ConstructionandRealestate-WheretoInvestinAfrica

Construction activity across the continent

The AfDB noted in 2018 that the infrastructure needs of the continent are between US$130bn and US$170bn annually. Currently, just a fraction of the AfDB’s estimate is being spent — US$45bn. While the chasm is wide and daunting, we have seen a general rise in construction activity across the continent as governments and private sector alike realise that there is a need to close this gap if Africa is going to meet its growth needs.

Figure 7.1: Construction activity in Africa over the last five years

Note:
The data includes projects that are valued at US$150m and above. The 2018 figures include projects that had broken ground by 1 June 2018. The values are cumulative and not new investments.

Source: Deloitte, RMB Global Markets

The task of fundraising to close this gap is one that has been largely financed by the public sector. Ninety per cent of the projects that are currently underway are financed by public revenues through national governments or municipalities, and the remainder by private funders. The private sector’s contribution to infrastructure development has steadily increased over the years, but it remains concerned about weak legal, regulatory and institutional frameworks; inadequate infrastructure planning and project preparation; ineffective governance; and corruption. Consequently, private-sector involvement is likely to remain limited until these structural rigidities are sorted.

In 2018, the growth in construction activity by both value and number of projects spiked largely due to the real estate sector, which saw an 81% increase in the value of projects (Table 7.1).

The year-on-year change in the value of the projects potentially infers the return on investment opportunity in these sectors and is yet another marker for investors to consider.

Which regions and countries are leading the construction charge?

East Africa leads the charge in terms of number of projects, accounting for 29% of all construction projects across the continent, but still lags North and Southern Africa by value of projects (Figure 7.2).

East Africa’s commanding share of the number of projects on the go is largely due to the region’s ambitions to improve the state of infrastructure development, which has already started to bear fruit by way of higher economic growth rates. Djibouti’s efforts for instance, have been guided by the government’s Vision Djibouti 2035 plan, which was launched in 2014. This plan aims to transform Djibouti into a logistics and commercial hub for the region by developing new deep-water harbours while simultaneously expanding its existing ports. In addition, a railway and a water pipeline to connect Djibouti and Ethiopia have been constructed.

In Ethiopia, infrastructure investments have been a key part of two successive Growth and Transformation Plans (GTP 1 — 2010-2015 and GTP 2 — 2016-2020). In addition to joint projects with Djibouti, Ethiopia has also expanded domestic railroads and launched the construction of Africa’s largest dam (the Millennium Dam, sometimes referred to as the Hidase Dam) and a number of large industrial zones.

For Tanzania, another country aiming to become the logistics hub of East Africa, investments are also part of three consecutive five-year development plans under the Tanzania Development Vision (TDV 1 — 2011-2015, TDV 2 — 2016-2020 and TDV 3 — 2021-2025 programmes).They aim to capitalise on Tanzania’s comparative advantages, in particular its agricultural and mining potential and its geographical location. Investments include the construction of a railway that connects Dar es Salaam with Mwanza, the Stiegler’s Gorge hydropower project, the development and expansion of a number of mines, the expansion of ports, and the planned construction of the oil pipeline that will connect the Ugandan oil fields with the Tanzanian port of Tanga.

In Rwanda, Kenya and Uganda, infrastructure investments are also an essential part of their development strategy. In Kenya, for example, they have resulted in the construction of the US$3.5bn railway connecting the capital to the port of Mombasa. For Uganda, one of the priorities is to develop the necessary infrastructure to extract the country’s oil resources.

On a country-by-country basis, Egypt has the most projects by number at 46 (9.5% of projects on the continent) as well as by value at US$79.2bn (17% of the continent’s value), edging out South Africa and Nigeria respectively (Figure 7.3).

Figure 7.3: Top five countries by number and value of projects

Source: Deloitte

Construction continues to be the main driver of economic growth in Egypt, with the sector recording gains of 10% in 2018 — almost double the average growth rate of other sectors. The most notable construction projects are the US$3.8bn Mountain View iCity in New Cairo and the US$3.7bn Citadel Refinery in Cairo. A number of other projects have recently been announced, most of which align with the trend of private developers targeting higher-end residential projects:

• Hyde Park Real Estate has launched Park Corner, a US$563.2m residential project in New Cairo. The project, covering 533,000m2, will have 205 independent villas, townhouses, and twin houses; 1,400 apartments; and 300 duplexes and family villas.
• Egypt-based Wadi Degla Developments, part of Wadi Degla Holding Company, is set to build a US$39m residential project, called Promenade Maadi Compound, in the country’s Zahraa Maadi region. Work is expected to take more than five years to complete.
• Egypt-based Palm Hills Development Company has entered an agreement with the New Urban Communities Authority (NUCA) to develop an integrated residential project in eastern Cairo on a revenue-sharing basis. The 2.02km² scheme is co-developed with the Ministry of Housing and is expected to attract more than US$4.4bn of investment.
• In April 2016, real estate developer Capital Group Properties launched a US$4.5bn residential scheme called Alburouj, which involves building 30,000 homes on 4.9km2 between the city of Suez and Ismailia Desert road.

Deconstructing the contractor landscape

The economic value from any construction activity is often felt through contractors long before the completion of a project. The immediate benefit is often seen in employment creation by contractors, which often boosts aggregate demand. The construction of the standard-gauge railway linking Mombasa and Nairobi in Kenya is a good example of this. It is estimated to have created 60 new jobs per kilometre of track or approximately 30,000 jobs, which has led to the construction sector outperforming most sectors in Kenya long before the completion of the railway.

However, in Africa it’s not always the case that these contractors are local-based firms that pass on the full benefit of their activities to the local economy. The discovery of oil by Tullow Oil in Kenya is a poignant example of this. The oil giant noted the burgeoning skills gap as the main reason for not including more locals in its workforce. This challenge is most severe for technical and vocational skills like welding, drilling, repair of heavy equipment and pipeline design — all of which are in demand in the oil sector.

The data collected by Fitch Solutions on construction activity in SSA shows that most of construction activity across the continent is carried out by foreign-based contractors (Figure 7.4).

Figure 7.4: Number of construction roles by company nationality

Source: Fitch Solutions

The pervasiveness of foreign contractors in this sector brings with it challenges that are also opportunities for local economies. The first is one of sophistication of the local industry to adequately provide ancillary goods and services that are needed for large construction projects. Sticking with the Kenyan example, the commercialisation of the country’s oil deposits required specialised equipment for extraction and production purposes which were unavailable and hence increased the amount of imports, thereby putting pressure on its external accounts.

Secondly, legal frameworks that protect the interests of the local economy in some cases are either not present or not very well thought out. In the case of the former, again using Kenya as an example, the Petroleum (Exploration and Production) Act 1986 includes an obligation for contractors to give preference to locally available goods and services, and that Kenyan nationals be prioritised in employment and training. But the Act doesn’t provide for targets, outlining how much local representation is needed. It also doesn’t provide for monitoring or reporting.

Zimbabwe’s Indigenisation and Economic Empowerment Act 2008 was meant to promote local industry participation in any deal or transaction from foreign firms. The challenge is that the requirements were so restrictive that the law itself reduced FDI inflows; the Act has been amended several times since then to make it more commercially viable for foreign investors.

Foreign contractor participation in local construction projects differs significantly from country to country.

Figure 7.5: Projects by value

Source: Fitch Solutions

Countries such as Nigeria, Ethiopia and South Africa have relatively high levels of local contractor participation, which counterbalances the hold that foreign firms have on projects.

South Africa is an outlier relative to other African countries in that domestic firms have a larger share of the market relative to foreign firms. The market is relatively sophisticated, with local firms competing aggressively with international companies on domestic projects. However, the sector peaked in March 2014 and since then has been undergoing a significant decline as economic activity slows.

Figure 7.6: Construction growth in South Africa

Source: RMB Global Markets

A few firms have failed in the South African market over the years, such as Basil Read, Esor Construction, Liviero Group, NMC Group and Group Five, while the likes of Aveng and Steffanutti Stocks are facing significant financial pressures. As the market consolidates, this creates an opportunity for foreign firms to expand their reach, further entrenching the dominance of these on the continent.

Zooming in on real estate

Investment returns from real estate in Africa’s rapidly expanding economies significantly exceed those achievable in almost all developed markets. PwC’s forecast of 20% net annual returns from investing in shopping malls, office blocks or industrial complexes in countries across Africa continues to draw in new investors.

The prospects of this growing asset class are being driven by improving political stability; relatively high growth rates in Africa compared to most developed markets; increased infrastructure developments; and a steady improvement in local financial industries, making access to finance a little easier.

The attractiveness of real estate as a sub-set of construction activity has been growing at a higher rate than most other components of construction (Table 7.2). Demand for housing is unlikely to taper in the medium term as rural to urban migration is set to increase in the years to come.

Africa’s gross rental yields rank significantly higher than other regions, at an average of 8% compared to a 5% average of other regions, making a good case for investing in Africa’s real estate (Figure 7.7)

Figure 7.7: Gross rental yields in Africa relative to other regions

Source: Knight Frank, Global Property Guide

What has changed in a decade?

Gross rental yields over the last decade have remained fairly static, with average gross rental yields across office, retail, industrial and residential only increasing by 0.9ppt. Breaking down the different segments of African real estate, we notice that industrial yields have outperformed other categories with a near 2ppt increase from 2009 to 2018.

Figure 7.8: Average change in gross rental yields (%)

Source: Knight Frank, RMB Global Markets

Cities that have shown the greatest increase in gross rental yields over the last decade are illustrated in Figure 7.9.

Digging deeper: Real rental yields

While rental yields are important to make informed decisions about how to allocate capital across the continent, we need to consider the effect of inflation on these yields. A good example here is Zimbabwe (Harare): rental yields across all asset classes are in line with regional averages, but after adjusting for inflation, the expected returns turn out to be subpar.

Table 7.3: Five highest and lowest real yields — Offices

Source: Knight Frank, RMB Global Markets

Table 7.4: Top and bottom five real yields: Retail

Source: Knight Frank, RMB Global Markets

Table 7.5: Top and bottom five real yields: Industrial

Source: Knight Frank, RMB Global Markets

Table 7.6: Top and bottom 5 real yields: Residential

Source: Knight Frank, RMB Global Markets

The above results paint a more realistic picture of the potential returns after adjusting for inflation. However, the mechanics and the market nuances of each country, such as regulations and the ability to repatriate returns, are other layers of complexity to consider.

Future of real estate: Growth drivers must be weighed against risks

Drivers of growth or demand in the sector are attractive and are expected to remain that way in the years to come, but such an outlook must be balanced with palpable risks.

Drivers of growth

• Demand for real estate will remain high, driven by urbanisation
• Over the next five years, GDP per capita is expected to grow by 6%, which will support demand for housing
• Increased political stability will improve the security of investments
• Improved capital regulation and liquidity will allow for easier in-country fundraising for real estate projects
• Technological advancements in banking will make saving easier, thereby improve savings rate which will boost investment rates

Risks associated with investing

• Complex legal considerations, such as property ownership rights and investment restrictions
• Limited ability to hedge your FX exposure if funding is in hard currency
• Social instability resulting from inequality

Country-specific considerations for commercial property

Table 7.7 sets out the key metrics that investors must consider when making investments in specific African countries.

Table 7.7: Commercial property considerations

Download table 7.7 Source: Knight Frank, RMB Global Markets

Video: Construction sector overview