For a nascent market like the Nigerian Real Estate industry, there are loads of problems punctuating the flow of development to make it compete favourably with other emerging markets. Core in these baskets of problem is finance: as finance windows such as mortgage, pension, bonds, and so on appear more as paper tigers.
In this chat with 3Invest Intelligence, Mr. Chu’di Ejekam, Director of Real Estate, Actis, opens up on the concept of Private Equity, especially in the Nigerian market.
He spoke against the back drop of Actis as a reputable Private Equity Manager trying to redefine the Nigeria real estate space for optimum delivery. He opined that if the enabling environment is created, Private Equity has great potentials to ameliorate the nagging problem of finance in Nigeria’s real estate sector.
He observed that the problem with finance in the industry is that there are few patient sources of equities, thus high interest rates on lending, because lenders want to make their money back.
He defined the concept of Private Equity, its scope of operations, why retail real estate makes the best deal for private equity investors in today’s Nigerian Real Estate and the future of Nigerian real estate from a private equity investor’s point of view. Excerpt.
Tell us about the concept of private equity.
Private equity is a pretty broad term. But in principle, it deals with the investment of equity into various companies as well as projects.
In general, it could be categorised into venture capital, which is investment into early stage company such as Google; and more specifically, institutional private equity, where equity is invested on behalf of limited partners for a finite period, typically about 10 years, and with the expectation of certain investment thresholds such as internal rate of return targets, times money back targets, and so on.
I believe this is the more generally accepted definition of what private equity is. It is also deals with investment in established companies with stabilized cash flow and growth opportunities.
Why Real Estate an attraction to Private Equity Managers such as Actis?
The good news is that Real Estate provides for private equity more attractive returns. For Actis, we are looking to generate returns of about 25% IIR and about two and a half or three times our money back for an investment of over a four to five year period. So that attractiveness is quite compelling.
Second, we see high barriers to entry, large scale real estate developments that we focus on, typically require large amount of capital and there are only very few patient sources of such large capital besides Private Equity.
Actis as an organisation as shown more interest in Retail Real Estate; Is that the most attractive venture in the sector?
In general, there are three asset classes which we consider compelling. One of them is retail on the commercial side, second is ‘grade-A’ office development because see compelling demand-supply imbalances, and third, is middle income housing.
On the retail side, we find it particularly compelling because it actually fits into what we consider primary drivers in this market place. These drivers include; a rapidly urbanising population, a growing middle class and an increasing spending power and consumerism. These things are very important for the development of formal retail which is why we look to investing.
What in your view is makes a good deal for a Private Equity investment?
There are quite a few factors that we consider attractive. The first is location. If we are looking at investing in a retail centre, we look at a deal in major urban centres: an area that has high potential shoppers and also strong access to transportation network, so that shoppers can come and leave with relative ease.
Also we conduct demographic analysis to understand the spending power within that catchment area. For example, the Ikeja City Mall that we recently delivered in December; we found that there was very strong buying power. Within an eight kilometres radius that we measured as our catchment area, there is at least, an average of $1, 500 monthly spending power per household. And there are close a million household within that eight kilometres radius. In addition, there is a strong population of about four million people within that radius. So, location is one major thing.
Second, title, it is important for us to have a clean registered title. We will not invest in a transaction if we are not comfortable with the title. We invest in an area with strong laws and understandable approval process. So we have a good idea of how long it will take us to secure approval for our proposed development.
Third, there is need for an attractive tenant profile. We want to be sure that we have strong tenants who can come in to lease the spaces as well as small tenants who can do business on our platform. This leads to the next important thing which is pre-letting.
A good deal for us will have to incorporate some degree of pre-letting. We typically look to pre-let about 30% prior to the commencement of construction.
Next is design, we need to have a design that has good efficiency ratio; we typically look for at least, 83% ratio of net letable space to gross builtable space.
And finally, is what we call ESGS (Environment Social and Governance), which deal with the contribution that you are making to the location in which you are investing. We care for our retail project contributing to employment, taxation, transfer of knowledge, boast of local supply chain, and basically providing locales with goods and services that would not have ordinarily been available to them.
If your ESGS is interested in the locales; why are you not investing in the residential real estate?
As I earlier mention. Middle income housing is important to us. We believe that there is in fact, a dearth of relatively affordable housing for the growing middle class. So we focus on identifying viable projects where we can invest in the middle income housing sector. And again, I stress, not luxury market that will allow us to still achieve the yardsticks that I earlier enumerated. We seek to invest within $25 - 40 of equity, so we are also looking for relatively sizeable transactions.
Do you think funding through private equity is a likely solution to the financing problems we have in the Nigeria Real estate sector?
Absolutely! One of the key things is that to do large developments require large amount of equity. For example, the total project cost of the Ikeja City Mall is about $100m - which include the land, construction, and other sundry costs. And we typically look at securing 50% dept funding to cover that $100m total project cost, so the balance of $50m in this case, has to come from equity investor.
In this local market place, there are few institutional, patient sources of such amount of capitals, and with the introduction of private equity as a market place, we are able to see a growth in the development of such large centres. So private equity is critical.
At another level, Private Equity brings to bear, a relatively structured process so that projects are delivered on time and on budget. It is crucial for us to be able to generate the minimum 25% IIR and two and a half to three times money back that I mentioned. So it is important for us to bring to bear processes that allow us deliver on budget and on time, and that is the discipline that private equity can bring to the table.
Do you have indemnities, insurance or how do you hedge against risk?
First of all, like I mentioned, we try to bring into the market place best practices in development. But one of the biggest challenges in this market is that people don’t have expertise to develop on time and on budget. So we actually sought to create development companies that have world-class expertise to ensure that coordination of all aspects of the development process from conception, design, management of construction and letting are delivered at international standard. So development risk is one key way for us to ensure we are able to meet our returns.
Second, asset management, it is important to optimize rental mix so that we can have an optimal mix. We actually out source property management to established professional firms to ensure, again, that assets are managed properly. Balance sheet management helps to ensure that the capital expenditure is managed properly in our developments as well.
Next is currency risk. We manage this risk by establishing Dollar-pegged rentals to match the dollar denominated project that we seek to secure. Next is planning risk. We do not take any re-zoning risk. So we will not do a project that can be rezoned, for example, from residential to commercial.
We also hedge against financing risk. What we do is that before the commencement of a project, we seek secure irrevocable commitment from a lender. So we do not commence with the hope that somewhere down the line, someone will come to the rescue.
Interest rate risk is also what we consider in project development. You know we seek to ensure that we are not caught in a situation where interest rate suddenly goes up. So week seek to hedge a portion of our interest rate risk for the dept that we borrow.
In the Nigerian market place, what would you consider the Challenges against the success factors?
The first major challenge is availability of land. Land is scarce and often over priced; making it unacceptable for us to invest. So it is important to structure a win-win situation with land owners. For example, where land owners can contribute his land into a joint venture with a group like ACTIS, at a reasonable price, with a structure that allows them to get additional valuation for their lands post construction and post establishment of the centre.
The challenges we face is that a lot of land owners seek to contribute their land at percentages that are not workable. The maximum percentage of land within the project cost should be within 6-7% but some projects trys to consume a whopping 30%, making them unworkable.
Another major challenge is adequate capital. For centres that we look to undertake, some require as large as $50 million worth of equity. And one way to ameliorate that is by the introduction of patient private equity sources and in order to attract such investors, you must be able to demonstrate that you can actually secure adequate yield from this local market, which is what ACTIS is in the fore front of doing and we hope to have other investors join us.
Another challenge is cost and expenses. We find out that it costs double of what it takes to build a retail centre in South Africa to build same here in Nigeria. So we certainly have a challenge with the contractors’ rate here.
Do you use local or foreign contractors?
We normal engage local contractors. But their cost like I said is double what you have in South Africa as I mentioned.
What do you think is responsible?
First, 70% of all the materials used on site are imported. That’s one major issue, but I don’t believe that accounts for all of it. So someone has to look into how we can reduce some of these costs. One of the approaches is to come up with a different concept of the retail centres that could work in this market.
Next major is earnings. You know this market until recently has been relatively unproven. So it was hard to get big tenants and even small tenants to come to the market place. But with the successes of some of the projects that ACTIS has been involved, like The Palms, Ikeja City Mall and Accra Mall that we also majorly own, you see that many tenants now see a great prospect and are now coming in.
Don’t you think that the unattractiveness to tenants is because of the price?
I don’t believe so. If you speak to some of our tenants over the last seven years, they will tell you that they are now speaking to other potential brands to come to the market place. And they have demonstrated to them that given the turn over revenues they are generating in these centres, they are generating sufficient returns to make their businesses viable. So we believe that the rent at this time, given the cost of land and construction, are well priced to make the project viable for investors like us. Otherwise, we would not invest.
How in your own view do you see the Nigerian Real Estate Sector in the future?
We are very optimistic; which is why we are here. You know, across the various asset classes, starting from the retail that I have mentioned, there is a huge demand-supply imbalances, there are not enough retail centres still here, Johannesburg has 74 Retails centres of at least, the size of The Palms and Lagos, which has about 18 million people has only two centre that can be considered world class of at least 20,000 square metres. There is a bigger opportunity to develop additional centres and that is what ACTIS is trying to do.
Second, on the office front, we also see this imbalance. There are quite a few multinational and local companies that are looking for ‘grade A’ space, which is not available in this market place. There is a bigger opportunity for an organisation like ACTIS to engage in the development of such spaces.
Third, on the middle income housing side, you know, it is famously said that there are about 16 million unit shortage in housing. So there is a big opportunities for investor like us to explore the development of these asset. So over all, I think we are only at the beginning of the retail revolution, revolution in grade A space and also a large scale of low income housing and we are committed to ensure that we engage in this opportunities.
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