What you need to know:
- Financial institutions generally shy away from lending to real estate projects, and with good reason.
- According to a CBK report on the status of bad loans among commercial banks in Kenya released in September 2022, real estate was among three sectors that contributed to more than half of all non-performing loans.
- Alternative funding institutions, which operate like banks but have slightly unique requirements for lending are good sources.
John Githongo, his wife and two children, have for a long time wished that they could own a place to call home, but one factor that has kept them from realising this dream is the lack of enough money.
They are a family of average means, and while Githongo and his wife have tried their very best to pool resources together, they still haven’t been able to raise enough money to kick off a construction project.
The rising cost of building materials has not made this any easier for them, so they have tried to seek additional funding from financial institutions, but these have either asked for collateral or proof that they can cover a certain percentage cost of the construction project before they can lend them money, conditions the Githongos have not been able to provide.
The family would have liked to apply for a mortgage, but their levels of income do not qualify them for one either. Like this couple, this is the situation that many other Kenyans face. Many desperately want to buy or build their own homes, but how to go about financing such projects is a big challenge.
Indeed, of all sectors of the economy, the real estate industry perhaps faces the most difficulty when it comes to raising funds. Financial institutions generally shy away from lending to real estate projects, and with good reason.
According to a Central Bank of Kenya report on the status of bad loans among commercial banks in Kenya released in September 2022, real estate was among three sectors (others being manufacturing and trade) that contributed to more than half of all non-performing loans.
This was attributed to a number of factors, such as the tough economic conditions that developers experienced during the pandemic, rising inflation caused by the war in Ukraine, as well as uncertainties during the election year.
In recent years, however, there have been various efforts by the government and private sector to bridge this funding, and by extension, the housing gap. The formation of the Kenya Mortgage Refinance Company (KMRC), for instance, has resulted in the provision of cheaper loans for real estate projects.
The firm, which was launched in 2018, mobilises long-term funds for onward lending to participating lenders, which include commercial banks, savings and credit cooperatives (SACCOs) as well as microfinance institutions.
The lenders are then able to match the maturities of the long-term credit available to them from KMRC with the home loans they offer to borrowers, resulting in lower interest rates, hence driving affordability.
Previously, most banks would lend at interest rates of 12 per cent or more per annum, but through KMRC, they are now able to lend at 10 per cent interest rates - KMRC has mostly been relying on concessional funds from the World Bank and the African Development Bank (AfDB) to refinance lenders, but has since been creative as to issue bonds in order to raise more capital.
Last year, the firm raised Sh8.1 billion through its inaugural corporate bond, which enabled them to re-finance more home loans and make them affordable and within reach for more Kenyans. It is set to issue another bond this year to raise more capital.
Alternative funding institutions
Alternative funding institutions, which operate just like banks but have slightly unique requirements for lending, have also been venturing into the local market, eyeing the potential that the real estate industry has for growth. Indeed, a recent Knight Frank Kenya real estate market survey showed that prime residential property prices grew by 3.8 per cent in the year 2022, recording an upward growth for the second year in a row. The growth was attributed to a burgeoning economy and a growing middle class.
Coupled with a relatively calm political environment, these factors have made Kenya, compared to most other African countries, a very attractive destination for investors. Some of these investors are coming in willing to even fully finance projects, without any deposit requirements, and may instead ask for such things as equity if it is a commercial project, or charge you a slightly higher interest rate for the full amount if it is a residential project.
Michael Muthengi, the country manager of investment firm Business Partners, says before lending, these investors will generally mostly evaluate the project in question by comparing the cost of construction, against the projected revenue or sales.
They may also look at the location of the project to evaluate its attractiveness for rent if it is a commercial property, or the likelihood of sale if it is residential. Especially for big projects, he says investors may also look at the borrower’s experience in the industry, as well as the qualification they hold, before lending.
“Is this the first project that the person in question is undertaking? How long have they been in the construction industry? Are they investors, developers, contractors, architects, or quantity surveyors by profession? These are some of the questions an investor will ask to help to determine the level of risk in the project and if it can be mitigated,” notes Muthengi.
He cautions borrowers against withholding information from lenders, as this could destroy trust, and therefore chances of securing future credit. He also cautions against changing the project plan or scope midway without the approval of the financier.
“When it is evident that there is a variance in the cost of construction, discuss it with the financier early and find a solution. Don’t take shortcuts, especially with the legal process which includes getting approvals from NEMA, the county government in question and KENHA. It is not worth the cost and cheap is always expensive. A project will be stopped and end up being more expensive,” notes Muthengi.
Whether getting your money from the bank or from an investor, he points out that employing basic financing skills such as accounting and budgeting is key to avoiding stopping your project midway or ultimately running it to the ground by failing to meet your monetary obligations.
Mohsin Adamjee, the managing partner at the financial consulting firm Adamjee Auditors, agrees, adding that a well-planned and executed budget ensures that you have enough funds to complete the construction project without unnecessary stress. For developers, he says this also helps to decide where to prioritise the allocation of the funds based on the goals and target market of the property constructed.
“For a project in upmarket areas such as Westlands for instance, more money would need to be allocated towards obtaining higher quality interior finishes and additional amenities within the property, compared to a project that is located in Eastlands,” notes Mohsin, adding that budgeting not only helps to plan but also minimises the chances of overspending by ensuring that costs are controlled.
It is also important to leverage cashflow forecasting tools that help in analysing past and current data to make informed decisions while allocating and spending funds through the construction process. While these tools are not entirely accurate, they at least give a rough depiction of what to expect.
“Funds are rarely available fully at the start of the project, they become available in phases. Through cash flow forecasting, you are able to know how much will be needed, and at what point of the construction project, therefore you can additionally plan to have adequate funds, reducing delays in the property construction due to lack of cash,” says Mohsin.
Once the project is underway, he says that keeping a clear account of how the funds are used is also very important. While accounting is probably one of the least favourite tasks that most developers would want to do, good accounting has many benefits.
These include helping to keep property profits higher by accurately tracking income, expenses, and tax deductions, as well as ensuring that there is no wastage. If you do not have the capacity to do the accounting internally, you could consider outsourcing the services of a well-qualified accounting firm.
“Accounting is an important factor in ensuring the profitability of any business, including real estate. Using an accounting system to track your real estate activities and financial transactions allows you to see how well your project is doing and helps to keep costs in control. Without accounting, future budgeting can also not be done as you would not have a clue of how much money you have spent on the property nor how much income you’ve received against it.”
In realising your project, Mohsin adds that raising money or doing a good budget and keeping proper accounts will not matter if you do not comply with the statutory requirements for any real estate project. This is especially true for commercial projects. Failure to file returns and make submissions to KRA in a timely manner can result in heavy fines and penalties including interest on unpaid taxes.
“It is critical to be tax compliant to avoid fights with the taxman. In worst-case scenarios where disputes were unresolvable, we have had situations where KRA freezes the company accounts and this has resulted in the stalling of projects.”
There are different statutory requirements for residential and commercial developments, but the most important of them is the VAT. Commercial projects need to charge VAT for any property they sell including charging VAT on any deposits received for the purchase of a property. It is also important for the developer to understand his tax obligations before starting off the project as these would also affect the off-plan prices of the project.
“A developer would either build for sale or for rental purposes. If he or she is selling, then he would hold the units as inventory and declare them as sales when sold and pay income tax on the profit. In the case of rental of residential property of rental income less than Sh15 million a year, the developer could register for the Monthly Rental income (MRI) scheme and pay 10 per cent of the gross income. Residential rental income above the Sh15 million a year mark would fall under business income, and would therefore be subject to 30 per cent corporation tax on the profits annually,” notes Mohsin, adding that being well-versed with these tax policies is important not only because it enables you as a prospective homeowner, developer or investor to stay in the good books of the taxman, but also because it enables you to take advantage of the tax incentives and rebates offered by the taxman.
For instance, any person who borrows money from a registered financial institution to purchase a home or to improve a home as long as he or she occupies the home will be entitled to an interest deduction of up to a maximum of Sh300, 000 per annum of interest paid to the approved and registered financial institutions.
Similarly, one will be entitled to relief or deductions on funds deposited under a registered Home Ownership Savings Plan subject to a maximum of Sh8,000 per month or Sh96,000 per year for 10 years.
Any interest income earned by a depositor on deposits of up to a maximum of Sh3 million shall be exempt from tax. Meanwhile, for investors, any individual who purchases housing bonds will be granted tax exemption on interest accruing on housing bonds up to a maximum of Sh300,000.