lists at least 300,000 groups in Kenya with assets worth Sh300 billion.

Real Estate Investment Trusts (REITs)

REITs are investment instruments that source for funds to build or acquire real estate assets, which they sell or rent to generate income. There are two types: Investment REIT - an investment in an income generating real estate such as residential or retail development. About 90 per cent of the income is distributed among the REIT holders as dividends. Development REIT - this is an investment in a development company where the REIT holders receive their returns once the company exits the development.

Capital markets

Real estate firms also raise capital for projects by dealing in public shares and bonds. A listed real estate investment trust develops or manages different types of properties by trading its shares on the bourse like a normal stock. These funds are then used to build or acquire real estate assets, which then generate more income. Such companies are exempted from some taxes such as stamp duty and capital gains tax.

Joint ventures

A developer partners with a landowner in development where the landowners’ capital contribution is the land value while the developer is required to source for funding for other development costs. At project completion, both the landowner and the developer recover their capital investments and share the profit from the sales.

Off-plan sales

Developers can opt to release parts of their projects for sale at any stage before completion. It provides interest-free capital, which is channelled back into the project.