A Review Of Stanlib’s Fahari I-Reit

Is Kenya going to join the list of countries which include pioneers USA, Australia, Brazil, Canada, South Africa and France with a trading Real Estate Investment Trust? The answer will be known if Stanlib’s Fahari I-REIT is successful in attracting subscribers and starts to trade on the Nairobi Securities Exchange (NSE) as scheduled on 24th November, 2015. According to the prospectus released on 22nd October, 2015 by the promoter Stanlib Kenya Limited, the REIT offer size is between KSh. 2.6 billion and KSh. 12.5 billion. A total of 625,000,000 units each at KSh. 20/= are on offer and the total cost of the REIT is estimated at KSh. 365,500,000/=. From this, the total maximum net proceed will amount to KSh. 12,134,500,000. The offer is available to Qualified Institutional Investors (QIIs) from East Africa who have an allocation of 55% each while Retail investors have 25% each and foreign investors have 20% each. Qualified Institutional Investors and foreigners have a minimum application size of KSh. 1,000,000 and thereafter in multiples of KSh. 100,000/= while retail Investors minimum application size is KSh. 20,000.00 and thereafter in multiples of KSh. 2,000/=.

REIT’s provide a unique opportunity for investment in income generating real estate in a tax efficient way. REIT provides investors, at low cost exposure to the real estate market. Given its unique nature, investors require special tools to analyse an opportunity presented to help them make an informed decision. While there are many issues to consider, for the purpose of this brief, we have focused on the property management team, made a comparison between the proposed I-REIT yield with yields from alternative investments like high yielding government bonds and quoted shares, analyse the forecast on rental income, assess the credit worthiness of the tenants, examine the underlying real estate assets and its susceptibility to obsolescence as well as examine portfolio diversification as way to mitigate unsystematic risk.

One of the major attractions of a REIT is that, the investor is set to receive passive income and is therefore not burdened with direct management of the underlying pool of real estate assets. An offer to invest in REIT’s comes with a promise that the real estate assets will be professionally managed. Real estate being a complex asset needs a management team that is well educated, has practical and relevant experience and (in certain jurisdictions which include Kenya) the key personnel be registered as real estate practitioners by a state regulator. In Kenya property management falls under Estate Agency and the applicable law is the Estate Agents Act Cap 533. This law which was enacted in 1984 and commenced in 1985 requires all Estate Agents to be registered by the Estate Agents Registration Board. According to the Act only individual (not corporates) Kenyan citizens are eligible for registration and can therefore practice. In the prospectus, the promoter of the I-REIT has listed a management team plus its leaders under an entity known as JHI Kenya (a joint venture between Excellerate Property Service Kenya and Grenadier Group Limited) that will manage the real estate assets. JHI Kenya is a newly formed company that as recently as April this year was scouting for a Chief Executive Officer to lead its Kenya operations. From the provided brief profiles of key personnel and management team, there is need for the promoter to appoint either a professional property management firm or strengthen the existing management team with registered professionals with sector knowledge experience and who meet the requirements of the Estate Agents Act.

Real estate investors are interested in returns. Accordingly investors will put their funds in instruments that will give the greatest return from the available comparable alternatives. From the prospectus, the target IRR before deduction is 14%. The prospectus also indicates that the three seed properties have forecasted yields of between 8.1% and 9.8%. The average returns are estimated to grow from 9.4% in 2016, to 11.5% in 2017, 11.4% in 2018 and drop to 11% in 2019. The annualized average is 11.1%. Given the performance of office real estate submarket, the state and location of the properties, it is doubtful that the I- REIT will achieve targeted yields. According to www.economictrends.com, a 10 year Kenya Government Bond was quoted on 2nd November, 2015 at 15.58% and the average for the period 2004 to 2015 was 11.99%. The site forecasts the 10 year bond to trend around 16.19% in 2020, 18.40% in 2030 and 22.08% in 2050. According to Peter Stanyer, in his book Guide to Investment Strategy: How to Understand Markets, Risks and Rewards “No real estate investment should be undertaken unless it is expected to perform better than the guaranteed return from high quality government bonds”. Stanyer further adds “Any real estate investment should be sold if it is expected to underperform government bonds over some relevant time horizon”.

An alternative to comparing the investment to a high yielding bond is to compare the REIT to quoted shares in a security exchange. The development of public markets for REIT’s has made real estate comparable to the rest of the quoted equity market. In this regard investors have a choice of investing either in a REIT or any other quoted stock traded in an exchange since they can draw comparisons. Kenya has a vibrant and growing securities exchange with over 60 listed companies. While NSE has had a poor run this year and estimated to be 20% down, there are specific counters that have been performing exceptionally well. Investors therefore have a choice of investing their KSh. 20/= per unit in any of the shares already listed in the NSE or in the REIT. For instance Safaricom the largest and most profitable company in Kenya is currently trading at KSh. 14.95 per share. The company has projected to earn KSh. 36 Billion after tax profit for the financial year ending April 2016. In the last financial year, Safaricom made 17.5 billion after tax profit and paid a dividend of 0.64 cents per share. The dividend yield worked out to 4.27%. Stanlib’s Fahari I- REIT is projected to pay KSh. 1.25 per unit and assuming the price holds at KSh. 20/= per unit, the dividend yield works out to 6% for 2016. With KSh. 20,000/= one will acquire 1000 units of Stanlib Fahari I-REIT. With the same amount you can acquire approximately 1,335 Safaricom shares. There are counters that would give an investor exposure to real estate even though it will be to a much lesser extent. Such counters include Centum, Britam and Kenya Re. So given a choice between buying say a Safaricom share and Stanlib Fahari I-REIT where would you place your money?

The income generated from real estate emanates from the tenants who pay rent. This therefore brings to the fore three key issues of tenant credit worthiness, occupancy rate and maximization of development potential. It is one thing to agree to pay rent and another to throughout the lease sustain the ability to pay the rent on time. From the prospectus, two of the seed properties have one large tenant each while a large tenant in the third seed property is under receivership. The two commercial properties are located in industrial area where rents are low, demand for office space weak, infrastructure is dilapidated and there is chronic traffic congestion. In addition, in one seed property, there is a tenant whose lease is expiring in two years’ time with no mention that it will be renewed. The third seed property a retail centre which has over the years’ experienced high turnover of tenants and low occupancy rates. The prospectus does not state the current occupancy rates for the retail centre but project a portfolio high average occupancy rate of 95.90 % from 31st December 2015 and 31st December 2019. In addition land utilisation for the mixed development is low since there is a portion of land measuring approximately 2 acres that is undeveloped. It is not clear why the I-REIT is buying a property with a 2 acre undeveloped land and two obviously redevelopment properties in industrial area yet in its documents it is not anticipating (while the option exists through amendments) getting into property development in the short term.

Rational investors aim to diversify their investments. Diversification is a technique for reducing risk (particularly unsystematic risk) and maximizing returns by allocating investments to various instruments, industries, and classes. The basic reason is to avoid “putting all eggs in one basket”. REIT offers an opportunity for investors to spread their investment funds across various types of properties in several regions and along income groups. For example with KSh. 20,000/= in a REIT with a diversified portfolio one is entitled for instance to a return from a portfolio comprising office blocks, retail centres, hotel resorts, industrial complex located in Nairobi, Mombasa, Kisumu, Eldoret, Kampala and Dar Es Salaam. The aim of diversification is to maximise returns by investing in different properties that would each react differently to the same event. From the prospectus, there are three seed properties of which two are office buildings situated in Industrial area and one retail centre in the eastern part of Nairobi, a highly populated low income neighbourhood. All three seed properties are located in Nairobi. Of the additional 7 properties, 5 are in Nairobi and 2 in Mombasa. The whole portfolio will comprise 7 commercial, 2 retails centres and one mixed (retail and Office) properties, in Mombasa and Nairobi. An adverse change in the office market in Nairobi (which is enjoying surplus supply of office space) will have a significant adverse effect on the returns of the I-REIT. Real estate in Kenya is well diversified in terms of geography, types and income groups. The residential rental market is well established and the hospitality industry is growing. Devolution created 47 counties and brought life into hitherto backward towns (now County Government’s Headquarters) hungry for retail, office, residential and hotel accommodation. The 10 member Property Investment Committee (whose composition needs review) needs to relook at the portfolio afresh and include suitable residential and other types of real estate to diversify and balance the portfolio.

Real estate suffers obsolescence which is a matter of physical deterioration. Obsolescence can also be accelerated by changes in pattern in demand of a particular type of building or location. Obsolescence is an important issue because it is a major and real expense when it comes to real estate. As the asset ages, it wears out and ceases to be functional. The neighbourhood decays and degenerates. In short real estate suffers the risk of economic, physical and functional obsolescence. For this reason a substantial amount must be set aside for maintenance and upgrades including replacement. The two seed properties situated in industrial area have leases issued in the 1949 and 1956 respectively indicating an old neighbourhood in need of renewal. The two have unexpired terms of 33 and 40 years respectively. This means the REIT will soon need to engage in renewal with the possibility that the property will need to be redeveloped. Accordingly, these two properties will either have to be sold or the REIT will be forced to make major capital injections to upgrade/redevelop them. It is not clear from the prospectus how the I-REIT has taken care of obsolescence. It would have made more meaningful reading of the prospectus if the promoters shared the pictures of the seed properties and that of the neighbourhood. Other important consideration that investors need to take into account include the overall expanses of managing the REIT and particularly the payments to the REIT Manager as this reduces the amount available for distribution to the unit holders. Other costs include the acquisition costs of the properties one of which is to be acquired at approximately 5% the above valuation (there are two independent Valuers but only the values of one Valuer has been quoted in the prospectus. It would be interesting to know if the other Valuer had similar figures for the listed properties). The choice of acquiring companies that own the real estate assets may be explained as an effort to save on stamp duty. However this introduces new risks which the investors particularly retail and small QIIs investors (who lack the resources to hire experts) will be unable to take into account in the absence of thorough due diligence reports and contracts signed by the parties or additional disclosures such as availing audited accounts and indicating the directors and shareholders of these entities. In addition, for investors to give meaning to the declaration on “connected party transactions”, the promoters should in good faith reveal the identities of shareholders and directors of JHI Kenya, Excellerate Property Services Kenya Limited, Grenadier Group Limited, Bay Holdings Limited, Signature International Limited and Greenspan Mall Limited.

Generally a REIT is a wonderful opportunity for the public to invest in real estate. The excitement of the opportunity presented by Stanlib’s Fahari I-REIT should however be tempered with sound rational and analysis of the offer. Past attempts to create viable vehicles have largely failed because the promoters have taken for granted fundamental issues of a strong property management team, choices presented by available alternative investments, returns and knowledge and understanding of the dynamics of the property market as highlighted in this brief. Investors will recall in late 2000, Anglo African Property Holdings Limited made investment history in Kenya, when its initial public share offer (IPO) collapsed after investors failed to subscribe. More recently Home Africa which listed a few years ago at KSh. 12/= and reached a high of KSh. 25/= per share open trade has seen its shares price drop below KSh. 1.50/= and the wealth of the shareholders which at peak stood at KSh. 10.1 billion decline to below KSh. 600 million. A review of Stanlib’s Fahari I- REIT Prospectus, reveals that important lessons from the past have not been learned or put into practice when it comes to real estate investing in Kenya.

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