A shift in focus could unlock Nigeria's real estate potential

The property market in Africa’s most populous nation is defined by significant long-term potential, but realising that potential for developers is not necessarily simple. A drop in the price of oil, a lack of foreign exchange and a depreciating currency are all combining to slow the economy, in turn stifling demand for both residential and commercial real estate. However, with a young and urbanised population of more than 184m people, the outlook in the longer term is more positive. If household incomes rise and access to finance improves, the scope for growth is immense.

Performance 

Prior to the country’s recent economic travails, the real estate industry was the fasting-growing segment of the economy, growing at a rate of 8.7% in 2013, significantly above the overall GDP growth rate of 7.4%, according to Lagos-based real estate consultancy North Court Real Estate. While growth has slowed, in the fourth quarter of 2015 the industry still contributed 8.26% to real GDP.

Demand Drivers 

A brief glance at the basic demand dynamics in the country should be enough to explain this sizable growth and illustrate the potential opportunities moving forward. Nigeria is the seventh-most-populous country in the world, with an estimated 184m people in 2015, according to the World Bank, and it shows no signs of slowing down. It has a current population growth rate of around 2.8% and is expected to have 440m people by 2050, which would mark it out as the third-biggest country globally by population, according to UN data.

Furthermore, the demographics of the country are favourable for both residential units and increasing commercial property ownership. With a median age of just 19 years, Nigeria has a young population that will bolster the ranks of the working-age population and home seekers over the coming two decades. It is also increasingly urbanised: just under half of Nigerians now live in urban areas and the urban population is growing at 3.75% a year, according to UN figures.

Middle Class 

Furthermore, by 2030 Nigeria is expected to have an additional 7.6m middle-class households, according to the March 2015 report “Real Estate: Building the Future in Africa” by financial services consultancy PwC. This represents about a third of the total expected across the 11 fastest-growing economies in Africa in the same period.

Across Africa the number of middle class citizens grew by 30% between 2000 and 2013, according to the African Development Bank. By 2013 there were 122.7m Africans that had daily expenditure of $4-20, marking them out as middle class. In addition, 190.6m people make between $2-4 and are expected to join the middle class over the next decade.

In Nigeria specifically, global consultancy firm McKinsey estimates that between 11% and 18% of urban households in Nigeria reside in the “modest affluent class.” This represents more than 2m households with annual income over $10,000. This segment of the market will be the main driver of the economy, accounting for 50% of the country’s growth in wealth, according to McKinsey. Households that earn more than $5000 a year – the emerging middle class – are expected to grow from 20% of the population in 2013 to 27% of the population by 2020. This is particularly good news for retailers and retail property, as these consumers have moved into the targetable range. Furthermore, the picture looks even better in the major cities. The country’s commercial centre Lagos, for example, has a consumption pattern that is 134% higher than the average across the country as a whole.

However, the comparatively high cost of basic necessities in Nigeria limits the impact that rising income has, as purchasing power in some cases is barely able to keep pace with inflation. The country has some way to go before large segments of the population have the disposable income to own property. According to a 2013 report titled “Africa’s Consumer Story” by accountancy firm KPMG, “There is generally quite a strong negative correlation between the proportion [of income] that is spent on food and overall prosperity levels.” In Nigeria specifically the average expenditure on food represents over 70% of total earnings, according to KMPG, suggesting demand for real estate will be blunted by spending power.

Residential Market 

Given these conditions, it is perhaps unsurprising that the primary focus of developers and investors is on the more inelastic upper echelons of the market – a trend that has until recently held true in most of Africa’s largest frontier markets, including Ghana and Kenya. However, the high-end segment has seen a slow down. “The oil and gas industry has historically been the largest demand driver, especially in the corporate occupier segment for luxury residential units. However, given the current economic cycle, the demand in the residential sector in upmarket areas such as Ikoyi has dramatically decreased,” Bolaji Edu, CEO of real estate services firm Broll Nigeria, told OBG.

Large corporations typically represent a large proportion of demand, given their ability to lease whole blocks of residential units. However, between June 2014 and June 2016 oil prices fell by around 57%. Consequently, in Nigeria there has been a radical scaling back in the scope of operations in terms of both investment and manpower. As companies look to reassign employees to other countries and move from leasing residential property directly to providing staff with a monetary allowance for accommodation, high-end luxury buildings in prime locations, such as Victoria Island and Ikoyi in Lagos, are under pressure. According to Fine and Country, a global high-end real estate brokerage and research firm, multinationals and expatriates make up between 60% and 70% of the premium residential market. Oil and gas companies, airlines and professional services firms account for the majority of this demand.

Market Size 

One of the key challenges in Nigeria is assessing the size of the market in terms of both supply and demand. There is a lack of coordination and transparency with respect to data, which makes it very difficult to measure basic supply and demand dynamics. However, it seems clear that the luxury segment is relatively small in terms of volume. In 2015, for example, Fine and Country concluded premium residential deals with a total area of about 80,000 sq metres in Lagos and Abuja. While this was only in select neighbourhoods and was only one broker, it suggests the relatively small share of premium properties in the overall housing stock of Abuja and Lagos. Indeed, given an average three-bedroom luxury apartment size of 350 sq metres, it represents just under 230 such units in two cities with a combined population of well over 22m people.

Across the entire formal property sector, the picture is a little clearer. According to Lagos-based real estate research firm RAC, the number of new residential units delivered to the Lagos market reached 3929 units in 2015, a 15% increase over the previous year. In the last five years more than 15,000 housing units have reached the property market in Nigeria’s biggest city, excluding informal construction. RAC estimated that there are another 14,415 residential units under construction in Lagos. While these numbers are not insignificant, they are insubstantial for a city the size of Lagos. In comparison, Cairo, a city of around 10m people, saw the delivery of 7560 units in 2015, with a further 30,000 units expected to be delivered in 2016 alone, according to JLL.

Pricing 

Average leasing rates in the residential market are in the range of $60,000-100,000 per year for a luxury three-bedroom unit, according to Fine and Country. Given the economic conditions, it is unsurprising that this segment of the market has been affected. These pressures have led to greater flexibility, with some landlords reducing asking rates by as much as 20%. Edu told OBG, “While this is not across the board, the current economic conditions have changed the mindset of landlords and investors, and the market is gradually shifting to a tenant-friendly market, which was never the case before.”

It is not only the leasing market that has been impacted in the last 12 months. The premium sales market, in which a three-bedroom apartment might range from $600,000 to $1.5m in Lagos and up to $5m in Abuja, has also been affected. This is not solely the result of the current economic climate. Udo Okonjo, CEO and vice-chairman at Fine and Country, told OBG, “The anti-corruption campaign is affecting the real estate sector and slowing the pace of transactions.”

Indeed, the current administration’s commitment to tackling graft is likely to stem the flow of illicit funds into the property market. In its report “Spotlight on Lagos Housing Development – 2016 Outlook”, RAC noted, “The anti-corruption stance by the new administration has curbed the menace of corruption ... thus ensuring that the days of corrupt government money inflows into the economy, particularly into sectors [such] as real estate, which has always been the asset of choice for laundering ill-gotten monies by malfeasance, has been forestalled.”

According to the real estate research firm Knight Frank, Lagos is the second-most expensive city on the continent for prime rental rates across almost all segments, after Luanda, Angola. It is immediately followed by Abuja, which actually has higher prime residential rents than its southern Nigerian counterpart.

Renting Shift

There are numerous reasons for these high prices, and in terms of supply it is not simply about quantity. There is a fundamental misalignment between supply and demand, which puts additional pressure on housing stock and subsequently prices. According to research firm Lamudi, at the beginning of 2015 58% of demand in the Lagos market was for rental apartments. Apartments for rent only made up 22% of total supply. However, 41% of the supply in the city was houses for sale, while houses for sale only made up 14% of demand. According to Edu, there is also strong demand for buy-to-let properties in the upper-middle-income segment of the market.

Income & Affordability

This is part of a wider conundrum for the entire residential property market. Demand is blunted by affordability and financing constraints in both the sales and rental segments and supply shifts upwards to the premium end of the market. This is particularly the case given the cost burdens for developers. Edu told OBG, “The growing middle class is definitely where there is a huge opportunity. The sweet spot for large volumes is in the middle- and upper-lower-income segments of the market, defined by entry to mid-level employees.”

Given land and construction costs, as well as the high cost of financing, many developers are reluctant to build units in these segments and are drawn to luxury units in order to maintain margins. “There is excess supply in the luxury segment both for housing and commercial offices. Historically, there has been a disparity in the quality of the product being provided when compared to pricing. As supply has increased and the economy taken a hit, pricing is starting to adjust and level out,” said Edu. “Additionally, it is important to note that the affordable segment has largely been neglected by developers who have focused on luxury residential and grade-A offices.”

Affordable & Middle Income

Given that the national housing deficit has reached 700,000 units each year and 17m units in total, according to the World Bank, affordability is likely to be a key policy area moving forward. The government is well aware of this and has already taken a number of steps to address the affordability issue in housing. Certain developers have attempted to travel down the income scale. For example, the Lekki Gardens development in Lagos was offering units for sale for as little as N10m ($31,600). However, in March 2016 a five-storey building in the development collapsed, killing 35 people. Charges were brought against Robert Nyong, managing director of Lekki Garden Homes.

Even before this tragedy, however, the project still failed to reach a majority of Nigerians. Given current mortgage terms in the market, with a loan-to-value ratio of 90%, a tenor of 20 years and an interest rate of 17.9%, annual repayments for the cheapest units would come in over $8000. This potentially represents more than 80% of household income for members of the “modest affluent class” and up to 160% for the “emerging middle class”, as defined by McKinsey.

Mortgages 

While this speaks to the earning potential of ordinary Nigerians, it also illustrates the limitations of the mortgage market and its inability to boost the numbers of potential homeowners. Between 2004 and 2010 a meagre 44,000 mortgages were extended in Nigeria, with an average total of $31,500. This represents a mortgage penetration rate of just 0.6% of GDP, according to World Bank data. One of the biggest impediments to the greater uptake of mortgages is the prohibitively expensive cost of financing. It is not uncommon for the interest on mortgage loans to be charged at a rate of over 20%. Edu said, “There is a huge opportunity to capture a wider segment of the population if rates can be brought down to the low teens or single digits.”

Retail 

While affordability is perhaps the defining issue in the residential market, it is less of concern when it comes to retail property. Here, the reach of consumer goods goes deeper. Indeed, compared to the continent as a whole, Nigeria offers rich potential. According to a 2014 Nielsen survey, 54% of Nigerians fell in the middle to high-income consumer segments, compared to an African average of 45%.

With such demand, property developers are eyeing the retail market closely. It is currently an underserved segment, particularly given the prevalence of informal activity in retail. According to PwC, Nigeria has 1 sq metre of retail space per 1000 people, compared to 480 sq metres in South Africa. It is hardly surprising, therefore, that significant supply is set to hit the market over the next two years. In the last quarter of 2015 38,700 sq metres came onto the Nigerian market, while in the next 24 months a further 183,500 sq metres of space is in the pipeline for delivery, according to real estate research and brokerage firm Broll.

In the medium term there should be room for much more, as Nigeria continues to lag regional and international counterparts on retail supply indicators. Until the recent currency problems and economic downturn, developers were eyeing secondary locations outside of Lagos and Abuja. However, developers are now reassessing their strategy. Edu told OBG, “Because of the central bank dollar restrictions and import issues, retailers in secondary locations are struggling and many of them have delayed their occupancy because of extended timelines for imports.”

The slowdown has yet to translate into softer rental rates. However, in the third quarter of 2015 the retail market took a turn for the worse, with Nielsen noting that sales had begun to decline in both value and units as consumers began to feel the pinch. While rents have remained stable, landlords are giving concessions, such as offering a number of months rent free, to ease the burden on retailers, according to Broll. In the fourth quarter of 2015 the average net rental rate in Lagos stood at $68 per sq metre per month. In Abuja it was $55, $50 in Port Harcourt and $35 in Kano, according to Broll. 

Office 

Like retail and all other elements of the real estate market, office property has been significantly affected by the country’s economic troubles. However, many analysts remain sanguine about the affects. Edu told OBG, “The office sector has been hit by the drop in the oil price because oil and gas has been a strong driver of office demand in Nigeria. Though technology, financial services and professional services firms are partly replacing this demand, the quantum of space and take-up is not the same volume as was the case with the oil and gas sector.”

Indeed, as much as 50% of demand is driven by relocations, as firms operating in informal or grade B and C tenancy take advantage of the current climate to upgrade their facilities, according to Edu. Nonetheless, the sector faced a difficult year in 2015 on the back of a number of factors, such as oversupply and low oil prices. On Victoria Island, in Lagos, rents fell by 14% in 2015, while in Ikoyi they came down by as much as 10%, according to Broll. The real estate broker and advisory firm expects similar declines in 2016. By the end of 2015 average net office rents in Lagos’ two prime locations, Ikoyi and Victoria Island, had fallen to $910 and $730 per sq metre per year, respectively.

Outlook 

This general decline is symptomatic of the real estate market more broadly, with 2016 likely to be defined by the global slump in oil prices. Across all segments, this has stymied demand and created difficulties for investors and developers in terms of financing and foreign exchange availability. However, in the longer term Africa’s most-populous nation and arguably its largest economy will offer massive opportunities. As the working-age population grows and incomes increase, the retail and residential segments in particular will offer strong potential in terms of both volume and price. As such, the focus is likely to gradually shift from luxury development to middle-income development in Lagos and throughout Nigeria.

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The Report: Nigeria 2016

Construction & Real Estate chapter from The Report: Nigeria 2016

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