Jun 7, 2015

 Cytonn Real Estate, our development affiliate, last week highlighted Amara Ridge, a development coming up in Karen, a leafy suburb of Nairobi: Amara Ridge flythrough .

Amara Ridge, which is breathtaking, distinct and luxurious, showcases Cytonn’s unique platform of bringing financing, landowners and development capability together using innovative Joint Venture structures.

We have picked Karen as one of our key areas of focus because it is one of the few areas in Nairobi that still offers serene country living coupled with significant potential for attractive financial returns. Essentially, it offers an opportunity to not only own and enjoy a home, but also to build financial affluence driven by 3 main factors:

1. Improving infrastructure, the dualing of Ngong road, Langata road and the southern bypass, when completed, will dramatically improve the accessibility of Karen;
2. The on-going relaxation of zoning restrictions allowing for more comprehensive and higher density development, which increases real estate values;
3. Karen has unique historical heritage and also close proximity to amenities such as a city park, an abundance of quality school choices, a country club, several shopping malls, tranquil leafy suburban life, upcoming international conference centre at Bomas, etc.

The above unique factors have seen land prices in Karen increase almost 6 times over the last 7 years, yet Karen still remains the most affordable prime residential address compared to other areas like Lavington, Runda and Spring Valley.

All values in Kshs Millions unless stated otherwise
Prime Residential Areas	% Change from 2007	Average Value (in Kshs. Mn)
Karen	575%	45
Lavington	488%	202
Runda	482%	67
Langata	427%	46
Spring Valley	392%	147

Source: Hass Consult Q4 2014 Land Index

Despite the attractiveness of Karen as both a living and real estate investment destination, Karen faces two key challenges that are faced by almost all residential development concepts in Kenya:

1. Rapid urbanization and population growth has far outpaced infrastructure development, hence most residential developments do not have reliable water, sewer, power and good roads;
2. Increased insecurity.

Taking into account the opportunities that Karen offers (country living, amenities and real estate potential), and the challenges it faces (inadequate infrastructure and insecurity), the most appropriate residential concepts ought to be gated communities where families can share the costs of infrastructure and enhanced security.

This explains why the choices of housing in Karen are rapidly shifting from traditional stand-alone bungalows to shared but exclusive, gated communities.

Gated communities can be the typical small scale of 10 to 14 homes sitting on half-acres, similar to Cytonn’s Amara Ridge; or they can be more comprehensive, with a comprehensive clubhouse, coffee shop and light retail and commercial conveniences. This typically requires about 50 to 60 homes sitting on half-acres. Cytonn’s upcoming Situ Village will be a comprehensive lifestyle gated community.

Having chosen Karen as one of the Nairobi surburbs that Cytonn Real Estate will focus on, and gated communities as a core concept for Karen, then the next step was to quantify the return potential for gated communities in Karen through market research.

Market Research on Gated Communities: 

We carried out market research, targeting at finding four key assumptions for gated communities in the Karen region, to provide us with valuable information before undertaking any development:

Sales Price Research
Project Name	Location	No. of Bedrooms	No. of Units	Sale Achieved %	Selling Price Kshs Millions	Size per unit SQM	Price per SQM
Tai Woods	Murisho Rd	5	10	100%	50	250	200,000
Pergola Villas	Karen plains	4	10	100%	65	250	260,000
Dik Dik Gardens	Karen Hardy	4	9	100%	65	350	185,714
Miotoni Ridge	Miotoni	5	14	86%	110	500	220,000
Muhugu Park 11	Kerarapon Rd	5	20	85%	75	450	166,667
Marula Gardens	Marula Lane	5	6	83%	82	300	273,333
Miotoni Woods	Miotoni	5	14	71%	75	460	163,043
Primary Mean*		5	13	80%	77	403	201,014
Total Mean		5	12	89%	75	366	209,823
Primary Mean*- includes; Muhugu Park 11, Marula Gardens and Miotoni Woods

Summary of research finding:

1. Plinth Area:

Research showed us that Primary Mean plinth area is 403 square metres. However, we also note there are many gated communities with houses above 450 square metres, offering a high-end development feel and providing a sense of openness and grandeur in the houses. So for Karen gated communities, we recommend developments of about 400 to 450 square metres for high-end homes.

2. Sale Price:

Our research showed us that units in gated communities in Karen have sold for an average of Kshs 209,000 per square metre, while achieving a sale target of above 80% during construction. The price of a unit ranges between Kshs 50 mn to Kshs 110 mn, which highly depends on location, size per unit and provision of social amenities. But the average price is about Kshs 75 million.

3. Rental Income:

Our research showed us that units in gated communities in Karen have average rental rates of Kshs 333,000 per month, exclusive of service charge. Another interesting aspect is that the rental rate is not very dependent on the size of the house; rather we see the location of Karen sells itself as a high-end area for rentals.

All values in Kshs unless stated otherwise

Rental Rates Research
Project Name	Location	No. of Bedrooms	Size per unit SQM	Rental per Month	Rental per SQM
Miotoni Woods	Miotoni	5	460	350,000	761
Muhugu Park 11	Kerarapon Rd	5	450	300,000	667
Dik Dik Gardens	Karen Hardy	4	350	350,000	1,000
Tai Woods	Murisho Rd	5	250	300,000	1,200
Miotoni Ridge	Miotoni	5	500	400,000	800
Pergola Villas	Karen plains	4	250	200,000	800
Marula Gardens	Marula Lane	5	300	350,000	1,167
Primary Mean*		5	403	333,333	865
Total Mean		5	366	321,429	913
Primary Mean*- includes; Muhugu Park 11, Marula Gardens and Miotoni Woods

4. Land and constructions costs: 

Based on our consultations with quantity surveyors, a decent house in Karen should cost about Kshs 55,000 to Kshs 60,000 per square metre in constructions costs, giving a mid point of Kshs 57,500 per square metre. Given the average plinth area of about 400 square metres, then the average construction costs, excluding land is about Kshs 23,000,000, using a mid range Kshs 57,500 per SQM of construction costs multiplied by 400 SQM. With land at about Kshs 45 million per acre, a half-acre would be acquired at a cost of about Kshs 22,500,000, bringing total construction plus land costs to Kshs 45,500,000, before financing costs.

Assuming 60% debt (45,500,000 * 60%) at a cost of 18% per annum for 18 months, the financing costs would be approximately Kshs 8 million, uncompounded, bringing total costs of approximately Kshs 53,500,000.

Bringing it all together:

Rental Yield: Given a monthly rent of about Kshs 320,000 per month, that works out to be Kshs 3.8 million per year. Given that house prices are about Kshs 75,000,000, it means that the gross rental yield for Karen should be about 5% p.a., which is consistent with prime residential property yield expectations.

Total Return: Rental Yield + Projected Capital Appreciation. Over the last 7 years, the annualized total capital appreciation has been 28% per annum. However, we will be conservative and assume that despite the on-going infrastructure and zoning changes going on in Karen, the next 5 years will not be as good as the last 5 years, so we estimate projected capital appreciation at about a third of historical, hence a projected appreciation of 10%. A 10% projected appreciation plus the above 5% rental yield brings a projected total return of 15% per annum for Karen over the next 5 to 10 years. Given a 10-year government bond is at 12%, the conservative 15% total return, which has a potential to increase, is attractive.

Development Return: Developer return on investment, including financing costs, given sales price of Kshs 75,000,000 and total investments of Kshs 53,500,000, gives a total return of about 40% over 18 months, which works out to an annualized return of about 27%, which is attractive.

 In conclusion, a 5% p.a. rental cash yield, a 15% p.a. total return, and 27% annualized development return make Karen a very attractive long-term real estate investment destination for both investors and home owners.

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