Dual currency funding structures could be the answer to sub-Saharan Africa’s real estate market as developers and retailers seek solutions to the volatility currently faced in their domestic economies.
According to two experts from Standard Bank, the stability and robustness of dual currency funding far outweigh the inconveniences.
Traditionally, most property development projects are financed in US dollars to assist in creating a sustainable and predictable funding environment for the assets. But a solution is at hand, in the form of a dual currency structure.
“While property sector trends in West Africa are still positive, the main challenge has been currency volatility and related regulations,” said Adeniyi Adeleye, Head of Real Estate Finance for West Africa at Stanbic IBTC. “This has exposed tenants to rental increases because their rents are indexed to dollars. The devaluation of currencies in countries like Nigeria and Ghana has been quite significant.”
He added: “Over time, these cost increases will inevitably be passed on to consumers, which will in turn create additional affordability challenges. The level of interest from property developers has not waned in spite of the strained environment. In fact, most developers are positive about the long-term prospects of the economy and options available to them, largely because of the supply gaps in these markets. They are now challenged with trying to create robustness in their operating models to ensure they can continue to execute projects in the short-term.
“It is now more about new solutions that are needed to improve the structuring of these deals, so developers can manage the challenges caused by policies aimed at shoring up dollars, the high local interest rates relative to dollar-based interest rates and weakening currencies.”
Essentially, a dual currency structure refers to utilising a combination of hard and local currencies, while hedging the interest rate risk.
“These facilities would provide a natural hedge and create a win-win between developers and retailers. For example, a local currency facility can be accessed to hedge leases that are unlikely to be sustainable or easily adjusted in shock currency devaluation scenario, for defined periods.
“This way, the exchange rate risk can be more effectively shared between retailers and developers by keeping lease exchange conversion rates constant for periods of volatility,” explained Adeleye.
If the market stabilises it would also be simple to refinance local currency exposure back into foreign currency and then original lease assumptions and plans can then be achieved, unless macroeconomic indicators show that local currency funding has now become appropriate for these deals. “The robustness of the structure is that it adjusts in periods of shock to provide stability,” said Adeleye.
It provides sound financial structuring, inbuilt buffers and flexibility into project funding structures, to accommodate for unexpected changes in the economic environments.
“This structuring solution seems to be the most pragmatic approach to dealing with the challenges of unpredictable economic environments,” said Adeleye.
Most of the real estate markets are dominated by foreign real estate developers and investors and they seldom seek to undertake projects in sub-Saharan Africa with the view to earning hard currency returns, as they are mindful of their return targets and asset valuation considerations.
The key challenge is that though many markets have official channels for assessing hard currencies, they often require regulatory approval to convert. There remains the risk that a change of government or policy may hinder the unfettered access to the markets, thus creating a real risk of being unable to service foreign currency obligations.
“It is this serviceability challenge and robust flexibility that dual currency funding structures seek to mitigate,” explained Gary Garrett, Head of Real Estate Finance at Standard Bank. “Dual currency funding structures assist in reducing repayment risk in times of currency volatility. At times, there may be US dollar liquidity shortages in local markets, meaning that dollars can’t be accessed by borrowers to service dollar debt obligations.”
Garrett continued: “Should such a scenario occur, all available local currency would be used to service the local currency debt component, meaning that the borrower will not default on debt servicing obligations despite the shortage of dollars. It also offers some protection where the local currency depreciates rapidly against the dollar, and the impact of this can’t be passed on to tenants through increased rentals.”
Traditional intuition is to finance retail real estate projects in local currency but the differential in interest rate between the dollar and local currency, loans can be as much as 18 percent; which makes the foreign currency financing attractive, especially as there is a margin of compression from stabilising rental rates and limited scope for project cost reductions.
Policies in some countries in the region are aimed at preventing developers and retailers from using scarce dollars to service obligations and thereby place further pressure on the demand for hard currency.
“However, it is important that in such times, the financing of projects that have commenced can continue, to ensure they can ride these waves of uncertainty,” detailed Adeleye.
Garrett concluded: “A mere 18 months ago, very few clients considered hybrid currency loans as local currencies tended to be fairly stable against the dollar, and local currency interest rates tended to be expensive relative to US rates. Now, the volatility in exchange rates experienced over the past 12 months has urged borrowers to reconsider their stance on local currency funding.”