The Future of Real Estate Funding in Kenya
24 February, 2024 / Articles
Real estate is one of the most capital intensive investments compared to other asset classes such as equities or fixed-income investments. Real estate funding refers to the process of pooling resources to finance the concept, implementation and completion a real estate project. In Kenya, real estate funding remains constrained by i) increase in the sectors’ non-performing loans making financiers more cautious while lending, ii) intensive capital amounts for real estate projects, iii) lack of information especially for the informal sector players to warrant proper risk assessment for loan provisions, and, iv) lack of knowledge especially on structured products and Public-Private Partnerships (PPPs) modes of real estate funding. Some of the various sources of real estate funding include;
- Government funding
The government is a significant financier of real estate projects ranging from buildings and infrastructure such as roads and railways. Government funding may be done through;
- Public- Private Partnerships: For developers eyeing funding through this means, the government partners with the private sector through PPPs to deliver on major projects, and this can be through; i)Solicited PPPs where a private developer is able to initiate a proposal to undertake a project in response to a request from the government, and, ii) unsolicited PPPs where a private developer makes a proposal to undertake a project at their own initiative by submitting a proposal to the government,
- Equitable Share Funding: The national government, through the national treasury, disburses funds to the county governments to boost development including real estate development. The counties would then draft their budgets as per their own developmental agendas and fund their real estate projects, and,
- County Governments’ Own Funding: County governments have their own sources of finances such as revenue collections, investments and grants from which they undertake devolved projects such as roads and affordable housing.
Debt financing involves getting capital from a financier and paying it back at a fixed rate regardless of whether the investments yield returns or not. Due to the capital intensive nature of the real estate, debt financing is the typical way of real estate funding and can be done in two ways;
- Private Debt: This refers to funding advanced by individuals or organizations interested in returns and are neither institutionalized nor licensed as money lenders, most commonly the non-banking financing institutions. This method does not raise a lot of capital, and the terms of agreement differ from one lender to the other, and,
- Senior Debt: This is where the developer obtains funds from the bank or an institutionalized lender. The interest rates are usually determined by the market and regulated by the relevant authorities such as the Central Bank. Senior debt requires collaterals, and the debt must be paid first in case of liquidation.
Equity refers to owners' contributions towards development of a real estate project. It includes;
- Traditional Equity Financing: This is where a developer, whether an individual or institution, purchases land and develops the desired real estate project, which they later sell or rent out,
- Joint venture Financing: This refers to an arrangement between two or more parties to undertake a project after which they share the returns as pre-agreed. Mostly, they couple real estate developer expertise and financing capability with the landowners' contributions of land, and,
- Pre-sales Financing: This is whereby project developers can cover their capital requirements by selling their projects before construction and reinvesting into the project. Since sales are unpredictable, the developer may fail to raise enough funds if this is a required funding method for the project. However, this model has garnered the interest of investors since it allows them to take advantage of capital appreciation of properties that are sold off-plan.
- Alternative financing
One of the innovative funding solutions to solving challenges in traditional financing is structured real estate funding that investment professionals package to enable investors access a return and fund real estate development. These investments have since gained a lot of traction since they i) offer more market liquidity than fixed-income deposits, ii) give higher returns to investors, iii) meet specific investor needs as they are structured, and, iv) cut financial institutions middle man role.
Some of the critical funding categories here include;
- Real Estate Structured Notes: This involves options issued by private equity firms as means of real estate funding, such as the real estate backed medium term notes and other high yield loan notes. The investor (noteholder) makes a loan to the developer (issuer) who then agrees to repay it a future date, with fixed interest payments with typical investment term being short of around two years. Loan notes are flexible investments as they accommodate multiple lenders and bespoke investment terms, and offer higher and more stable returns compared to traditional investments,
- Real Estate Investment Trusts: This involves purchasing shares in a company that has converted the physical real estate asset into a liquid investable product either privately or publicly, such as the Fahari I-REIT traded publicly on the Nairobi Securities Exchange (NSE), and,
- Mezzanine Financing: This refers to a developer seeking funds from a subordinate financier to support the development and is paid after the bank debt but before equity investors. The lender can convert the debt to an equity interest in case of default and thus requires minimal or no collateral with investment horizon of 1-3 years. Mezzanine financing works best for developers whose cash flow is restrictive.
Real estate funding is important in i) attainment of development agenda ii) spurring economic growth, iii) boosting the private sector performance, and, iv) creation of employment to improve standards of living. Therefore, the government should look to level the playing field for structured products in terms of requirements and regulations, to reduce over reliance on the banking sector funding and support growth of alternative forms of funding that not only benefit investors through returns, but also spurs development with high levels of institutional efficiency.