Overview of Tenant Purchase Schemes in Kenya

Introduction

The core of a housing finance system is one that allows more people to own a house today, but to pay for it in the future. The challenge that plagues most housing finance systems in Africa and globally, is that home ownership tends to be expensive relative to income levels in a country, which then requires long term capital to intermediate the ownership process and increase the affordability.

Kenya’s housing finance system is no different. Due to the general lack of long-term capital, high interest rates and low-income levels, the traditional mortgage market has seen limited growth, 60 years after independence, with only c. 30,000 mortgages currently outstanding, representing 3.15% of GDP and low population penetration rate of 0.06% of the entire population. Commercial banks consider housing finance to be relatively unattractive compared to commercial lending and investments in government securities. Additionally, mortgage lending is funded almost entirely by short-term retail and institutional deposits, and only a few financial institutions have access to longer-term finance and the capital markets.

This has then led an increased reliance of Savings and Credit Cooperative Societies (SACCOs) and housing cooperative networks which offer smaller unsecured loans for housing, up to a maximum of three times the balance/savings held with the SACCO, at rates of 1% per month on average and for an average term of seven years. It is estimated that SACCOs have provided over 100,000 personal loans for housing, with only 10% being actual registered mortgages. However, without access to longer-term sources of finance, they are unable to grow their loan portfolios further, hence the need for additional alternative avenues to increase home ownership.

In the recent years, Tenant Purchase Schemes (TPS) have gained traction, as an alternative means to home ownership. A Tenant Purchase Scheme (TPS) is a lease-to-own financing model where the buyer makes a down-payment (deposit), and subsequent scheduled payments to redeem the home sale price over an agreed time period and interest rate. The scheduled payments are typically made on a monthly basis – akin to the rent a tenant would pay on a rental property – and the title of the property remains with the seller until the sale price is fully paid. Typical TPS products in Kenya’s market, have an average down-payment of 10-15% of unit price with repayment periods of between 10 to 15 years at fixed interest rates of between 13% to 15% on reducing balance. An additional requirement is that the monthly housing payments should not exceed 30% of an individual’s income (excluding service charge, utility bills, fire insurance and other ancillary expenses).

Intriguingly, under the Kenyan Government’s Affordable Housing Program, the only two housing finance options set for non-civil servant families earning less than Ksh. 150,000 per month are: (1) affordable mortgages facilitated by the Kenya Mortgage Refinance Facility (KMRC) and (2) Tenant Purchase Schemes (TPS) from the National Housing Development Fund (NHDF).

KMRC is a private public partnership (PPP) facility that intends to ease the strict lending requirements put in place by banks which result in the exclusion of low-income households seeking home financing. It will do so by providing subsidised lending rates to institutions that offer lower interest (8-9% p.a.) to households earning less than Ksh. 150,000 a month. KMRC has raised Ksh2.2 billion in equity capital and secured commitments of Ksh25 billion from the World Bank and Ksh10 billion from the African Development Bank (AfDB). Despite this, as of September 2o22, KMRC had only managed to disburse a total of Ksh. 7.0 billion, which was lower than the anticipated rollout and did not move the needle of homeownership. TPS financing under the NDF depended on a 1.5% mandatory contribution to be remitted by all formally employed Kenyans. This requirement has since been challenged in court by the Central Organisation of Trade Unions (COTU), causing the scheme to halt. However, TPS financing under other quasi-government and private institutions are operational.

Affordability Analysis

Under the Government of Kenya’s Housing Bill 2017 (currently in its second reading in Parliament), ‘low-cost housing’ is defined as a housing unit comprising a minimum of two habitable rooms, cooking area and sanitary facilities and covering a gross floor area of a minimum of eighteen square meters for single person households and couples without children, or thirty-six square meters per household for households of three and above occupants. Low-cost housing is further defined as a housing unit which shall not cost more than two hundred times the prevailing statutory minimum wage.

According to the Kenya National Bureau of Statistics the average minimum wage in Nairobi, Mombasa and Kisumu cities was KES 19,830 per month in 2017 and was increased by 5% on 1st May 2018. By this definition low-cost housing shall not exceed KES 4,164,300. Current housing supply however rarely meets these criteria and the cost of a generic 55 square meter newly built house by a formal developer is estimated at KES 6,500,000. The State Department of Housing & Urban Development has further profiled buyers in different income bands to determine the purchase profile affordability as shown in Table 1 below:

Table 1: Buyer Profile by Income

Source: State Department of Housing & Urban Development

Based on the above income segments, we developed an affordable housing matrix of a standard TPS market product to develop a guide in the development and financing of housing units that are within the reach of majority Kenyans. The analysis is based on a 10% down-payment, tenor of 10 and 15 years, and interest rates ranging from 10% to 15%. The analysis yields an outcome that for households earning less than Ksh. 150,000 per month, the cheapest affordable house ought to start from Ksh. 1.07million to Ksh. 4.76 million which is largely in line with the government’s definition of low-cost housing.

Table 2: Housing Affordability At 10% Down-Payment

All figures in Kenya Shillings

TPS Structures:

It is important to distinguish between TPS and Rent to own models of home purchase. The main difference between TPS and rent-to-own models is in their structure and ownership. Under a TPS, the tenant (buyer) pays a down payment and then makes scheduled payments to redeem the home sale price over an agreed time period and interest rate. The title of the property remains with the seller until the sale price is fully paid. In this way, the tenant is essentially renting the property until they have fully purchased it. In contrast, rent-to-own models allow the tenant to rent the property for a set period, usually around 3 to 5 years, with the option to purchase the property at the end of the rental term. The tenant pays a higher-than-market rent, with a portion of the extra payment going towards the eventual purchase of the property. If the tenant decides not to purchase the property at the end of the rental term, they may forfeit the extra rent they paid, hence the preference for TPS.

Tenant Purchase Schemes are not new to Kenya’s housing market. Historically, they have been offered by government agencies such as the National Housing Corporation (NHC), the National Social Security Fund (NSSF), and the Housing Finance Group. Among these, NHC has the longest history going as far back as 1953 when the government of the day created the Central Housing Board. Between 1965 and 2012, NHC successfully delivered 9,074 units through 73 projects all over Kenya under TPS. NSSF also provides a vibrant TPS offering for the housing market. In the 2017-2018 fiscal year, TPS made up 2% of the Ksh. 206bn NSSF investment portfolio.

What is interesting to note is that the structuring of TPS products has not been led by financial institutions but rather by developers of housing, who have taken up the home financing role within the wider housing finance system. Private sector developers, particularly those that have been able to raise longer term capital, have now joined the bandwagon and have begun offering TPS products. Previously, private sector developers have been slower to adopt TPS due to cash flow constraints as they often need to recycle their capital quickly to repay construction debt and realize development profits. However, with increasing competition among housing developments within Nairobi and its environs, more developers, especially pension schemes, are looking to adopt the structure and offer flexible payment plans. The two main TPS structures issued by developers are below.

The first structure, which is typically more common in developed housing markets, involves the financial institution purchasing constructed units from a developer and issuing the TPS from their balance sheets. In this structure, there is a decoupling between the developer and the financier of the TPS structure. The developer’s role ends at constructing the houses, and the financier’s role start from purchasing the units and exiting or selling them through a TPS product and managing the units.

 Structure 1:

In the second structure however, which is more popular in Kenya and has been adopted by developers, is where developers’ role is both in construction and issuing the TPS products. The developer then has the onus of securing project development investors who construct the units (in the Development Co). Once the units are constructed the developer seeks for long term capital investors (through the Operating Co.) to exit/repay project development investors and provide an exit for the long-term investors by issuing the TPS products. In this structure, the developer stretches their role into the financing role since traditional financial institutions in the markets they operate in are not willing to participate in issuing TPS products. NHC, NSSF and private developers like Mi Vida Garden City, have adopted the below structure in their TPS products.

Structure 2:

Conclusion:

Tenant Purchase Schemes offer several advantages to end buyers, as means of homeownership. Some of these advantages include easier eligibility criteria, lower upfront fees, faster sales process, structured and fixed monthly payments, and affordable housing tax relief. TPS products also preclude the buyer from using the home as collateral for borrowing purposes during the period the TPS contract is outstanding, which is an added advantage.

On the downside however, most of the risk, particularly credit risk and interest rate risk, sit with the developer. However, in a housing finance system where traditional housing financing instruments are suboptimal, then such TPS structure are better than nothing. While developers have extended their role to taken on financing of TPS on their balance sheet, there is a question of how far out in the future they will be able to sustain this financing. By their very nature, developers tend to have shorter cash conversion cycles (through unit sales), to ensure the keep constructing more projects. Lengthening this cash conversion cycle from 3 to 5 years to a longer period of 10 to 15 years, implies that they may not be able to construct as many projects as they would have as cash slowly trickle in. This would ultimately impact the delivery of housing the entire ecosystem.

The missing financing piece that needs to be remedied however is the lack of long-term capital in this space. Financial intermediaries and in particular Pension Funds need to be harnessed to remedy the existing asset-liability mismatch, lengthen the maturity of loans, and improve affordability. With such pools of long-term capital in place, then developers will focus on what they know best, which is constructing, while financial intermediaries will assume their role in providing financial instruments that facilitate homeownership while earning them a return. Until then, we shall laud the development of TPS and hope that developers are able to mitigate the financing risk they are taking on.

This article has been put together by the Open Access Initiative, after reviewing and synthesizing TPS studies undertaken by developers participating in the initiative.