Topical Feature: The Evolving Construction Procurement Methods in Kenya; and the Risk Management Measures for Investors #49/2020

Construction procurement is a process that starts with the identification of a construction need and continues through planning, preparation of specifications/ requirements, budget considerations, selection, contract award, and contract management.

A suitable procurement method is selected based on the client’s requirements at the project’s planning stage. The following are the factors that influence the procurement method in a construction project.

  • Speed or time to completion of a project
  • Budget – The procurement method selected should ensure the budget is not exceeded.
  • Client’s aspect of quality.
  • Specific project constraints
  • Risk
  • Type of project Financing method

Mainly, new construction procurement methods evolved from the traditional methods of procurement.

Traditional methods of procurement/ contracts

In traditional procurement methods, the contractor is responsible for the coordination of subcontracting of the construction design. The Contractor’s only task therefore in this case will be the execution of the project (and handling the subcontractors & suppliers).

There are three types of contracts under the traditional procurement method:

  • Lump-sum contracts – The contract sum is determined before construction starts and entered in the contract.
  • Measurement contracts – The contract sum is accurately known on completion and after re-measurement of completed work.
  • Cost reimbursement – The contract sum is arrived at based on the actual costs of labour, plant, and materials.

Over time, the changing dynamics of the construction industry in Kenya has driven developers and professionals in the construction industry to employ more innovative and effective procurement processes to derive the best value from the supply chain. Among the evolving Methods of Construction Procurement in Kenya include:

Labour contracts

Developers usually procure materials themselves, leaving the contractor to provide only the labour and associated management. In this contract procurement method, the contractor’s overheads are reduced and, consequently, the project’s construction cost. However, the labour contract calls for the time commitment, energy, and diplomacy on the client’s side to achieve the project’s objective.

Design and Build procurement

In this procurement method, the design and build responsibility is covered by the contractor, with the construction Consultant’s scope limited to management of the contract. The client is only responsible for the finance and operation of the construction component in the project.

Management Contracting

This type of procurement usually involves few management contractors appointed according to the project’s scale, and the project is divided into several packages with the specialized contractors undertaking the real build aspect on their specialized field. All the subcontractors are managed and supervised by management contractors, and the client is only left to communicate with the management contractors and provide the financing

Private Financing Initiative (PFI)

The contractor, in this type of procurement, is solely responsible for all functions of construction, including financing. After successful completion, the project is transferred to the client.

Integrated Project Insurance

The procurement teams work together with the client to present a preferred solution with cost savings against existing cost benchmarks. In this case, a single insurance policy covers all the project risks, including cost overruns. Thus, a single policy would cover all insurance policies that in other projects are held by the client, contractor, and the supply chain.

 

B.) WEEKLY NEWS HIGHLIGHTS

 

           MAJOR ECONOMIC NEWS HIGHLIGHT.

 

i.) Diaspora inflows surge by KSh30bn

Diaspora remittance grew by Sh29.97 billion in the ten months to October 2020, compared to a similar period in 2019, despite pressure from the economic knocks of the Covid-19 pandemic. The latest data from the Central Bank of Kenya (CBK) shows that the remittances amounted to $2.54 billion (Sh268.63 billion) in the first ten months of 2020, compared to $2.34 billion (Sh238.66 billion) in the same period in 2019 — a nine percent growth.

 

 

ii.) Value of the Kenyan shillings breaches Sh110 mark in a historic plunge

The Kenyan shilling plummeted to a new historic low on Thursday, 26th November 2020, to trade at 110.5 units against the US dollar, signaling rising costs of importing raw and finished goods such as petroleum products and construction materials. The depreciation on 26th November 2020 marked the twentieth straight day of trading the shilling had lost ground against the dollar since touching 108.83 on 2nd November 2020. The extending run of record weakening of Kenya’s shilling against the US dollar was attributed to the increasing demand for the greenback towards the end of the year and a declining foreign exchange inflow.

 

iii.) The National Treasury cuts GDP growth forecast to 12 year low

On Thursday, 26th November 2020, the Treasury downgraded Kenya’s growth forecast for 2020 to 0.6 percent amid the economic fallout from the Covid-19 pandemic, the lowest expansion in 12 years. According to the cabinet secretary for Treasury, Ukur Yatani, the impact of the Covid-19 on families, businesses, and economic activities has been worse than earlier expected, prompting a further slash on growth forecast set at 2.6 percent in September. Mr. Yatani further said that the 5.7 percent slump in the gross domestic product (GDP) in the second quarter of 2020 was notably worse than earlier estimates.

 

iv.) Loan cost at historically lowest levels

According to the latest data from the Central Bank of Kenya, lending rates fell to an average of 11.75 percent in September 2020, following a consistent drop in the regulator’s benchmark lending rate. Banks have also cut the cost of credit to historically low levels and reduced appetite to extend credit to high-risk borrowers in the wake of the Covid-19 pandemic that has raised defaults to a 13-year high and increased the amount of restructured loans to Ksh 1.38 trillion.

 

 

CONSTRUCTION INDUSTRY HIGHLIGHTS

 

i.) Real Estate Developers urged to use alternative building technology

In a forum to empower local contractors, the ministry of housing and national development on 23rd November 2020 urged developers to use new building techniques such as expanded polystyrene (EPS) panels to solve Kenya’s housing crisis. According to the Public Works Principal Secretary Gordon Kihalangwa, using alternative technology is time-efficient and more eco-friendly.

 

 

ii.) Kenya to partner with foreign contractors to boost local building capacity

On Monday, 23rd November 2020, the National Construction Authority (NCA) reported that the country plans to partner with foreign contractors to boost the building sector’s local capacity. The NCA revealed that Kenya is keen on technology transfer in the construction sector to ensure that local firms can undertake complex construction projects. The regulator further alleged that Kenyan contractors lag behind their international peers in skills and financial capacity.

 

 

 

iii.) Moad Capital introduces a new construction design.

Moad Capital, a Kenyan Real Estate developer, introduced an innovative housing construction design technique that will see construction companies adopt green housing technology through a circular economy approach. According to Moad, the circular economy of designing and constructing housing entails a shift towards renewable energy through the superior design of materials to reduce damage to climate and biodiversity. The developer plans to set up a multi-dwelling unit called Tungo place, which will comprise two and three-bedroom houses in Kibichiku (Kiambu County) on a 5.4-acre piece of land using the construction system.

 

iv.) Kiambu County set to construct 30,489 housing units

Kiambu County is set to host the biggest housing project under the government’s affordable housing program, with 30,489 units planned for the development on 302 acres of land in the Kamiti area along the Northern bypass road in Kiambu County. According to the regulatory filings submitted to the National Environmental Management Authority (NEMA) on 24th November 2020 by Hydro Developers Limited, the affordable housing scheme will comprise 10,166 studios (31SQM), 9,384 one-bedrooms (45SQM), 6,256 two-bedrooms (62SQM), and 4,692 three-bedroom apartments (91SQM).

 

 

             COMMERCIAL REAL ESTATE HIGHLIGHTS

 

i.) Kenya Real Estate sector Records subdued performance owing to the Covid-19 pandemic

A retail sector report by Cytonn Investment showed that there has been a subdued real estate performance across the various real estate themes in the country, as the economy grapple with the effects of the coronavirus pandemic. The report, released on 22nd November 2020, showed that the real estate performance has declined to record average rental yields of 6.7 percent, which is 0.3 percent point lower than the 7 percent recorded in 2019.

 

 

ii.) Retail space price fall as demand declines

A report by Cytonn Investment showed that the retail prices have declined by 2.1 percent to an average of Ksh115.1 per square foot from Ksh118.0 in 2019, as the real estate retail sector’s demand declines. According to the report released on 22rd November 2020, the year experienced reduced occupancy rates, which declined by 0.7 percent from 77.3 percent in 2019 to 76.6 percent attributed to the growing focus on e-commerce and retailers’ scaling down in the wake of reduced revenue inflows.

 

 

 

iii.) Women account for 30pc of Stanbic first-time mortgages

On 23rd November 2020, the Stanbic bank disclosed in an annual integrated report that women accounted for 30 percent of Sh19.95 billion first-time mortgages issued by the Stanbic Bank in 2019. According to the lender’s report, as of 2019, 78 percent (Sh19.95 billion) of all mortgages issued by number were to first-time homeowners, 30 percent (Sh5.99 billion) were issued to first-time female homeowners.

 

 

 

 

iv.) Centum Investments Reorganizes its real estate business

Centum Investment Company announced on 25th November 2020 in its published half year financial results for the year ended 30th September 2020 that it had reorganized its real estate unit into two distinct business units. According to the report, the reorganization separated centum real estate limited and Two Rivers development limited. The report further stated that Centum Real estate is pursuing a sales-led development model and is currently constructing 1482 residential units across three Nairobi, Kilifi, and Uganda sites.

 

 

C.) KENYA REAL ESTATE TRENDS

 

i.) The concept of Dual Branding gains popularity among developers in Kenya

An emerging trend within the Kenya hospitality market has been dual branding that has seen multiple developer’s pair serviced apartments with a mix of select and full-service hotels to enhance operational efficiency. As such, developers can go after both the select service and extended stay hotel customers with one property. Dual branding is gaining popularity in the Kenyan markets due to high cost of land and constructions costs.

Example of major developments that have incorporated the idea of dual branding includes the Mirema hotel and serviced apartment in Thika Road, and the Skynest Residences to be developed in Westlands.

 

 

ii.) Covid-19 triggers’ force majeure’ in the construction sector

In the wake of Covid-19, which has stalled most construction projects, contractors have increasingly invoked the force majeure contracts – a contract provision for inability to deliver a construction projects as stipulated. Construction contracts require contractors to perform within an agreed time or else face liability which includes liquidated damages, but the widespread disruption of works in construction projects caused by the Covid-19 pandemic has spurred many projects to stall and the need to invoke the ‘force majeure’ clauses, a provision in contracts that exempts them from fulfilling contractual obligation, or seeking negotiations.

Their purpose is to excuse a party from honoring contractual obligations where performance is made impossible by various unforeseen circumstances. The clauses recognize that a claim for breach of contract cannot materialize because failure to perform was made impossible by circumstances outside either party’s control.

 

D.) GLOBAL REAL ESTATE TRENDS

 

i.) U.S. housing market on a strengthening Trend.

The S&P/Case-Shiller seasonally-adjusted U.S. national home price index rose by 3.62% during the year to Q3 2020 (inflation-adjusted), an improvement from the previous year’s 1.57% growth. Real house prices in the United States increased by 2.29% during the second quarter of 2020. Furthermore, the Federal Housing Finance Agency seasonally-adjusted purchase-only U.S. house price index rising strongly by 5.02% y-o-y in Q3 2020 (inflation-adjusted), up from the prior year’s 3.34% growth and the biggest increase since Q4 2015. The FHFA index rose by 1.39% q-o-q during the latest quarter.

Moreover, both housing demand and supply are rising, despite the economic fallout from the coronavirus pandemic. On the other hand, the Kenyan housing market has been experiencing a declining demand and supply of new units.

 

ii.) Demand for residential units in the UK continues to fall

According to the HM Revenue & Customs (The UK’s tax, payments, and customs authority), nationwide residential property transactions of £40,000 or above fell sharply by 25.4% to 403,850 units in the first half of 2020 in the United Kingdom, amidst the coronavirus outbreak.

The downward trend has been experienced in the UK property market over the past years, with the coronavirus triggering a further decline. The housing demand fell by 1.2% in 2019 and 2.3% in 2018 due to the volatile political and economic environment surrounding the Brexit deal. On the other hand, the Kenya residential market has been stable over the past years, with the demand for affordable units expected to rise in the coming years attributed to a growing middle class and urbanization.

 

E.) COMMON REAL ESTATE & DEVELOPMENT CHALLENGES,  AND SOLUTIONS

 

Managing the Cost of Finance (Interest) on a Real Estate Investment Project.

 

YOUR CHALLENGE:

In modern real estate investment; a need to source external funding is inevitable because of the huge capital requirement coupled with relatively big scope in modern projects, as well as the need to leverage through borrowing or seeking an equity partner into the Project. The challenge comes in finding ways to reduce the cost of finance in the project; which can also be interpreted as to how to reduce the interest rate for debt or equity funding.

 

 

THE SOLUTIONS:

There are a number of ways to reduce the cost of finance in a project, as outlined below:

a) Increasing the Equity Contribution Share in the Capital Structure: One of the ways of reducing the cost of finance is to increase your Equity Contribution share into the project, or into the Capital Structure. This way, you borrow less thereby reducing the overall cost of capital into the Project. This can be done by liquidating other assets whose overall returns or capital gain is much lower than the cost of borrowing.

b) Paying the Investor early, for Equity Finance: The other ways of reducing the cost of Finance into a Project is to pay the Investor early into the project, through the first proceed that comes from sales of the Real Estate Investment Product. This is done through a systematic Tier formula, whereby a considerable amount is paid to the Investor or Lender in tier one and two, through negotiated interests that much lower than if the proceeds were paid at the end of the project.

c) Seeking Equity Partners in Potential Buyers: Another way or reducing the cost of finance is to seek equity partners in potential buyers. These are Buyers that you negotiate with so that they can pay a bigger percentage of the price of the sale units in off plan or initial stage, but at a much discounted price, such that the partners benefit through lower price premium discounts while the developer benefit in equity capital.

d) Selling Off-Plan to reduce to Capital Deficit: Selling off-plan still remains a viable way of reducing the cost of finance. The idea is to break ground at the site when you have raised a considerable amount through off-plan sales of Units.

e) Avoiding High Risk Finance Instruments, like Mezzanine Financing: Another way of reducing the cost of finance is to seek cheaper equity and debt finance instruments, and avoiding expensive debt instruments like Mezzanine Finance. One way of doing this is to negotiate the entire debt fund through one Senior Debt Capital.

 

THE CONSULTANT TO ENGAGE:

The Consultant to engage for this exercise is a Project Finance Consultant.

 

 

 

 

 

 

 

F.) THIS WEEK ON FREQUENTLY ASKED QUESTIONS (FAQs), AND ANSWERS

 

QUESTION:

What are the merits and demerits of importing Building Finishes materials, against buying them locally?

 

 

 

 

 

 

 

 

ANSWER:

 

We have seen a trend in recent past where developers imports building materials, especially finishes from other countries especially China, for reasons ranging from cost cutting measures to search of better quality materials. So what are the merits and demerits of this kind of an arrangement.

a) Merits: One of the merits is that developers are able to access a wide variety of finishes to choose from, thereby having an opportunity to explore on their taste and preference. Another merits is the wide range of quality to choose from, due to the huge variety of materials. Cost saving has also been cited by many developer as a merits to importation of building finishes, mainly being as a results of savings in profits and overheads for traders of the same materials, once you import the materials yourself. The cost saving also comes in discounts and economies of scale once you purchase materials in bulk, for large real estate development.

b) Demerits: Demerits for importation of building finishes includes uncertainty of the life cycle of the finishes, especially equipment due to unavailability of servicing parts locally, which means that you would have to import the serving parts, say for Lift Elevators every time there is a breakdown. Another demerit is technical compliance, especially for fittings equipment, whereby you may end up having a fitting that does not comply with counterpart local fitting during installation. Sustainability of sale guarantee also become an issue because of logistical issue related to an equipment imported from another country, when you want to activate a replacement through a sale guarantee.

 

G.) THIS WEEK ON DEVELOPMENT COSTS ANALYSIS – NGONG AREA, KAJIADO COUNTY

This week’s focus on Development Cost Analysis is for Ngong Area in Kajiado County, this being another fast growing satellite towns in the Metropolitan area of Nairobi. The Development type in this area according to the land-use and county zoning regulations includes Apartment Blocks, Maisonettes and Town House, Shopping and Retail Complex, and Warehouse and Godowns.

Below is an analysis of Construction Cost per Square Meter (SM), for the option of procuring the development project through a Building Contractor, or an option of direct procurement of the Materials and Labour through a Labour Contractor for recommended building types.

 

H.) THIS WEEK ON REAL ESTATE PRICE ANALYSIS – KINOO WAIYAKI WAY, NAIROBI COUNTY.

 

The Real Estate price analysis focus for this week is on land, sale, and rental prices for a 2 and 3 bedroom apartment in Kinoo Waiyaki Way – Nairobi County. The data were obtained through surveys, and analysis of asking prices on property listings in Nairobi.

i.) Sales price – Apartment and houses

ii.) Rent price – Apartment and houses

iii.) Land price per acre (commercial/residential)

 

I.) CENTRAL BANK OF KENYA INTEREST RATE WATCH – (T-BILLS)

The money market remained liquid over the week ending 27th November 2020, supported by government payments, which offset tax receipts. The interbank rate, which is an indicator of liquidity levels in the banking sector, went up by 0.62 percentage points to 3.669 percent, indicating increased banking sector activities.

91 day T-bill increased by 0.024 from 6.707% previous week rate to 6.730%. CBK offered a total of Kshs4 billion, and bids amounted to Kshs 4.578 billion, of which 3.595 billion was accepted. The volume of bids received increased week on week basis. 182 day T-bill increased by 0.041% from 7.152% previous week rate to 7.193%. CBK offered a total of Kshs. 10 billion, and bids amounted to Ksh 6.371 billion, of which Ksh 5.888 billion was accepted.  The 364 day T-bill increased by 0.057% from 8.094% previous week rate to 8.151%. CBK offered a total of Kshs10 billion, and bids amounted to Ksh 4.476 billion, of which Ksh 3.965 billion was accepted.

J.) KENYA EQUITY MARKET INDICES

Activities in the Kenya Equity Market increased during the week ending 27th November 2020. The NSE All-Share Index, NSE 25 share index, market capitalization, total shares traded, and equity turnover, which are the main measures of the equity market’s performance, increased by 0.64%, 0.05%, 0.64%, 19.71%, and 23.86%, respectively. The I-REIT stocks performed poorly than the equity majorly attributed to the depressed real estate market. The I-REIT deals and turnover plummeted by 78.87% and 74.35%.

K.) CURRENCY HIGHLIGHTS

The Kenya Shilling weakened against major international and regional currencies during the week ending 26th November 2020. The local currency plummeted to a historic low of Ksh 110.39 per US dollar on 26th November 2020, attributed to the increased demand for the greenback as the year approaches the end.

The usable foreign exchange reserves remained adequate at USD 7,951 million (4.88 months of import cover) as of 26th November 2020. That meets the CBK’s statutory requirement to endeavor to maintain at least four months of import cover and the East Africa Community (EAC) region’s convergence criteria of 4.5 months of import cover.

 

M.) FACTORS THAT WILL SHAPE THE REAL ESTATE AND OTHER MARKETS IN THE NEXT ONE WEEK.

i.)  Continued Depreciation of the Local Currency

The shilling hit a historic low of 110.5 on 26th November 2020 against the US dollar as its value continued to depreciate week on week. Last week’s depreciation was attributed to the increased dollar demand as the year approaches the end and a dim outlook for exports in the wake of renewed lockdowns in Europe following the second wave of Covid-19 infections

The continued depreciation of the local currency is expected to continue rising the cost of electricity as the forex levy (which comprises expenses incurred in foreign currency by power generators such as KenGen, independent power producers, as well as Kenya Power) will be passed to consumers, who are majorly the tenants and households. Combined with the country’s poor economic situation due to the second wave of the covid-19 infections, this might lead to rental lease breaks for both residential and commercial properties. Furthermore, the continued depreciation will raise the prospects of higher consumer bills for Kenya’s import-dependent sectors, such as the construction sector, which relies on imported raw materials like steel, building material finishes and fittings

ii.) Retention of the CBK benchmark interests’ rate

Central Bank of Kenya Governor Patrick Njoroge on 26th November 2020, announced that the current accommodative monetary policy stance remains appropriate, hence decided to retain the Central Bank Rate at 7 per cent. That was agreed during the Monetary Policy Committee meeting, at a time when the bank lending rate are at their lowest levels (11.75) since the 1980s. The governor noted that the banking sector is stable and resilient, with strong liquidity and capital adequacy ratios.

Retention of the lending rate at 7 percent is an indicator of economic resilience following the easing of Covid-19 restrictions. We, therefore, expect to see the economic fears brought about by the Covid-19 second wave dispelled and real estate investors’ confidence restored. As such, we expect to see more real estate transactions in terms of house purchases. The retention of the benchmark rate and reduced bank lending rate will also incentivize real estate consumers to take on debt, which will in turn, increase the number of buyers looking to purchase property over this time. Furthermore, we expect to see mortgage and unsecured loans default reduce in the long-term as homeowners are provided with further relief as they battle to keep up with their monthly payment.

 

N.) UPCOMING REAL ESTATE EVENTS AND TRADE SHOWS IN THE COMING ONE WEEK.

 

i.) Webinar: Social Housing as an Investment Opportunity: The webinar will explore ways to access the housing market and the market risks associated with investing in the social housing market.

Date: 8th December 2020

Time: 06:30 PM

Venue: Online

Event Organizer: https://www.ipf.org.uk/event/ipf-webinar-social-housing-as-an-investment-opportunity.html

 

 

 

ii.) Conference: Real Estate Private Equity Funds Virtual Conference – The future of private real estate investments and portfolio strengthening strategies will be discussed in the conference.

Date: 8th December 2020

Time: 08:30AM- 4:00 PM

Venue: Online

Event Organizer: https://www.imn.org/virtual-events/conference/Real-Estate-Private-Equity-Funds-Virtual/

 

 

 

Writer of the Report:

This Report is written by Buildafrique Consulting Group, Kenya multi-disciplinary consultancy, that offers END-TO-END DEVELOPMENT CONSULTANCY, REAL ESTATE, and PROJECT FINANCE solutions through specialized subsidiaries. Among our solutions includes:

  1. Feasibility Studies and Market Research.
  2. Project Finance and Capital Raising.
  3. Project Management.
  4. Investment Design Appraisal.
  5. Quantity Surveying
  6. Construction Cost Consultancy
  7. Physical Planning and Planning Permissions
  8. Environmental Management and Impact Assessment
  9. Real Estate Development and Structured Investment Solutions
  10. Property Valuation
  11. Marketing and Property Sales Agency
  12. Property Management and Facility Management

Our Contacts:

 

Disclaimer:

The information contained in this report is for general information purposes only. While we endeavour to keep the information up to date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the information contained on the report for any purpose. Readers are therefore advised in all circumstances to seek the advice of Registered and Licensed professionals in all matters related to Real Estate Investment and Project Development.