Special Blog Series 3: Harnessing REIT structure as a catalyst for affordable housing initiative

The Centre for Affordable Housing Finance in Africa (CAHF) entered into a partnership with the Reits Association of Kenya (RAK) and is pleased to provide a blog series on housing and housing finance. 

Please contact RAK via https://rak.co.ke/

Background

According to Knight Frank Africa Report 2020/2021, Africa’s housing crisis is mounting in the face of a growing population and urbanization both which are expected to persist in the coming years. The report further indicates that residential housing currently consists of only 2.5% of listed property holding in the continent as compared with an average of 25% in developing countries and 15% in developed countries. Further, Shelter Afrique estimates that Africa needs US Dollars 1.4 trillion in funding to address its 56 million housing units deficit. By all standards, these challenges also present a huge opportunity to invest in housing across Africa.

Africa Housing Finance YearBook 2020 indicates that Kenya is estimated to have approximately 52.6 Million people in 2020 with approximately 27.5 % being urban. Kenya also experiences high population growth estimated at 2.27% per annum compared to global average of 1.2%. The country’s urbanization rate of 4.02% is just below the sub-Saharan estimate of 4.1%. This has resulted on incremental pressure on amenities and services especially in urban areas with a spiral effect on cost of housing and land. As a result, it is estimated that 61% of Kenyans are living in slums often characterized by overcrowding, poor sanitation and poor structural quality.  In response, Kenya like many other African countries has continued to promote new urban developments through creation of satellite cities to offset pressure on existing urban centres.

Housing Supply

In Kenya, it is estimated that housing production stands at 50,000 units with an annual demand of 200,000 leading to a cumulative deficit of over 2 million units. Supply in the lower segment has even remained lower despite rising need. Despite the government having made strides to fill the gap by increasing the housing budget by 61.5% to Kes 10.5 Billion in Financial Year 2019/2020 up from Kes 6.5 Billion in Financial Year 2018/2019 (Africa Housing yearbook, 2019), for the financial year 2020/21, the housing sector recorded a decline in budget allocation, attributed to constrained fiscal space by the government as it grapples with economic effects of the COVID—19 pandemic, which means reduced development of affordable housing.  Further to earlier efforts aimed at decongesting the cities, the government affordable housing initiative launched in 2017 under the Big Four Agenda continues to gain momentum albeit at a snail pace. Centre for Affordable Housing Finance in Africa (CAHF) 2020 yearbook, reports that approximately 228 units delivered, suggesting that the programme will fall short of its 2022 target.

The main structures adopted to deliver housing projects are Government partnerships including Public- Private Partnerships, Private – Private partnerships and state funded projects. Conspicuously missing is the role of REITs despite Kenya adopting REIT structures in 2013 among them I-REITS and D-REITs. REIT structures are globally recognized and are very vital in catalyzing supply and demand for affordable housing as will be discussed below.

Role of REITS

The success of affordable housing includes a fusion of supply, demand and enablers. Despite several policy initiatives undertaken by the government including formation of Kenya Mortgage Refinancing Company to enhance long term mortgage affordability and capital market access to primary mortgage lenders, National Housing Development Fund to bridge the gap for affordable housing by de-risking private developers through guaranteed offtake and provision of affordable financing solutions to end buyers, the supply function is still far from making significant strides. One may then ask: What could be the challenges? How can they be further mitigated?

The government has gone further to review the PPP structure with a view to fast track it and included other options such as land swaps and joint ventures. However, challenges remain in areas of uncertainty of revenue sharing and private developers’ reluctance to commit to projects of more than five years as a result of uncertainty associated with the cyclical nature of our presidential elections. I opine that a REIT structure (especially development REIT) though still nascent in the region, is well placed to address these challenges due to its long-term focus as well as significant disclosures and mandatory transparency requirements that are anchored in law.

Opportunities for REITS in catalyzing demand within Affordable Housing Sector

Though REITs markets in sub-Saharan Africa are still at a nascent stage, the recent adoption of REITs legislation in Kenya, Ghana and Uganda for example is, however, set to contribute to continued real estate market formalization and deepening in Africa. In Ghana for example, through the National Housing and Mortgage Fund, Ghana (NHMF) partnering with GCB Securities, an Affordable Housing Real Estate Investment Trust (REIT) was set up to provide rental homes for public sector workers. The scheme is based on a rent-to-own model where public sector workers can access decent and affordable homes for between 15 to 20 years and pay a residual value to own the property at lower interest rates (11.9 to 12.5 percent) compared with the nominal minimum rate of 24 percent for non-foreign currency or cedi-denominated mortgages (CAHF, 2020).

To catalyze demand, a REIT would participate as an off-taker to free capital for the developer as well as receive a steady annuity for its’ investors by acquiring projects under two scenarios i.e. direct sale or sale and leaseback.  The trade-off between the two options is one of market risk vs. reinvestment risk both of which could be manageable depending the specific REIT’s investment objectives. Some of the salient commercial features of such off-take agreement would be:

• Purchase of recently completed developments or Greenfield with potential development plans valued at market value.
• Direct sale or a sale and leaseback between developer and a REIT with a requirement to guarantee specific target yield backed by a bank/insurance company guarantee.

In a sale and Leaseback:

• The tenure would be more than 5 years and at a pre-agreed target Internal Rate of Return (IRR) between the REIT and the developer to achieve long term predictable and growing returns;
• Developer would then pursue a rental strategy for the units as well as a steady sales program that would result in the pre-agreed exit return over the tenure;
• Developer would not be pressed to sell the units hurriedly and could achieve higher sales prices over time versus attempting to offload full development in the market at once (concentration risk);
• Through the ongoing rental and sales hybrid strategy during investment period, the developer would pay both the agreed running yield (may need to dig into their pocket to top up in cases of deficit) and sales proceeds to the REIT, and the carrying value of the development on the REIT’s balance sheet would steadily reduce and be replaced by cash;
• As a result of the guaranteed pre-agreed exit IRR (via the ongoing sales) the REIT essentially has no exit market risk which it would have if it bought the units outright and then sold them eventually in the market at target exit date. The Developer shoulders the full market risk through the pre-determined exit IRR.

Conclusion

REITS though still a nascent sector is well placed to complement successful delivery of affordable housing by catalyzing supply and demand thereof. However, in-depth stakeholder engagements are required especially in areas of structuring, funding, performance measurements and operations to be able to align the REIT structure with the affordable housing Initiative.