The Real Estate Credit Paradox in Sub-Saharan Africa
The globalization of real estate capital has been driven largely by a surplus of liquidity, a requirement for portfolio diversification and the current scramble for yielding assets. There is no question that despite recent economic headwinds, Sub-Saharan Africa (SSA) has and will continue to attract ‘intelligent’ capital flows, from both local and international investors. This capital not only seeks superior returns, but is also fuelled by the curiosity of investors who look to educate themselves about the long-term potential of the continent. There almost exists a “fear of missing out” in markets which are perceived to present unparalleled investment opportunities in years to come.
Commercial Real Estate provides a relatively transparent asset class, in often far from transparent markets. According to JLL, existing SSA Real Estate Fund platforms, along with new entrants, are together estimated to have USD 7 – 8 billion in equity commitments by 2020 (compared with c.USD 2 billion committed to date). Therefore, the key question is, who, in an increasingly regulated banking market, will provide partnership debt capital to the influx of equity investment in the African markets? Surely the availability of leverage has to be a fundamental component of any investment decision into the continent.
The majority of structured real estate finance in SSA is still being provided by local and regional banks. These banks are the natural lenders to investors, developers and landlords in the region. However, with the exception of a select few, these lenders lack the ability and expertise to provide efficiently structured, ring-fenced capital. In fact, these lenders are quite often considered to be heavily relationship-focused, also known as “name lenders”. Since the Global Financial Crisis, most international banks have curtailed their real estate appetite, with their balance sheets constrained by stringent banking regulations, impacting the ability to derive meaningful risk-adjusted returns.
Select international and South African banks typically offer more sophisticated financing solutions, but by market perceptions, remain selective in geographic appetite and conservative in their borrower group selection. Other key investors include the Development Finance Institutes (DFI’s) who are able to provide longer tenor, patient capital, without the stringent regulatory hurdles that banks face. These DFI’s are experienced in emerging markets and have flexibility in their choice of investment instruments (debt or equity), but remain very clear on their motive to promote economic development and create employment.
The challenges in qualifying for available credit will most likely lead to an emergence of non-bank lenders, which to date have seldom been seen. Such lenders may include private credit and mezzanine investors who see a significant opportunity to leverage the market’s illiquidity premium to earn compelling risk-adjusted returns.
When considering structured funding solutions, sponsors with reputed real estate expertise and proven track record are key criteria. The banks’ ability to effectively ring-fence transactions include: the assignment of key management/operator contracts; assignment of underlying leases; contractor step-in rights; and relevant share pledges. Where possible, the availability of broader corporate recourse is often also a deciding factor, particularly with development finance, which is considered higher up the risk curve. Banks also need to be comfortable that there is historic evidence of enforcement and an independent local judiciary – legal enforceability opinions are therefore almost always a pre-requisite to taking security benefit.
Africa brings its own challenges in currency volatility, with limited money mechanisms able to effectively hedge against FX risk. Lenders often choose to match their liabilities against cash-flows, in an effort to minimize the downside of currency risk. Obvious complications arise for landlords where tenants receive local currency income, but are obligated to pay their leases in US Dollars.
In conclusion, there is a distinct gap between the availability of structured credit and the ability of investors and developers to access this much needed funding. The key challenge for lenders is not only knowing their client and understanding the counterparty risk, but also understanding the regulatory, legal and market risks intrinsic within their target geographies. For instance, the market nuances in Lagos, such as the current USD convertibility and repatriation procedures, are substantially different to those in say, Nairobi. Currency fluctuations, political sensitivities and high-cost local currency finance are some of the other challenges to be considered.
As SSA real estate markets begin to show signs of transparency, lenders are likely to gain further confidence to increase their exposure and provide competitive solutions. In addition, policy makers in regional markets are cognizant of existing challenges and are making positive strides in creating investor-friendly real estate markets. For example, the much anticipated REIT regulations in countries such as Kenya will further encourage the emergence of institutional real estate platforms, which provide a strong credit story for the banks.
Africa, despite its market challenges and inherent risks, still provides substantial long-term growth and investment opportunities for real estate investors. As for credit providers, be it banks, DFI’s or mezzanine lenders, well secured asset based lending may be a compelling risk-reward trade-off for those willing to understand the risks and commit to these markets.
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