The capital intensive nature of real estate developments and transactions demands proper and adequate funding different from what obtains today where investors and developers fund their projects from either own savings or loan facilities from lending institutions. These options have their antecedent disadvantages as loans from banks for example make such a project unprofitable for the developer. This is because when the interest rate is added to cost of the property, the price may be too expensive and prospective buyers may be disinterested; thus making the furnished unit take a longer time before leaving the market while the interest will keep mounting.
Some of the available options are:
1.) JOINT VENTURE: A JOINT VENTURE (JV) deal with the owner of the property works most times on the basis of the owner putting down the land as equity in the project and receiving a pre-agreed number of finished units after construction. This means that the developer does not have to pay for the land immediately but funds the construction and then take his shares of unit, when the project is completed.
2.) OFF-PLAN SALES: While undergoing a project, the developer can look for off-takers (buyers) who are ready to pay deposit against the final purchase price (generally known as OFF–PLAN SALES). The developer will then use these funds to finance the construction of the project. For example, a developer planning to build 10 units of 3 Bedroom Terrace apartments on an expanse of land and is low on cash may be able to easily conclude the project if he sells some of the units off-plan.
3.) CROWD FUNDING: Real Estate developments can also be financed through CROWD FUNDING. Crowd funding is the collection of finance from backers (the “crowd”) to fund an initiative and usually occurs on internet platforms. In the case of real estate investment, pooling of resources and collaborative underwriting has probably been around for a couple of centuries (usually known as ajo or esusu) and now with the internet, pooling of resources has now opened up a global reach to individuals and companies looking for backers. Although this method of funding real estate projects is not so popular in Nigeria at the moment, more and more real estate crowd funding sites like Coreun RE, Visafront, Gogo-Africa to mention a few are emerging.
Crowd funding a real estate project offers an opportunity to get a project financed more quickly and easily than it would through more conventional channels. By eliminating some of the middlemen usually involved, it can lower transaction costs. One attraction for investors is that they typically do not have to pool up a huge commitment to participate in a single project. Hence, they could spread smaller chunks of cash among several properties or even several developers, thus spreading their risk.
4.) REAL ESTATE INVESTMENT TRUSTS (REITs): In Nigeria, Pension Fund Custodians (PFC) and insurance companies have a massive pool of funds. Pension Fund Custodians (PFCs) currently have an estimated asset base of N4 Trillion ($24 billion). However, PFCs and Pension Fund Administrators (PFAs) are unable to participate in real estate lending activities due to regulations that prevent direct real estate exposure and investment in un-rated financial instruments. Consequently, PFAs and PFCs seeking exposure to the real estate sector are limited to REAL ESTATE INVESTMENT TRUSTS (REITs).
REITs are a form of collective investment scheme regulated by the Securities & Exchange Commission. Capital is pooled together from investors and same is used in the acquisition of income generating real estate, mortgage loans, or a combination of both. As an investment instrument, REITs have many benefits including portfolio diversification. This is because REITs are relatively liquid assets (when compared to direct investment in real estate) that could be sold fairly quickly to raise cash or to take advantage of other investment opportunities.
In Nigeria, the legal backing for REITs is The Investment and Securities Act (ISA) which defines REITs as a kind of Collective Investment Scheme (CIS). The Nigerian Securities and Exchange Commission (SEC) released the first set of guidelines for REITs in Nigeria (N-REITs) pursuant to the ISA, 2007. The Central Bank of Nigeria (CBN) and the Debt Management Office (DMO) declared Asset Backed Securities (ABS) as exempt from taxes for ten years. It is of value to note that N-REITs are Asset Backed Securities.
5.) TRADE CREDIT: Another finance option (if it can be classified as one) for funding real estate projects is TRADE CREDIT. In a Trade Credit, building material suppliers and providers of services give products/services and collect payment at a later date. There are a number of building material suppliers and distributors that have shown the willingness to give trade credit to builders and developers. The practice is that after accessing the project, a buyer is required to pay 50% of the cost of required materials upon arrival at the site and then pay the balance over a period of time. Such agreements normally come with a 0% interest for potential customers. What is required of the developer is that the developer must enjoy the trust of the ‘financers’ even in cases where persons have no personal knowledge of the developer.
From the above, a developer now has other options available to him to finance his real estate projects aside from the traditional means of real estate finance. Exploring these other options will improve the quantity and quality of housing supply from both the public and private sectors to meet the ever increasing housing demand in Nigeria.
Written by Ayobayo Babade Esq., Atilola Ajayi Esq., Temitope Oshaji Esq. and Omobolanle Apelehin (Miss).