Structuring is the cornerstone of any transaction and investment sector development.

A robust and well thought through structure is one of the key determinants of the success of any transaction in any sector and location; and at any point in an economic or business cycle.

The same applies to the multitude of transactions envisaged and already underway in Africa as the continent sees an influx of capital (both debt and equity) deployed across various sectors from real estate and infrastructure to oil and gas, healthcare, financial services and manufacturing.

According to Ernst & Young, in 2013, Sub Sahara Africa Foreign Direct Investment projects in the real estate, hospitality and construction sector increased by 63%, making the sector the fifth most attractive in terms of investment and returns to investors; up three positions from 2012.  In the same year, FDI into Nigeria was USD 7.3 billion and projected to increase to c. USD 9.6 billion by 2015.  The Nigerian Investment Promotion Commission estimates that Nigeria needs investment of c. USD 100 billion over the next 6 years for projects including roads, electricity, oil and gas, railways and housing.

As these funds flow into Nigeria and especially into infrastructure

transactions, focus must shift to real estate transactions.  Consequently, the real estate sector must be primed and ready to take advantage of the flow of funds into all aspects of the sector following (the) infrastructure development.

Real estate development is unlikely to attract the same level of government support as infrastructure development; it is therefore of paramount importance that investors and, where applicable, their local partners are aware of the intricacies of structuring real estate transactions properly.  This includes the ability to identify, mitigate and apportion risk efficiently.  It is this awareness (knowledge and understanding of transaction structuring) that would drive investment in the real estate sector whilst also improving transparency, liquidity and regulation within the sector.

Structuring Considerations

In a rapidly developing and growing market like the real estate development and investment market in Nigeria, the awareness of transaction structuring aids the understanding of the needs and risk profiles of both local

and international investors.  This understanding enables one to ask and answer a key question – ‘what does investor capital require?’.  The answer includes understanding the tenor of investment, required return on investment and level of investor risk aversion, required local investment or co-investment, sector bias i.e. affordable or luxury housing, retail, office, industrial, hospitality etc.

In addition to understanding capital requirements, practical matters such as robustness and adequacy of the security package; cash flow modeling including detailed sensitivity analyses; transaction capital / financial structure; and, of course, the exit strategy should also be considered.

Ideally, all these should be considered within the context of a non-recourse transaction with various bespoke mechanisms such as day-one ring-fenced interest and principal payments – to reduce default risk in the early stages of the transaction; cash trap/sweep mechanisms - to ensure the transaction sponsor(s) are incentivised to ensure transaction completion and the transaction can survive fluctuations in its cash flow; and a detailed bank account structure.

Apportioning Risk

With a robust structure already highlighting and mitigating various transaction-specific risks, attention

then shifts to market and country risk, which in Nigeria include a lack of legislative clarity on property and land rights ; high cost of construction; and financing.

With the right local legal team, issues around property and land rights could be mitigated; with a robust transaction structure (and a good financial advisor) financing risk could be mitigated; and with a good project manager and local knowledge, construction risk could be mitigated.

With all of the above in place, financing, whilst not a walk in the park, should be quite straightforward and competitively priced when approaching the right financing partner(s).

Transaction Financing

Alternative sources of transaction financing should be sought.

Given the local (Nigerian) financing constraints, it is advisable that various forms of transaction financing are explored before considering traditional senior debt from local (Nigerian) banks, especially for real estate transactions.

Some of the reasons for considering other forms of financing before approaching the local banks include the high cost of funds; a lack of project finance facilities and real estate development-friendly terms such as roll-up interest; inability to refinance a real estate development facility with an investment facility at a lower cost of funds; and the (somewhat unusual) request for additional third-party collateral.

Some alternative sources of financing in Nigeria include pension funds and insurance companies.  According to Stanbic IBTC (a subsidiary of South Africa’s Standard Bank), Nigerian Pension Fund Administrators (PFA) and Pension Fund Custodians (PFC) currently have an estimated asset base of c. NGN 4 trillion (USD 24 billion).  However, PFAs and PFCs 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 REITs.

Other alternative sources of financing include approaching other emerging market economies / BRICS under the South South partnership; Development Finance Institutions and / or developing innovative financing solutions.

Financing Structures

Given the nascent nature of the real estate development and investment market in Nigeria, various innovative financing structures and options can still be developed and implemented.

The key consideration when proposing an innovative financing structure is to ensure that transaction risks (highlighted and mitigated) and returns are properly apportioned within the proposed financing structure.

Other financing structures such as sharia-compliant financing could also be considered for real estate development transactions.  Sharia-compliant financing, by its very nature, apportions risk and incentivises all parties within any transaction to ensure successful completion.

Exit Strategies

As the inflow of capital into real estate and infrastructure transactions continues, one must be cognisant of the fact that these funds deployed to create value would eventually be repatriated.  A transaction structure that limits or does not give consideration to (the implementation of) one or more exit strategies is

unlikely to be viewed favourably by potential investors.  It is therefore of paramount importance to consider (practical) exit strategies and repatriation of funds as part of any transaction structure.

Real estate exit strategies include, amongst others, issuing securities in the capital markets i.e. REITs, Mortgage-Backed Securities, Asset-Backed Securities; portfolio sale to private equity or asset managers that do not have an appetite for real estate development risk; and listing as a property company could be an exit strategy.  These exit strategies serve to further develop and increase investment in the real estate sector whilst also reducing real estate financing costs and improving liquidity and regulation within the sector.

2014-07-16