| Investing Through Property Development |
 Real estate remains an asset class with very attractive returns on investment. The sector has experienced strong growth over the last couple of years. Key growth drivers have been population growth, political stability, divestment of government interests in businesses, and economic reforms, which have seen better management of the economy, and the recapitalisation by banks. This has led to the growth in the middle class and increased foreign direct investment, fuelling demand for both residential and commercial property.
Real estate remains an asset class with very attractive returns on investment. The sector has experienced strong growth over the last couple of years. Key growth drivers have been population growth, political stability, divestment of government interests in businesses, and economic reforms, which have seen better management of the economy, and the recapitalisation by banks. This has led to the growth in the middle class and increased foreign direct investment, fuelling demand for both residential and commercial property.Return on investment in the sector has been put at an average of 35% annually. Going by the last census figures, four million Nigerians need housing and office space each year. Experts put the yearly housing need at 750,000 units. This represents a huge investment opportunity in property development. However, it is one area that comes with a myriad of challenges. For one, The Land Use Act makes the acquisition of land on which to erect structures cumbersome. (See our article on getting land without being scammed P6). Another major challenge is financing the development. The mortgage sector is still largely underdeveloped and getting finance for property development comes at a high cost. Recognising this challenge, the Group Managing Director of United Bank for Africa (UBA), Tony Elumelu, called on the federal and state governments to stimulate housing finance in the country. He believes this is achievable if the hindrances associated with foreclosure and land titling are removed. He puts mortgage financing at a mere one per cent of the GDP. The private/institutional developer Two major categories of real estate developers are land and building developers. The sub-sector has witnessed both individual and corporate players handling projects from the small, medium to the very large. Land developers typically acquire natural or unimproved land and improve such with utility connections, roads, earth grading, entitlements and other necessary facilities. Infrastructure improvement provides a base for further development. But building developers acquire raw land, improved land, and/or redevelopable property in order to construct buildings. The buildings are then sold entirely or in part to others, or retained as assets to produce cash flow via rents. Large building developers often have their own internal departments for designing and constructing buildings while others subcontract to third parties. City Scape's Paul Okwaraocha advises that developers be professionals in one or more areas of the project or have competent professionals to guide them. To him this ensures that you are familiar with the business terrain and can get desired results. Challenges in the sector The basic challenges investors face in developing property include legislation. The land Use Act is a major culprit here. The present administration has promised to look into it. Property registration is another major challenge. The procedure for registering a property in Nigeria is cumbersome, sometimes taking up to a year, before it was reduced to three and a half months (80 days). This is still an unusually long time considering that in countries such as Norway and Singapore it takes a day. Some other challenges are dearth of professionalism, getting licences, taxes, and the high cost of building materials. Starting out The starting point for property development is to research the area you intend to develop your property. You have to find out what property type best suits the location, if it meets your target clients’ expectation and other factors. Next is to have a good plan or feasibility study. A good plan makes accessing of funds for the development easy. The plan must have details of the project such as budget, partners, professionals involved, time frame and profitability of the project. The Deputy Managing Director of Synergy Capital, an advisory and investment services company, Akintoye Akindele, says the “first thing you need is a very good project plan that makes a business case for the project.” He says the developer must answer questions such as “where is money here [the project] and why will it make money, and how will the investors or financiers get their money back.” Working with professionals Professionals like surveyors, engineers, and architects must be part of the project team to help mitigate construction risks. Sometimes developers trying to cut cost have bypassed these professionals, resulting in collapsed buildings, cost overruns or unattractive buildings that do not achieve market rents. Given the difficulty in getting finance and construction risk, which is quite high in Nigeria, you cannot afford to take more risks by using non-professionals. In choosing your team you also have to do some research; know who they are, their history, their track record, the type of projects they have handled before and their level of experience. This will help you decide if they are the best for the job. It is important your team finishes the project as scheduled. Professionals can tell you how long a project should take; a project overrun has an implication on finance, especially on loan interest. Raising finance Banks still remain a major source of funding for real estate projects. In the last two years, banks have committed several billions of naira to financing property development, through private and institutional investors. The attraction of good returns has also lured banks into property development. For instance, Union Homes delivered the Ikorodu Owutu Estate Scheme in Lagos, the Abia State Housing Estate in Ehinmiri, Umuahia, and Skye Bank financed the Goshen Beach Estate, Femi Okunnu Phase II, in Lagos, and others. Private equity funds have also financed some high profile projects such as the Actis-financed Palm shopping complex in Lekki, Lagos. Although getting banks to finance projects should not be difficult, current realities show otherwise. Union Homes Project Manager, Okey Aguncha, says the problem stems from the irregularities surrounding the documents some developers present. Aguncha adds that a lot of requests are turned down largely because of improper documentation and scanty planning. Some developers do not carry out a due diligence on their plan documents. You should research well the project for which you are seeking funding; this will enhance the chances of getting funds. Financing structure Financing also sometimes come in form of equity, investors putting down money for a share of the pot. Equity could come from a number of sources but mainly from the developers, their partners, and other interested investors. Though there are no fixed ratios, an ideal debt to equity ratio, experts agree, should be 60 to 40. For banks though and other mortgage institutions, a 70/30 or 75/25 ratio is also okay. Akindele says though the range covers the entire asset class, it could vary for different property type: residential, commercial, and others. “Nothing stops a developer from getting 100% funding if he has good credit rating,” says Aguncha. Also, the credibility and track record of your team and partners are factors that count in getting finance for development. The deal structure Part of your plan should say what you intend to do with the property when it is completed. Are you building to sell or lease/rent? A research officer for Synergy Capital says research shows that the market is currently hosting more lease deals than others. Akindele attributes this to the mortgage situation in Nigeria, which he says is still less than 0.1% of the population of people that want mortgage in the country. According to him issues such as interest rate and titles for land mitigate against mortgage in Nigeria. However, “certain variables inform your choice of deal,” says an expert, such as type of property, location, your target audience, cost incurred, and other factors. If your property is a prime one you might prefer to lease it to corporate bodies or expatriates, who just want to hold for a number of years. Properties in high-density areas with good pricing can be readily sold. Selling is best for property targeted at high-income earners who may not need a mortgage to buy. But two important factors to consider are location and target audience. Financiers’ preference Financiers look out for certain documents and attributes in a prospective borrower. Apart from a good credit rating, you will need to have documents such as an account opening form of the mortgage institution you intend to do business with. Other documentation required are: A loan application request accompanied with a mortgage loan form Title document to the property being mortgaged Minimum equity contribution Financial statement for two or more years Evidence of cash flow; pay slips or statement of income Priced bill of quantities by a registered quantity surveyor Copy of layout/survey plans Copy of approved building plans Valuation report of the property, if renovation, by a registered estate surveyor You may want to read issue two of our magazine for more on this. Special attraction Projects with wide profit margin are often more attractive to investors and financiers and properties located in areas with high demand will easily get funding and will be readily sold or leased. You need to find out areas where demand is highest, the type of property in top demand, your target audience, price range for your target audience, and the best location for the type of property you want to put up. Large projects, experts say, are often easier and more profitable to execute than smaller ones, and so more easily get funded. Despite the alluring opportunities in property development, investors must get their plans right: know before hand their expected profit and work out the best ways to achieve it. This includes combining the best skills and finance options to deliver the expected result. Anything short of this could cost you money in losses. |
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