African real estate funds have struggled to raise as much capital as private equity and infrastructure vehicles in the region. Johanna Monthe, Jonathan de Lance-Holmes and Nicole Paige investigate why
Of the three most prevalent fund asset classes in Africa – private equity, infrastructure and real estate – it is undoubtedly real estate that appears the most overlooked. Research by law firm Linklaters has found that over the past five years Africa-focused real estate funds have raised just US$2bn (€1.6bn) from investors, compared with the US$11.9bn and US$4.2bn in the same period by private equity and infrastructure funds, respectively.
This imbalance is striking, because Africa’s prevailing demographic trends – and, in particular, its rapid population growth – should make both its commercial and residential real estate markets an obvious opportunity for fund managers and investors. Why, then, is Africa’s real estate market yet to attract the level of capital that its private equity market has?
One factor that has historically deterred many fund managers and investors from entering the real estate market in Africa is the continent’s lack of robust and consistent protection for property rights – either because a particular country has no formal titular property system at all, or because systems which do exist are often difficult to navigate.
The administrative burden of managing African property portfolios is exacerbated by a lack of established domestic service providers, which often leads investors to demand that fund managers maintain a significant (and costly) presence in the countries in which its funds operate – reducing the ability of funds to adopt an opportunistic, flexible approach to new markets.
Moreover, investor concerns that a combination of the real estate market’s immaturity, highly illiquid nature of real estate assets, and regular fluctuations in many of Africa’s currencies will make it difficult to exit from funds in which they invest.
Finally – and importantly, given the risks outlined above – while evidence indicates that investment-grade real-estate assets in some Sub-Saharan African markets are capable of generating average yields of 7-9%, these reasonably enticing returns appear less attractive when compared with those offered by other more aggressive investment strategies in less-risky geographies.
The net effect of these factors is that the investor base of African real estate funds remains dominated by development finance institutions (DFIs), whose environmental, social and governance criteria often sit uncomfortably with the higher-yielding commercial and residential developments in which more traditional investors tend to be interested.
In spite of the challenges that African real estate poses for fund managers and investors, the vast market possibilities are proving irresistible. Those who have been able to identify and make early investments in countries with the most potential have been rewarded. In Kenya, for instance, the real estate sector as a whole has returned 25-30% to investors over the past five years, consistently outperforming other asset classes. These returns have unsurprisingly prompted increased investor appetite.
It is also notable that African governments are making concerted efforts to attract foreign investors with legal and regulatory reform – for example, by broadening the range of structures through which prospective managers and investors can invest.
In particular, the success of real estate investment trusts (REITs) in South Africa, where the market is valued at US$16.1bn, has prompted other countries, including Kenya, Morocco and Rwanda, to introduce their own REIT legislation.
The promise of REITs
REITs have the potential to address difficulties historically posed by the African real estate market.
Firstly, many jurisdictions allow REITs to be listed – a feature that is sought after by fund managers and investors for many reasons. Listing offers greater valuation transparency and certainty for investors, and also provides fund managers with plentiful evidence about which types of properties are most attractive to investors.
Listed REITs also offer improved liquidity and exit opportunities to investors. Increased liquidity gives additional flexibility to fund managers, because funds initially established as non-REIT, closed-ended vehicles might subsequently be converted to REITs and listed. This is a significant advantage in the real estate context, where projects – particularly those involving substantial development – can require a commitment extending beyond the lifespan of an ordinary closed-ended fund.
It also provides a structural solution by which the shorter-term investment horizons of commercial investors can be made compatible with DFIs’ willingness to make longer-term commitments.
The great promise that REITs appear to offer fund managers and investors is illustrated by the fact that funds using this structure have even been established in jurisdictions, for example, Ghana, where REIT-specific legislation has not yet been enacted.
Johanna Monthe and Jonathan de Lance-Holmes are partners at Linklaters, and Nicole Paige is a partner at Webber Wentzel
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