The unfolding events in the banking sector following the Central Bank of Nigeria (CBN) intervention and the subsequent sacking of CEOs of major banks, amongst other corrective directives will for some time to come continue to have far-reaching effects on the economy. TradeInvestNigeria examines how the real estate sector is impacted with a focus on two key areas - funding and property valuation.

Finance linked to construction and real estate ownership became a dynamic element of loans and credit granted by Nigerian financial institutions from about 2003. It is believed that more than 20% of credit granted to the private sector is related to activity in the real estate sector.

Over-valuation of property prices and rising interest rates, increasing difficulty in the attainment of project viability, growing debt as well as the global financial crisis from the end of 2007 together put a stop to the period of rapid growth of the sector. Fortunately, even through the global crisis, the slow-down has been relatively smooth, that is until Nigeria's latest banking crisis.

The recent action of the CBN has set off a re-evaluation of the credit risk and brought about a tightening of the terms of granting credit to the sector in what can be best described as a knee-jerk reaction. This rather rapid contraction almost guarantees that the sector has commenced a rollercoaster fall. Banks are retrospectively correcting the imbalance of loans to collateral. First Bank of Nigeria Plc (FBN) recently stated, amongst other strategies to recover non-performing loans, that it would "obtain alternative/additional collateral (up to 150% coverage on new transactions) and pursue gradual work-out plans".ⁱⁱ

Construction Finance: There is a noticeable slow down/lack of activity on many project sites as financiers re-evaluate project risks and make further demands on promoters. There is no doubt that fewer projects will be actualised in 2010 and even less funding will be available to real estate sector related businesses such as building materials manufacturers. The lending behaviour of the banks has far-reaching implications for real estate pricing. Financing institutions already indicate a reluctance to lend to developers. Many developers are caught between a rock and a hard place – escalating construction costs, uncompleted projects, and a lack of funding. Developers with several properties within their portfolio have chosen to sell down, in order to finance on-going or new projects rather than approach banks.

Off-Take (Mortgage) Financing: The increased paucity of mortgage finance means fewer and more expensive mortgage products. The new vista in the financial system will lead to a review of existing mortgage terms and portfolios, with pending evaluations taking longer as banks embark on a tidy-up of existing 'bad' transactions.

As anticipated, the Federal Mortgage Bank of Nigeria (FMBN) recently published its list of debtors and has begun to recover its portfolio of bad loans. The knowledge that the FMBN has a bad loan portfolio of N12 billion further exposes the weakness of the apex mortgage institution and pushes the overdue re-structuring of the sector forward. Earlier in the year CBN officials expressed concern that the mortgage sector might witness a backlash due to its undertrading activities. A review of the money lending activities of the mortgage firms in 2007 showed that liquidity ratio (mortgage assets to total assets) is low (30%, instead of the stipulated 60%) and placements in commercial banks stood at N118.1 billionⁱⁱⁱ.

It is expected that more than a third of major real estate projects may end up being foreclosed. Some banks are already working with real estate expertise to review, develop and implement strategies to deal with pools of real estate assets to which the banks are exposed.

Real estate assets re-valuation - A rollercoaster ride

Sophisticated investors see the current upheaval as the perfect opportunity to grow their portfolio by positioning to acquire distressed assets. According to the chairman of Skye Shelter Fund "the recent asset recovery drive by financial institutions following provisions for troubled assets, provides a great opportunity for the Skye Shelter Fund, as it seeks to invest in the distressed assets at a reasonable price". Reasonable price refers to the downward valuation expected of most real estate assets.

Between July and August 2009 the real estate values in Lagos fell by up to 30% on the average. In severe cases, particularly in the suburbs prices have fallen by up to 50% of previous quotes^iv. There is a lull in trading activities and many real estate managers/agents report a drop in volume of business by more than half.

Bank debtors have besieged the Economic and Financial Crimes Commission (EFCC) following the announcement that defaulters will be arrested and prosecuted. With the on-going liquidity crisis, many have resorted to debt re-scheduling agreements with the Commission, depositing title documents of owned properties with the EFCC^v.

While the real estate market is not awash with news of major disposals, several projects have quietly exchanged hands between promoters and financiers in what we predict will become a common trend over the next six months.

Prognosis

The challenge for the real estate sector lies in the ability of the various stakeholders to respond quickly and effectively to the evolving imbalances. The real estate sector is a significant contributor to the financial position of financial institutions in terms of asset holdings and mortgage loans; therefore real estate pricing is critical to the financial sector and is an indicator of the wealth of a country.

A decade ago, the IMF commenced work on the development of Financial Soundness Indicators (FSIs) in an effort to help policy makers identify financial system strengths and vulnerabilities ahead of crisis situations. Several of the core indicators are real estate indices - pricing and size of deposit takers exposure to the sector. Sector stakeholders must revisit with the urgency it deserves the case for the development of property indices as a contribution toward an understanding of the soundness of local financial institutions.

The CBN and Nigeria Deposit Insurance Corporation (NDIC) announced the commencement of a re-tooling exercise in order to become more proactive regulators and supervisors of financial institutions. Banks are expected to embrace new risk management disclosure and policies and also build capacity for risk management. The FMBN as regulator of the mortgage sub-sector must embark on a similar exercise of self diagnosis and corrective action.

The mortgage sector reform is expected to kick off in Q4 2009, with the recapitalisation of both the apex mortgage bank and the primary mortgage institutions (PMIs). This is expected to attract some foreign direct investment funding into the mortgage industry. It is also expected that some of the PMIs owned by commercial banks will be sold in part or in full as commercial banks focus on their core businesses.

The CBN's Asset Purchase Facility Fund - a special purpose vehicle for the acquisition of the liabilities of the troubled banks will help maintain the needed stability in the system. It should be possible to further create vehicles for the real estate related liabilities. These should be managed by asset managers with a mandate which includes the preservation of value.

Government's role in stemming the current slide requires creative thinking and incentivising. Developers must be encouraged to continue to build "more for less cost". Infrastructure created by developers at their own expense (in pursuance of technical specifications) should be transferred to the relevant government agency on a compensatory basis and not free of charge as is the case. Buy-out schemes (for unsold units) of low income/professional workers housing schemes by government using special “stabilisation” funds will encourage residential construction. Specific incentives for infrastructure projects and real estate related companies should be developed.

In spite of the gloomy outlook, we expect that there will be positive effects in the long term, on the sector. The overhaul of the apex mortgage bank, the development and strict supervision of regulations especially in the sphere of residential construction, and financing will perhaps be the most significant contribution to the well being of the sector. We also expect that the market will be rid of unprofessional developers, operators and other market participants who have over the past decade taken over the industry. This latest crisis will hopefully, strengthen the real estate sector, make it more effective as a contributor to the wealth of the country, and ensure some transparency.

i) Address by Governor of the CBN, Mallam S. L. Sanusi, on Developments in the Banking System in Nigeria, August 14, 2009.
ii) Risk Management Disclosure, First Bank of Nigeria Annual Report & Accounts, June 2009,
iii) Reform looms as mortgage sector placements in banks hit N118.1bn, Guardian Newspaper, January 12, 2009.
iv) Property market in forced sales as bank loans shrink, Chuka Uroko, Business Day, 02-09-09
v) Castle Weekly Magazine, August, 2009.

This article first appeared in Alitheia Capital Real Estate Insight

Alitheia Capital is an investment manager and advisor. Our mission is to broaden the ownership of businesses and real estate; to this end, the company is committed to doing well, while doing good. Alitheia enables socially sustainable investing and provides the opportunity for investors across the economic pyramid to invest in key sectors of the economy via structured investment vehicles. From its base in Lagos, Nigeria, the company is focused on channelling private equity investments into businesses and real estate assets.