Alternative Financing for Real Estate Development in Kenya

In developed economies, only 40% of business funding comes from banks, which is the traditional way of funding businesses; the balance of 60% comes from alternative sources of funding, such as capital markets, where businesses in need of capital can issue stocks or bonds to raise money. However, in less developed economies such as Kenya, businesses rely on traditional bank funding for 95% of their financial requirements.

In the current environment where banks prefer to lend to the government rather than to private sector due to the interest rate cap legislation, and given the negative sentiment currently associated with the real estate sector, traditional bank funding for real estate has dried up; that is why we have seen some real estate developers that relied solely on bank debt run into financial problems.

It is crucial that real estate developers are able to access alternative financing sources either through capital markets instruments, which include issuing equity, bonds, raising capital through Real Estate Investment Trusts (REITs), or through structured finance. Of these options, we see structured real estate investments as the solution that can gain most traction.

Structured real estate investments are solutions that are packaged by investment professionals to enable investors access a return supported by the performance of real estate, in a form that meets an investor’s needs. Put simply, the developer goes and borrows directly from individuals rather than from a bank; after all, the bank would have gotten the funding from the individuals anyways. 

For the developer, they are able to access funding directly from individuals, and for the individuals, they get a higher yield on their money, the same as what the developer would have paid to the bank.

However, developers need to come together to make some changes in order for the alternative financing and structured real estate finance markets to develop:

• Educating the Public on Structured Finance – Investors in the market are used to investing in the money markets, where annual rates of return range from about 8% to 10% i.e. bank deposits, money market funds, and government bonds. They are not used to investing in the loan markets such as structured finance, where annual rates of return range from 14% to 18%. When investors encounter investments in the loan markets, they are usually wary of the high rates because they erroneously compare them to money market rates,
• Form an Association to Set Standards and Provide Governance on Structured Finance Issuances – There is no self-regulatory body that covers structured finance issuances. Bank deposits are governed by Central Bank of Kenya (CBK) and money market funds by Capital Markets Authority (CMA). We need a body that will provide a set of standards and approve issuances. We see the East African Forum for Alternative Investment (EAFAI) as the best placed association to play this role,
• Reduce the Minimum Amount Investable in all Real Estate Investment Trusts (REITs) – In order to attract capital into capital market vehicles such as REITs for real estate development, the minimum investment amount needs to be amended. The current regulations, which define the minimum subscription amount per investor at Kshs 5.0 mn for a Development REIT (D-REIT) is too high for a country where the median income is just Kshs. 50,000; the Kshs. 5.0 mn minimum is 100x the median income,
• Expand Trustees of a Collective Investment Scheme - Collective Investment Scheme Trustees should not only be banks but also include appropriate companies and professionals licensed by the CMA. For example, in the UK, a Trustee may be (a) an individual, (b) a body corporate, (c) a partnership, or (d) an unincorporated association, that has received permission from the Financial Conduct Authority to act as a Trustee, and must be independent of the manager of the fund,
• Expand Tax Relief for Regular Savings Towards Home Purchase- Savings into Collective Investment Schemes (CIS) regulated by the CMA should qualify for Home Ownership Savings Plan (HOSP). Savings in CMA approved products, such as money market funds currently don’t qualify as HOSP. Therefore, savers only have the option of banks, which pay low interest. There is need to expand the meaning of an "approved institution" that holds deposits intended for the HOSP to include Fund Managers, thus enabling the potential homeowners making savings through the CIS to enjoy the tax relief provided under HOSP, and,
• Allowing Specialized Collective Investment Schemes- There is currently no provision to register a CIS that invests in a single asset class, specific sector, or is formed for a specific purpose, thus limiting the financing available to real estate from CIS’s. The Capital Markets Regulations for Collective Investment Schemes should be amended to allow a sector-specific fund to be formed e.g. a technology, financial services, or real estate fund.

At a time when banks are not lending to the real estate sector, alternative sources of funding are critical to help meet the housing demand and real estate needs of the country, which is to provide affordable housing. These changes would help not just developers but also significantly advance the Kenyan Government’s Affordable Housing initiative.

Disclaimer: The views expressed in this publication are those of the writers where particulars are not warranted. This publication is meant for general information only and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.