Distressed asset real estate investing – is now the time to be buying?

NAIROBI (Capital Markets in Africa) – As discussed in our “where to invest in 2018” article, 2017 was a difficult year for the Kenyan real estate market. With some residential and commercial nodes facing an oversupply, depressed sales figures across the board, and the disappearance of the senior debt market, we have to assume that some real estate investors are hurting and in desperate need of Liquidity. As any equities trader will tell you, this is the best time to buy.

A distressed asset is defined as an asset that is put on sale, usually at a cheap price, because its owner is forced to sell it.

Sometimes, the asset is genuinely distressed and should be avoided at all costs. Examples include:

A poorly designed building may have prohibitively high maintenance costs which the landlord is unable to cover.

The development of a building being stalled because due to lack of demand for the final product

Where a project has run out of money due to high on-going unforeseen costs

There are however many instances where landlords are forced to sell perfectly fine buildings because of external factors. These deals are often hard to spot but can significantly improve the returns of a real estate investment. Here are some of the opportunities to look out for:

Market related funding gaps
It is not uncommon for funding to be pulled from a perfectly good project because of external market forces – something we are seeing a lot in Kenya right now. The 2017 interest rate cap made the margin between lending to real estate developments and investing in government securities too low to warrant the additional risk. This has had two marked effects on the real estate market:

Banks with debt in recently completed development projects (ranging from private houses to entire malls) are reluctant to restructure financing to longer term asset financing – something that was common place just 16 months ago – in favor of forcing the landlord to sell at a discount and repay the loan; and

Funding committed to on-going developments which had yet started to draw down are being taken off the table. 

Private lenders and non-bank financial institutions who – are not constrained by the rate capping legislation – are well placed to refinance these opportunities at low risk with high interest rates. In instances where landlords are desperate.

Impatient capital in a slow market
When traffic is slow, we all know the best thing to do is to pull over and find a place to have coffee or do some work until traffic clears. Unfortunately, some people cannot afford to be patient and these are the people you see driving into oncoming traffic and getting arrested by the police. The same is true about real estate investing. The prolonged 2017 election led to low investor confidence, resulting stagnated or falling land prices in many of the Nairobi suburbs.

The patient investors (investors with patient capital) used this time to process titles and maybe do a spot of farming. Some land owners however – e.g. those who borrowed in order to buy the land – are looking to sell quickly and are offering significant discounts

Unrelated capital requirements
It is not uncommon for corporations in Kenya to house multiple business and assets under one group company. This has some benefits – for example the company can borrow against its multiple assets to fund expansion. The downside is that in a market slowdown companies are forced to sell these assets to raise cash to sustain business. Though yielding real estate is relatively illiquid, it is usually easier to sell than a business going through tough times. In 2017 we saw some manufacturers feeling the retail market pinch choose to sell their go-downs/factories at 12%+ yield in order to raise money to keep their core business afloat

Distressed asset investing however is risky. Investors looking to play in this space need a very good understanding of both the real estate market and the market leading to the external factor. Resist the urge to make bets on the market improving, or on your ability to raise additional funding. Look for true value opportunities and focus on yield and exit.

For more information on how your business can use build to suit development, please contact Fusion Capital at enquiries@fusiongroupafrica.com, or email me directly at jmaclean@fusiongroupafrica.com