By Olu Olanrewaju, Associate Director, Altair.
When so many Africans cannot afford to buy their own homes, what can be done to bring home ownership to a wider population? Olu Olanrewaju looks at the opportunities afforded by Rent to Own.
Mortgage markets in Africa are generally among the smallest, as a percentage of GDP, compared to mature economies and well below the level needed to fund the aspiration for home ownership of those who could afford the revenue and capital costs.
Alongside expanding the mortgage market and reducing mortgage interest rates, there should be a parallel focus on providing affordable financing solutions to develop the rental market, the mainstay of most urban dwellers in Africa. Most importantly, there should also be efforts directed at the creation of an asset base.
African economic policies have, to an extent, encouraged both production and related employment but have had only limited success in the creation of this asset base.
The most important asset is home ownership. There are a few underlying reasons for the lack of progress. First, the banks are not sufficiently capitalised to offer viable mortgage finance for the average earner. Poor financial regulation and unsuitable savings products often compound this.
Second, there are few volume house builders and the support for the supply chain in terms of materials and services is often limited. Lastly, the lack of savings and an active secondary market, mean that home ownership can be for the mass of the population more of a burden than a wealth creation platform.
A tried and tested model already exists for introducing home ownership to a wider population whilst overcoming the restrictions of the mortgage market and stimulating volume house building: Rent-to-Own or Flexible Tenure.
Within this description there are a variety of options designed to meet purchasing in stages such as having an option to purchase, and incremental savings schemes. These aim to best fit the income streams of the purchasers, the finance available and the requirements of investors. A key component of Rent-to-Own schemes is to reduce the initial annual cost of home ownership below the relatively high mortgage interest costs found in most African economies.
The basic Rent-to-Own model envisages that purchasers would put down an initial deposit ranging from 12.5% to 20% of the property value, then pay a market rent per annum plus an annual premium calculated at between 3% and 5% of the value at the start date.
Each year, the rent and the premium would increase either by a fixed amount or be linked to the property value or some proportion of price inflation (upward only). These formulae are typically fixed at the time initial contracts are entered into at around half the rate of price inflation.
The initial deposit plus the premium received would each year be placed into a notional savings account which would earn a notional interest rate slightly above the rate of annual increase of the rent and the premium. In a volume investment, this money would be used to offset debt or reinvested in further properties.
As the amount in the savings account increased, the proportion of the value of the property that the savings account represents would change. The value of the property would be calculated annually by the formula and if fixed in the contract, increase by the same rate as the annual rent and premium.
At the end of each year, the savings account would be credited with that portion of the rent as notionally, the purchaser had bought that proportion of the property. When the amount in the savings account equalled the current value of the property, then the ownership of the property would be transferred to the purchaser and the payments of the rent and premium would cease.
In a typical model, this would take 12-15 years. The investor has then benefited from rent, the formulated increase in value of the property and exited from an existing cash balance, i.e. the savings account.
In the event of a default, the monies in the savings account would be returned to the purchaser less sufficient to act as a buffer for the risk incurred by the lender or other equity partners, plus any costs incurred from reselling or re-letting the property. The formula for this is set out in the initial contract.
If equity were used rather than debt, the returns would be similar in the standard model but with the potential to improve returns from flexing the funding arrangements to reflect the increasing value of the property during the life of the project.
Help to buy schemes
Most sophisticated economies have examples of Rent-to-Own or Flexible Tenure which enable households to purchase homes where either the mortgage market is very restricted, or the structure of household savings and incomes makes it difficult for them to access mortgage finance, even though their household income is sufficient to meet both the interest and capital of a property purchase.
For example, in the US there are versions of the help to buy scheme, which is also found in Europe, where there is an equity investment by either the government or commercial developer to replace all or part of the initial deposit. The investor benefits from potential future increases in value in return for a deferred repayment of the initial investment.
In Europe and parts of South America, there are schemes where the household buys part of the equity and the investor buys the balance of the equity and charges the household either rent or interest on their part of the property, while the household has the option to later purchase the rest of the equity, giving the investor a capital gain. In many of these countries the investments, which tend to range from five to 20-year maturities, are normally made by both life assurance and pension funds. These are sometimes sold on to individual investors as part of a retail offering through unit trusts, which invest in a range of assets from residential property, commercial property, equity, and bonds.
In the UK where interest rates are low, funding of these schemes tends to be through bonds on the capital market and at the time of writing, there is approximately £33bn of bonds invested in UK housing associations including shared equity schemes. The low rates of interest make the capital markets more attractive as the requirements of equity investors are for a higher yield.
Altair, one of the world’s leading independent consultancies specialising in the governance, financing, development and long-term management of organisations and structures committed to the provision of affordable housing, has been involved in assisting with many of these capital market issues, which have also been denominated in euros and dollars.