Property Bonds: Are They Worth It
- Investment Desk
- Oct 28, 2024
- 5 min read
Updated: Oct 31, 2024
October 2024
Traditional financing through commercial bank loans often entails high costs, while relying solely on equity may dilute ownership. Property bonds, a form of debt instrument, offer developers an alternative route to raising capital by tapping into the bond market, providing investors with a more secure investment underpinned by the collateral of the real estate asset itself.
For CapeView, property bonds can be an efficient financial tool, whose success will be contingent upon the strength of the underlying asset. Their nature of providing long-term financial financing for the real estate projects without the immediate financial strain of servicing large loans is an appealing factor for the Desk. Unlike equity, bondholders will be creditors entitled to periodic payments (interest-free), with the principal repaid upon maturity. These bonds will be typically secured by the property being developed, which increases investor’s appeal by reducing risk through the collateralization of tangible assets.
We have witnessed both successful and challenging instances of property bond issuance. A notable success story is Housing Finance’s KES 10 billion bond, which was oversubscribed by 140% in its first phase. This bond issuance was supported by strong demand in the housing market, according to analysis, coupled with Housing Finance’s solid financial standing and effective market engagement. The Capital Markets Authority (CMA) approved Housing Finance’s (HF) issue and listing of a seven-year, Ksh10 billion (US$103.24 million) housing bond. The first tranche of this bond, which was issued in October 2010, was oversubscribed by 41 percent. During its second tranche issued in October 2012, HF raised Ksh5.2 billion (US$53.68 million), which represented an oversubscription of 76 percent above its Kh2.9 billion (US$29.94 million) target. The ability of these institutions to raise funds in domestic capital markets enables them to offer local currency lending to their clients under better terms. The first tranche successfully closed in October 2010 with HF receiving bids for KES 7.03bn, versus their target raise of KES 5bn, resulting in a subscription of 140%. Several offshore and local asset managers, pension funds and insurance companies subscribed to large amounts. HF decided to exercise the option to accept the entire KES 7bn received in bids. The bond was issued at par, and was mainly a fixed rate bond offering 8.5% per annum. A small portion was offered on a variable rate, offering 3% over the 182-day T-bill rate, with a floor of 5% and a cap of 9.5%. The costs incurred in raising the first tranche were KES95.5 million or 1.3% of the total raise.
Another successful and recent issuance was done by Centum Re, for the phase two of the Loft Residence. The property was completed with the sale of 24 4-bedroom luxury apartments. The apartments were sold at prices ranging from Ksh 36 million to Ksh 52 million. 90% of buyers are investors including businessmen, Kenyans living abroad, and expatriates from various parts of the continent. 21% of buyers used mortgage financing while 79% made milestone payments. The company said that the units have strong rental income, with rental yields of over 10% per annum and capital appreciation. The project was funded through Centum Re’s Ksh 3 billion bond. The three-year bond was floated in December 2020 in two tranches comprised of a Sh2.6 billion batch earning a fixed coupon (interest) of 12.5 percent and a Sh354 million lot with a variable return starting from 12 percent. The bond was secured by the projects with deposit collections flowing into a sinking fund.
Focusing more on Sharia Compliance, Sukuk (the Islamic equivalent of a conventional bond) enables the investors to have ownership of the asset underlying the debt instrument and the periodic return received will be pegged on the performance of the asset. The conventional property bonds do not translate into ownership of the underlying asset. Diving deeper into this, Kenya’s inaugural Shariah-compliant bond, Linzi Sukuk offered an internal rate of return of 11.13%, and raised the targeted Sh3 billion after bids came in at Sh3.02 billion. Proceeds from the Sukuk were aimed at developing 3,069 institutional housing units as Linzi Finco Trust aligns itself with the government’s affordable housing agenda. According to Business daily, the bulk of investors who tapped into the opportunity did so through CPF Asset Managers and Liaison Asset Managers. Linzi Finco Trust secured the Capital Market Authority’s (CMA) approval to issue Kenya’s first Sukuk on September 20, 2023 and has been in the market since, with a targeted issuance which means only specific investors were courted to tap into it.
When it comes to Property Bonds’ failure, the Home Afrika case study comes to mind, In 2014, Home Afrika, the only listed property developer in Kenya, had to seek more expensive commercial loans from banks after its maiden bond issuance failed to raise the minimum required amount of Ksh 500 million (US$5.2 million). Despite offering investors an attractive return of 13.5 percent, a 2.63 percent premium over similar government paper, Home Afrika’s attempt to raise Ksh 900 million (US$9.29 million) through corporate bonds was unsuccessful. Given the oversubscription of government and corporate bonds in the past, liquidity in the market was certainly not the issue. Home Afrika’s bond flop can be attributed to the institution’s weak performance and declining profitability. Home Afrika was forced to refund Sh300 million raised after the CMA found that the property developer had an inflated interest rate to make the bond more appealing to potential investors. CMA also penalized NIC Capital and Kingdom Securities, the bond advisors for misleading Home Afrika to revise the coupon rate from 13.5 to 17 per cent.
In an effort to cushion corporate bondholders from financial losses, the CMA now requires potential bond issuers to meet additional requirements. These include undergoing mandatory credit ratings, the provision of financial guarantees from recognized institutions such as banks or insurers and the procurement of the services of trustees who represent bondholders and appoint independent receiving banks that hold investors’ funds until the securities are credited to their CDS accounts. These are just a few of the additional rules put in place by the CMA so as to protect investors and reduce the risk of bond issuers defaulting on their debts.
So, are property bonds worth it? Additional rules and regulations increase the level of complexity of successfully issuing bonds however, the successful issuances like that of Centum Re enabled them to develop high-end properties like The Loft Residences, making it a worthwhile investment. To reap the benefits from the issuance of property bonds, we as Reon Capital must ensure that we have a healthy balance sheet; fulfill all stringent requirements to be listed on the capital market while still offering attractive returns to investors and maintaining Shariah compliance.
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