Understanding the vast potential of real estate

BY VICTOR ADAR Investing in real estate requires big capital. But players in the sector say that the key factor to consider is market performance. That is what helps determine expected yield: How does land appreciate in a particular area? What about occupancy rates and the uptake? Is there supply and competition? Are you the only one there? At the end of the day if, and only if, you can answer these questions, you are good to go. Real estate investment involves a relatively favourable risk and reward profile, but with relatively low liquidity as compared to alternative investments such as bonds or buying shares – which are listed or not –money market instruments whose returns are fixed and mature within one year. When considering investing into real estate, one ought to analyse the trends over a given period, say, five years to measure the expected future returns on the investment based on the uptake, occupancy, rental yields as well as capital appreciation. Find the historical and current records of the market uptake, as this is directly related to the future expected gains in terms of price appreciation and demand hence a better cash conversion period for the projects. Occupancy will on the other hand inform on the rental market performance, in terms of expected rental yields and annual rental escalations. Rental yield is a key factor to long-term project profitability as it is related to the time needed to recover your initial investment. Thus a market or real estate theme with a higher rental yield is more attractive. For example, it is more profitable to invest in commercial office at 10% rental yields as compared to residential at 6% rental yield in Nairobi, all other factors held constant. Capital appreciation, though, mainly touches on land investment and helps investors make a decision based on whether to buy land for speculation. Developers too can consider land banking for future gains. Real estate and construction industry’s contribution to GDP has been on the rise since 2000 from 10.5% to 13.8% in Q2 of 2016. It has also been the consistent asset class in terms of performance, delivering a 5-year average return of 25%. With continued government expenditure in improving infrastructure and energy provision, the sector is expected to continue to grow. With this positive outlook, it is imperative that fund managers should have an exposure to this sector to achieve high and stable returns in future. Challenges Inadequate funds, high land costs, inadequate infrastructure and high construction costs are the key challenges facing real estate sector. Absence of a proper finance mechanism for real estate developments has resulted in excessive debt financing, resulting in increased financing costs owing to the extended project time frames. High interest rates by financial institutions lead to high financing cost that pushes up project cost. High land prices result into high development costs translated to the buyers as well as complex tenure mechanism. Picture the cumbersome, lengthy and expensive processes involved in registration, due diligence and acquiring land and properties. Land fraud among the landowners and land agents where a land is sold to different developers hence stalling developments is another problem. Inadequate supply of infrastructure such as sewerage, water and other social amenities have greatly hampered supply of housing and commercial developments – land in a forest somewhere where there is no proper road network pushes up construction and development costs since the developers have to cater for the relatively high costs of putting them up. Construction costs have been high owing to the high costs of construction materials, which constitute 70% of the total construction costs. How the Smart do it Traditionally, Kenyans used to invest in real estate through brick and Mortar. They would purchase a piece of land and then embark on developing a building. This is simply the development of a building or the purchase of a parcel of land, aiming to benefit from future capital appreciation and rental income. Financing for these investments is typically personal savings and expensive bank debts. If you ended up using huge amount of money on construction, prices will be high, and people would not buy, then you default if you borrowed from a financial institution. You simply worked for banks as your security is taken away. This old style had many stumbling blocks. Exiting brick and mortar real estate investment is hard as there lacks an official platform for transactions and pricing is opaque, what experts call “illiquidity.” Delays in land titling is another elephant in the room. Apart from the traditional “smart” way of investing in real estate, investors can opt for “sharp” options, depending on the investors’ investment needs, risk or return profile, time horizon and liquidity needs. Equity where an investor purchases partial ownership of a vehicle owning real estate developments and using a professional developer to manage the development activities is one example. Risk appetite is high hence this path demand returns in excess of 25% with an investment horizon usually running from 3 to 5 years. Mezzanine is the second option referred to as subordinated financing provided to a real estate development. The financing is junior to bank debt but senior to equity, hence those who invest here get paid before equity investors. An investor gives cash to a developer then exits as long as they have received what they want. Risk appetite is moderate thus demand returns of between 14 – 15% and has a window of one to three years. And finally, project notes, which involves financing for construction by investing in a fixed income note backed by real estate player is another option to take. If you know of a developer who is carrying out a project just go to them directly. Let the developer start the project, give them money (even for one year) then get paid back your money plus returns then later you can convert to equity. Risk appetite is low, and you can spend as low as Sh100, 000 however, they demand returns on average of 18% due to the leverage they hold, and takes one year depending on set milestones. Getting exposure Investing in real estate is capital intensive and therefore, not everyone can get into this kind of investment. However, there are several ways through which one can gain. Real Estate Investment Trusts (REIT’s) is one sure-fire way – A REIT is a company that mainly owns and operates income producing real estate such as apartments, shopping centres, offices, hotels and warehouses. REITs were created in order to make investments in large-scale income producing real estate available to average investors. The many ways that individuals who are not financially well heeled but can set a side some cash, say, Sh20, 000 can use to get into real estate investments include the below; Investment REIT (I-REIT) – This is an investment in an income generating Real Estate such as residential or retail developments where 90% of the income is distributed among the REIT holders as dividends. In Kenya, The Fahari I- REIT is the first of its kind having achieved only 29% subscription at issue . Development REIT (D-REIT) – This is an investment in a development company where the REIT Holders will receive their returns once the company exits the development. In Kenya Fusion D-Reit would have been the first of its kind but failed to get the minimum requirements in terms of subscriptions and number of individual investor . Project Notes – This is a structured debt instrument backed by a Real Estate project where investors buy into the note, which guarantees them a return. The notes can be structured in a way that the minimum amount investable is favorable for people with fewer funds at their disposal . Shares in a real estate company – A real estate firm, either a developer or an investing company, can list on the main bourse allowing common investors to have a chance to tap into the high returns from Real Estate. As the company derives value, so will the investors realize value through share price appreciation and dividend payments.

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