James Mworia, Group CEO, Centum Investment Company, on using capital markets to finance real estate development

Real estate development in Kenya has historically been financed by a mixture of bank financing and the developer’s own equity. Such lending is usually limited to about 60% of the total project cost, with the developer having to raise the other 40%. The situation is further exacerbated by the developer’s inability to draw down the project’s debt before its own equity has been fully drawn down.

Even when a developer has the cash on hand, this has meant that it is not feasible to do multiple projects simultaneously due to capital constraints. As a result, there has been a persistent shortfall in the supply of real estate compared to the demand for it. Estimates in 2008 projected that the shortfall in middle-class housing in Nairobi will be 1.6m by 2030. The government subsequently set a target of 200,000 housing builds in the city each year. Nevertheless, planned housing builds in 2013 reached just 15,000, of which more than 90% are apartments. While offplan sales have somewhat eased the cash crunch that developers face, this still amounts to only a small proportion of the monies required.

The capital markets in Kenya have proved to be a revolutionary tool in the development of Kenya’s economy. In the eight-year period from 2006 to 2014, a full KSh157.4bn ($1.8bn) was raised in the equity markets by over 20 institutions through initial public offerings, follow-on offerings and rights offerings. Over the same period, the market capitalisation of listed securities has increased from KSh792bn ($9bn) to KSh1.95trn ($22.2bn), an absolute increase of KSh1.16trn ($13.2bn). Nor have the debt markets been left behind, maturing from mostly a budget financing tool for the government into a veritable funding source for Kenyan corporates. More than KSh70bn ($798m) was raised in the seven years between 2007 and 2014.

Currently no mechanism exists for the real estate sector to raise either debt or equity through the capital markets. Third-party equity financing for real estate is practically non-existent: the vast majority of debt financing is done through banks. This is for a good reason. The real estate market lacks transparency, and real estate deals in Kenya are reported to be notoriously opaque. A search for prevailing capitalisation rates in the market today is conspicuous by its absence. No regulatory body oversees the property market in Kenya. As a result, there is no body of laws and rules governing the raising and use of funds for property development in Kenya.

Real estate investment trusts (REITs), which are in essence structured, regulated vehicles through which third-party equity financing for real estate can be raised, offer a solution to both the dearth of third-party funds and the high cost of debt for development. REITs do this, firstly, by using the capital markets environment to raise equity efficiently. Secondly, because of their scale – in Kenya the minimum size of Development REITs (D-REITs) is KSh300m ($3.42m) – they have more leverage when negotiating for debt financing. In fact, the REITs presented to the Capital Markets Authority for approval are much larger than that, meaning even more negotiating muscle. Furthermore, these are exempt from tax at the REIT level and, as such, are the most tax efficient property development vehicle in Kenya today.

The benefits of REITs – the ability to raise large sums and the tax incentives – outweigh both the monetary costs of setting up and running a REIT and the regulatory burden when compared to private vehicles. We therefore expect that more and more developers will look to REITs and the capital markets in general to finance their developments.

The overall impact on traditional bank financing is also expected to be positive. D-REITs are limited to 35% gearing, which is low compared to the typical 60% limit for large developments. However, the volume of real estate development is expected to be higher by several orders of magnitude, meaning that banks will lend more than they currently are today.