This blog originally appeared on BuildingKE.
By Barrack Obaga M.
It goes without saying that land development and building construction require funding. In Kenya, real estate projects are funded in a number of ways, for example, equity financing or debt financing. Individual home-owners can also finance their projects from savings. Developers can also raise funding for their projects through issuing bonds. By issuing bonds, developers are able to raise private finance from the capital markets. It is, in short, a way of borrowing money. With this option, a property developer borrows money through issuing a bond to a lender, also known as a bond holder. In return, the developer (the borrower) will repay the lender the full amount plus interest over the life of the bond.
In order for developers, such as Home Afrika or National Housing Corporation (NHC), to raise funds through issuing bonds, they must get the necessary approvals from the Capital Markets Authority (CMA). There are a number of conditions that have to be met before the bonds start trading at the Nairobi Securities Exchange (NSE). For example, a developer has to meet a requirement that dictates the minimum amount of money that has to be raised. Developers have to make a tough decision between choosing between expensive commercial bank loans and the volatility and unpredictability of the capital markets. Bonds fall under the capital markets.
In order to understand the twisted nature of dealing with bonds in financing real estate development we shall use two examples in Kenya. The first example is the National Housing Corporation (NHC) housing bond that has experienced enormous setbacks since 2004. We shall also highlight the volatility and unpredictability of the capital markets in Kenya by focusing on the Home Afrika bond that was to help them raise funding for their projects.
The National Housing Corporation Bond
The National Housing Corporation (NHC) is a state corporation. In January 2015, NHC announced that it would issue a housing bond in the second half of 2015. At the time of the announcement, the corporation was concluding the final processes of approval ahead of the issue of the KSh 5 billion housing bond. It had already acquired the approval of the ministry of finance.
The proceeds from the housing bond will be used to finance new projects and increase the production of the EPS panels at NHC’s Mavoko factory. The three projects to be funded are in Stony Athi, Mombasa and Kisumu.
The period or tenor of the bond is expected to be between five and ten years. The bond will be exempted from tax.
Why a bond?
Since its inception in 1967, it was highlighted that this was the first time that NHC was borrowing from the private market through the CMA.
The state corporation is facing new challenges with respect to project financing due to a limited budget. As a result, they are addressing the challenges in the following ways:
- Issuing the housing bond which is cheaper than commercial bank loans. NHC has been funding its past projects through debt and from the money obtained from the sale of the houses it develops. It is easier for the corporation to raise such colossal amounts from the public as opposed to borrowing. In the 1990s, NHC’s performance was slowed down due to surging interest rates that made investment in real estate an expensive endeavour. The terms of financing projects were more favourable then. Periods or tenor of the funding span between 20 and 40 years. Interest rates were subsidized depending on the source of financing – donor or government. The interest rates ranged from as low as 6.5% to 13%.
- Forming partnerships with developers. In the model discussed by the NHC chairman, the corporation seeks to create and sustain partnerships with developers who will fund the projects. On the other hand, NHC will provide the land and technical resources required to design and put up the houses.
- Government input – the government is also expected to continually increase the budgetary allocation for housing in Kenya. NHC has been traditionally been funded by the government. Kenya’s National Housing Corporation activities were predominantly long-term in nature. The main sources of finance were the government through the Treasury and donors.
The management hinted that the NHC housing bond would be issued any time from July 2015.
The National Housing Corporation has, for at least 10 years now, been talking about issuing the much-awaited housing bond. The announcements have been re-appearing in the business columns over the period with little to show for it.
On October 15, 2003, the NHC Board passed a resolution to approve the issue of the Kshs 5 billion housing bond. In January 2004, the ministry in charge of housing was notified accordingly on the corporation’s intention to issue a bond in order to realize the projects financing goals. After the Ministry of Finance was informed, the Capital Markets Authority (CMA) and the Nairobi Securities Exchange (NSE) were notified in September 2004.
The plans failed to take off after the government could not guarantee the bond since, in 2005, NHC’s risk rating was unfavourable. Due to failure to back up the bond, it would have been an expensive option. Corporations such as NHC seeking to issue bonds are required to have a strong balance sheet in order to obtain acceptable credit ratings as well as to secure a guarantee from a third party.
In 2009, the NHC announced that the bond would be, at the latest, be issued in early 2010. Like in the case of Home Afrika in 2015, the announcement was made shortly after KenGen has successfully issued a Kshs 15 billion infrastructure bond. In 2010, the Central Bank of Kenya and the Ministry of Housing indicated that they were working together on placing guarantees that would make the bond attractive to the bond market.
In July 2010, NHC’s management had enlisted three banks: Suntra Investment Bank, Kenya Commercial Bank (KCB) and CFC Stanbic Bank to take the corporation through a due-diligence exercise and advise them. Among other things reviewed was the affordability of the bond’s coupon rate. The NHC at this time was faced with challenges that would have affected the affordability of the bond.
The bond that was approved did not allow NHC’s housing bond to be guaranteed by the government. Consequently, the corporation’s financial books would have had to be audited. The other option available was to have a credit enhancement. In this option, the government would have provided an additional guarantee or collateral in order to improve the credit rating of NHC. Little can be said about the correspondence between NHC and the Treasury regarding the guarantee on the bond.
In March 2011, after the prospects of NHC issuing a housing bond diminished, the corporation announced plans on banking on partnerships. Faced with the pressure to deliver affordable housing while dealing with the slow pace of raising funds through a bond, the corporation had to explore alternative sources of funding their projects. The management was concerned about raising funds through financially viable options rather than “raising a bond for the sake of it”. For example, the NHC partnered with the Iranian Housing Corporation on a project in Mavoko as part of their plan in improving housing delivery. It also partnered with the Kenya Commercial Bank’s S&L mortgage.
Initially formed in 1953 under Kenya’s colonial government, NHC was mandated to provide affordable housing and low-cost units in Kenya. Since then, it has undertaken projects worth approximately Kshs 4 billion, adding at least 40,000 housing units into the Kenyan market. The NHC has since faced stiff competition from the private developers in Kenya who are focused on providing housing for both the middle and upper class and the low-cost housing.
NHC was, prior to the 1990’s rise in interest rates, Kenya’s leader in the provision of property development and housing finance.
This year, ahead of the scheduled issue, the National Housing Corporation, ought to be prudent enough to assure Kenyans and investors that the contentious issues have been fully addressed. For instance, that the financial guarantee that is at the heart of the delays has been sought endlessly should be ascertained. Also, the information regarding creditworthiness of the state corporation should be revealed to investors.