An Investigation into the strategies for commercial real estate development financing in Kenya

Abstract

Real estate is the largest asset class in the world. For example Johnstone (2004) observed that the value of housing in the United States of America alone was Sixteen Trillion United States Dollars. Other authors have claimed that real estate is the greatest source of wealth for most families and makes up to 50% of the world's wealth. Njiru (2003) as cited by Muchiri (2006) indicates that in Nairobi, Kenya, land was estimated to have a value of Kenya Shillings One Hundred and Forty Billion as at the year 2003. The purpose of this study is to investigate the strategies adopted in financing commercial real estate development or investment in Kenya and specifically to examine their accessibility and affordability. Investments in commercial real estate require huge financial outlays and once the funds are invested, the resources are sunk. Liquidating the full investment will usually take months or in some cases years. Based on the foregoing, an investor in real estate usually takes in addition to the normal business risk, a liquidity risk. In seeking a return on his investment, usually as rent and capital gains, an investor will then seek to be compensated for this additional risk. Hence the financing strategy must the comprehensively considered for the investment to be economically viable. The study adopted the deductive approach as it defined the overall scope of the project. Both primary and secondary data were collected through review of existing literature, questionnaires, interviews and site visits. The results were analysed and presented using statistical package for social studies (SPSS) version 12. The study found out that factors such as minimal economic performance and the Retirements Benefits Regulations of (2000) have considerably reduced the amounts that the government and pension funds can invest in real estate. This model has left the role of real estate provision in the hands of private sector with limited sources of equity funding. Most aspiring real estate investors were also not well versed with the financing options available to them. This led some entrepreneurs to opt for some financing options which have proven to be very costly in terms of financial costs. This led in turn to delayed completion dates, occupancy dates for prospective tenants or purchasers hence the investors incurred huge financial losses and penalties including auction of the property used as security. IX The problem of real estate financing in Kenya is aggravated by scarcity of money which is brought about by lack of security for borrowing, the high and fluctuating interest rates and the problems of maturity profile brought about by deposits and loan mismatch. Financing institutions in Kenya overwhelmingly relied on public deposits which were mostly short term in nature while lending for real estate investments are long term in nature. There is therefore a mismatch between borrowing short and lending long, which eventually pushed up interest rates and tended to lower the loan periods. Because of the limited financing options, the real estate industry has been characterised by rigid financing conditions and relatively high interest rates. On the other hand, the research also revealed that most investors in Kenya considered real estate a good investment class and were striving to make whatever equity resources that they have go as far as possible in acquiring real estate investments. Thus, relatively small noninstitutional investors mostly had limited equity and relied more on debt financing to acquire real estate, since it was difficult for them to acquire additional equity funds in any organised and liquid market. Kenya lacks the secondary mortgage market and other modem forms of property financing like Real Estate Investment Trusts (REITS) which could go a long way to increase investment in real estate sector. This would alleviate the illiquidity and indivisibility risks. Other solutions were found to be through innovative financing strategies which should be aimed at the small and medium enterprises and the specialised groups like Muslims and women who have been left out in the financing sector for long. This would increase the accessibility and affordability of real estate financing and increasing the supply of commercial real estate.