Kenya Government

Economic
Transformation
Agenda
2022-2027

Housing and
Infrastructure Chapter

White Paper
By
Kenya Pension Funds
To
H.E. Hon. Dr. William Samoei Ruto, PhD, C.G.H
President of the Republic of Kenya and Commander-
In-Chief of the Defence Forces
OCTOBER 212,2022

Working Draft 1
Table of Contents
A. Introduction And Context ............................................................ 2
Pre-Amble ................................................................................. 2
Problem Statement .................................................................... 2
Kenya Pension Industry .............................................................. 4
B. The Affordable Housing Structuring Team ..................................... 6
Committee Members .................................................................. 6
Observers And Rapporteurs ......................................................... 6
C. Committee Working Process ........................................................ 8
Objective .................................................................................. 8
Meetings ................................................................................... 8
Output ...................................................................................... 8
D. Pension Industry Problem Statement Matrix .................................. 9
E. Legal Framework ..................................................................... 16
F. Capital Markets In The Housing Finance Ecosystem ...................... 17
Connecting Capital Markets And Kenyan Homebuyers ................... 17
G. Pension Industry Funding Allocation ........................................... 18
H. The REIT Solution .................................................................... 19
The Supply Side Funding Structure ............................................. 20
The Demand Side Funding Structure .......................................... 20
Typical REITS Structure ............................................................ 21
I. Required Enablers .................................................................... 23
J. The Way Forward ..................................................................... 24

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A. INTRODUCTION AND CONTEXT

PRE-AMBLE
The Association of Pension Trustees and Administrators of Kenya (APTAK)
jointly with the Fund Managers Association, Association of Retirement
Benefits Scheme, Association of Custodians and The Actuarial Society of
Kenya (TASK) on 13th October 2022, held consultations with H.E The
President aimed at improving the pension industry while supporting the
Government in achieving its mandate to the Kenyans.

Following the initial consultative meeting, the Structuring PPPs Team

working committee was constituted, on a voluntary basis, with a mandate
to come up with a private driven initiative to finance affordable housing and
infrastructure. The team drew representation from the Ministry of
Investments, Trade and Industry, trustees, investment bankers, capital
markets, industry regulators and legal counsel all of whom were co-opted
as either experts or observes to achieve the objective.

PROBLEM STATEMENT
Housing affordability is a key challenge in Kenya with many households
unable to afford to buy or build their own home. The Government’s priority
in housing is to deliver affordable housing to its citizens by partnering with
the private sector on affordable housing projects.

The Government’s commitment is to provide land and horizontal

infrastructure, which is expected to drastically reduce construction costs
and deliver affordable homes at 30-40% of today’s current cost structure.

The delivery of affordable housing has been met by supply and

demand challenges associated with high finance costs, expensive
building materials, costly horizontal infrastructure and land. The
government has committed to provide non-monetary guarantees
such as land, subsidies through tax exemptions and associated
enablers. The pension industry is therefore called upon to support
the affordable housing program by providing project and offtake
finance, ensuring an end-to-end housing & infrastructure solution.

The figures below illustrates the above challenges and shows the
impact of the various mitigations and enablers.

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3 | Affordable Housing Funding
The Pension industry will support the offtake of affordable housing projects
through a Structure anchored under the Public Private Partnership Act.
KENYA PENSION INDUSTRY
The Kenyan pension industry has experienced significant growth in the
recent past and had total assets under management of KSH. 1.58 trillion
as of December 2021.

4 | Affordable Housing Funding

5 | Affordable Housing Funding
B. THE AFFORDABLE HOUSING STRUCTURING TEAM

COMMITTEE MEMBERS

Members Role / Representative

1. Chairman: Tom Mulwa MD, Liaison Group

2. Geoffrey Odundo Nairobi Stock Exchange

3. Moses Cheseto NSSF

4. David Koros LapFund

5. Einstein Kihanda FMA

6. Anthony Mwithiga FMA

7. Joseph Rono Trustee

8. Ali Mohamed Islamic Finance

9. Ngatia Kirungie Housing & Infrastructure Finance

Advisor

10. Winfred Mbai Trustee

11. Prof. Paul Ayuo Trustee

12. Salim Kumaka Trustee

13. Alfred Kagika National Treasury

14. Brian Mutie Governance Legal NDMA

15. Mary Maungu Trustee – State Department of

Public Service

16. Eva Warigia EAVCA

OBSERVERS AND RAPPORTEURS

Ministry of Trade, Investments and Role / Representative

Industry

1. Hon. Moses Kuria Cabinet Secretary

2. Caroline Kinyanjui

3. Triza Muthoni

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 4. John Mwendwa

5. Lily Kabanya

6. Evans Lagat

Observers Role / Representative

1. Timothy Kaaria / Abubakar Capital Markets Authority

Abubakar

2. Lazarus Keizi Retirements Benefit Authority

3. Edgar Kamara PPP Unit

Rapporteurs

1. Mbithe Muema
3. Victor Chumo
4. Michael Mitau

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C. COMMITTEE WORKING PROCESS

OBJECTIVE
Consider and Design structures that will mobilize Pension assets to fund
national projects in the areas of 1) Affordable Housing and, 2)
Infrastructure

MEETINGS
1. Initial kick – off meeting to discuss and explore structures

Date: Monday, 17th October 2022 at 2:00 PM

Location: Liaison House, State House Avenue

2. Plenary session with Industry to table findings

Date: TBC

3. State House Meeting to table industry findings and positions

Either Friday 21st October, 2022 or Monday 24th October, 2022.

OUTPUT
Concept note on Industry Funding Structures for Investments in Affordable
Housing and Infrastructure

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D. PENSION INDUSTRY PROBLEM STATEMENT MATRIX

No Issue Brief description of the Recommendation(s) Expected impact

issue

1. Access to end user  It’s hard to roll out  Fund end user mortgages at  Expand home ownership
finance for housing affordable housing due rates similar to
those  Increased offtake of large
units to (i) cost of unit (ii) extended to staff as an sized affordable housing
cost of mortgage – employment benefit, within and infrastructure
impacted by interest the range of 7-9% projects.
rates  The use of long Term Tenant
 The challenge of costs Purchase Scheme (TPS)
of units will be agreements will resolve
addressed by the this.
Government, whereas  The pension fund industry
the challenge of cost of will co-invest in such a
mortgages will be structure
mitigated by the
pension industry.

2. Structure and  The KMRC model has  Expand the mandate of  Avail local and cheaper
mandate of KMRC failed to drive up the KMRC to include offering of guarantees to developers

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 No Issue Brief description of the Recommendation(s) Expected impact
issue

uptake of mortgages in local guarantees for rent-to- and off takers securitized
Kenya. own arrangements. rent-to-own payments.

 KMRC’s balance sheet  Recapitalization of KMRC by  Strengthened balance

size limits its lending Government sale down. sheet that will be
capacity. leveraged.

 Deepen capital markets.

3. Lack of a  The industry is highly  Consolidation of pension  Growth of primary and

consolidated pool of fragmented with over assets in a structure similar secondary housing finance
pension fund assets 1,300 trusts and 7,000 to the US Government systems
for investments in trustees. Funds are Sponsored Enterprises that  Provision of liquidity and a
affordable housing widely distributed pooled funds for affordable secondary market for
and infrastructure making it difficult to housing pension assets
pool funds for large  Create an SPV for the  Innovation in the nature of
ticket size investments pension industry to pool holdings of pension assets
funds for investment
 Growth in PPPs in
projects
affordable housing and
infrastructure projects.

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 No Issue Brief description of the Recommendation(s) Expected impact
issue

 Have separate SPVs for

each project and leverage
on the PPP ACT.

 Use the LLC structure for

the SPVs to enable the
Government to participate.

 Use capital markets to

create and trade securitized
assets.

4. Limited foreign  Active foreign investors  Use LLP model to align local  Unlocking foreign
capital investments with a focus on and foreign capital interests institutional capital for
in affordable housing affordable housing  public projects.
Co-investments with local
want to enjoin with pension funds and the
local institutional Government (via the
investors and the provision of land and
Government to deliver horizontal infrastructure).
on the housing agenda.

 These investors are not

interested in offtake as

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 No Issue Brief description of the Recommendation(s) Expected impact
issue

they would not want to

be stuck with market
risk, but are willing to
partner in development
projects.

5. Investment returns  From a fund  Policy action on lower rates  A lower interest rate
management needs to be consistent so environment will make
perspective one of the that financial markets are investing in affordable
judgements on a aware and well informed. housing and infrastructure
performance basis is  projects at lower yields
investment returns. attractive.
This is the overriding
motivation to drive
pension schemes to
invest in any project.

6 Offtake of affordable  The Government has  A REIT structure to offer an  Increased offtake of
housing and committed to end-to-end solution to affordable housing projects
infrastructure addressing supply side developers and home
projects challenged on owners.

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 No Issue Brief description of the Recommendation(s) Expected impact
issue

affordable housing and  REIT considerations:  Co-investment

infrastructure. The  opportunities for local and
D-REIT: For developers
pension industry then foreign institutional funds
 I-REIT: A TPS structure for
needs to focus on  End-to-end solution for
the offtake of projects
uptake of these housing system financing
projects in a joint  Islamic REIT: For MENA
from the primary markets
manner. investors & local investors
through to the secondary
 Considerations: Who  The rental income from the markets
will be the buyer of the housing units will be used as
 Increased distributions to
houses, how will the income to an I-REIT and
the pension industry
entity be funded, and distributed to the unit
though the REITs (at least
how will it run and fund holders.
80% of taxable income),
the TPS.  The I-REIT will be
 Regular income streams,
 Kenya has a REIT securitized to provide
diversification and long-
regulatory framework secondary market trading
term capital appreciation
and capital market options.
products in place. D-  A D-REIT will be used for
REIT and I-REIT development.
structures that will be
used as a proxy for

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 No Issue Brief description of the Recommendation(s) Expected impact
issue

structuring future
pension industry REITs.

7. Tax on pension  Currently, the  Give exemptions on income  This will enable deepen the
withdrawals for allowable 40% to a tax for those pension demand side by providing
housing investments maximum of KSh. 7Mn withdrawals allocated to ready equity for home
withdrawal for home affordable housing. ownership.
purchase is taxed
under the graduating
PAYE tax structure,
making it cumbersome
for members to
exercise this option

8. Pension fund  The IPS for most of the  Revise the withholding tax  This will release c. KSH.
investment allowable pension schemes have to interest income on 150 billion for affordable
single asset class a 15-25% cap on single housing bonds from 10% to housing, infrastructure
allocations is capped asset class exposure, 5%. projects and REITs and we
at varying rates guided by the RBA  expect at the very
The pension industry to
across the different regulations cap minimum an equal
consider revising current
pension schemes investments in match from the global
allocations to single asset

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 No Issue Brief description of the Recommendation(s) Expected impact
issue

affordable housing and classes to both assets by investors, delivering KSh.

infrastructure projects either increasing the 300 Billion in funding.
under the PPP Act at allowance or removing it.
10% of assets under This way, we will
management and 30% scientifically assess the level
for allocations to REITs of funds that will be
available for investments in
affordable housing as
follows:

 Investments to affordable
housing and infrastructure
projects under PPP Act will
fetch up to 5% of the
current pension asset AUM,
or c. KSH. 75 billion, and

 Investments in REIT
projects will fetch up to
5.0% of the current pension
asset AUM, c. 75 billion.

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E. LEGAL FRAMEWORK

1. The Public Private Partnership Act, 2021 which came into effect on
December 23, 2021. The objective of the Act includes:

a. To prescribe procedures for participation of the private sector in

public private partnerships;

b. To harmonize the institutional framework for the implementation of

public private partnership projects;

c. To give effect to Article 227 of the Constitution on procurement

relating to public private partnerships;

d. To streamline and rationalize the regulatory, implementation and

monitoring mandates of the relevant agencies;

e. To provide for the participation of county governments in public

private partnerships

2. The Capital Markets Act (Chapter 485A)

a. Capital Markets (Real Estate Investment Trusts) Collective

Investments Schemes) Regulations, 2013

3. The Retirement Benefits Act (No. 3 of 1997), Legal Notice No. 191

a. The Retirement Benefits (Forms And Fees) (Amendment)

Regulations, 2020

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F. CAPITAL MARKETS IN THE HOUSING FINANCE ECOSYSTEM

CONNECTING CAPITAL MARKETS AND KENYAN HOMEBUYERS

The housing finance ecosystem has two major components: a
primary market and a secondary market. Lenders make new loans in
the primary market, and loans are bought and sold by financial institutions
in the secondary market. Kenya has a nascent primary market for housing
finance that is dominated by the banking sector. The secondary market is
relatively new, with Real Estate Investment Trusts more preferred and
traded in the capital markets. Securitization of assets is yet to take root in
spite of having the requisite legal and regulatory frameworks in place.

For the housing finance system to function properly, it needs a dual primary
and secondary market. In the primary market, a lender extends a loan to
a borrower to purchase a house. After a lender originates a mortgage loan,
the lender has several options. The lender could choose to hold the
mortgage in its portfolio or sell it to another entity. Mortgages are bought
and sold in the secondary market to domestic and international investors.
The secondary market plays an important role in providing funding for loans
made in the primary market. When a mortgage is sold in the secondary
market, the lender will use the proceeds to fund additional new mortgages
in the primary market.

The capital markets in Kenya have the requisite legal frameworks to

facilitate the creation and uptake of investments by the pension industry
into affordable housing and infrastructure, and complement the role played
by the banks. In so doing, this would develop and spur activity in the
secondary markets for housing finance and enhance mortgage uptake and
home ownership for millions of Kenyans.

The use of mortgage backed securities will help in bridging the duration
mismatch of many primary lenders, where they will easily recycle capital
backed by future mortgage repayments of the existing and new home
loans.

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G. PENSION INDUSTRY FUNDING ALLOCATION

The Pension industry proposed structure for the offtake of affordable

housing projects is through the REIT Structure, with SPVs specific for each
project, structured around the PPP Act for affordable housing and
infrastructure projects.

The RBA guidelines allow pension assets investments of assets under

management of up to 10% in affordable housing and infrastructure projects
done under the PPP Act, and up to 30% allocation of assets under
management to REITs.

Based on these guidelines and under prevailing market conditions, the

pension fund’s allocation to the asset classes under Table G that provides
for investment in housing or real estate will be as follows:

1) Investments to affordable housing and infrastructure projects

under PPP Act allocation will be c. 5%, c. KSH. 75 billion, and

2) Investments in REIT projects allocation will be c. 5.0%, c. 75 billion.

This provides for c. KSH. 150 billion for affordable housing and
infrastructure projects under the PPP Act, and affordable housing projects
under the REITs structure and we expect at the very minimum an equal
match from the global investors, delivering KSh. 300 Billion in funding.

The Pension Industry could participate in a well-structured Public Private

Partnership (PPP) project which will subsequently be listed in the capital
markets. The investment instruments would be issued by the private
project partners and would not be on the Government’s balance sheet.
Pension funds and offshore co-investors will be the key enablers of
government development initiatives by investing in the listed PPP
instruments.

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H. THE REIT SOLUTION

There are three main types of REITs as follows:

1. Development Real Estate Investment Trusts (D-REITs): A D-

REIT is a type of REIT in which investors pool their capital together for
purposes of acquiring real estate to undertake development and
construction projects and associated activities.

2. Income Real Estate Investment Trust (I-REITs): An I-REIT is a

type of REIT in which the investors pool their capital for purposes of
acquiring long term income generating real estate including housing,
commercial and other real estates.

3. Islamic Real Estate Investment Trusts: This is a unique type of

REITs which only undertakes. Shariah compliant activities. A fund
manager is required to do a compliance test before making an
investment in this type of REIT to ensure it is Shariah compliant.

The REITS ecosystem will be summarised as below:

The various medium-term and long-term REIT instruments options are as

highlighted in the ecosystem. It provides for an end to end structure in the
production of housing product, catering for supply and demand side.

To achieve this, the project will be carefully evaluated and put in place to
ensure efficient delivery of housing projects, which will guide on the funding
structure for the project. This will cater for both supply side.

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On the demand side, the challenge is the lack of an offtake mechanism
which we have cured by the reduced cost of the product and the guaranteed
receivables from the product, thus making a REIT an end-to-end solution
which will widen the existing home purchase options.

THE SUPPLY SIDE FUNDING STRUCTURE

THE DEMAND SIDE FUNDING STRUCTURE

Real Estate Investment Trusts (REITS)

REITs are companies that own or finance income-producing real estate

across a range of property sectors. REITs allow anyone to invest in
portfolios of real estate assets the same way they invest in other industries

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– through the purchase of individual company stock or a mutual fund or
exchange traded fund (ETF). The stockholders of a REIT earn a share of the
income produced – without actually having to go out and buy, manage or
finance a property.

REITs invest in a wide scope of real estate property stocks, including offices,
apartment buildings, warehouses, retail centers, medical facilities, data
centers, cell towers, infrastructure and hotels. Most REITs focus on a
particular property type, but some hold multiple types of properties in their
portfolios.

Most REITs operate along a straightforward and easily understandable

business model. By leasing space and collecting rent on its real estate, the
company generates income which is then paid out to shareholders in the
form of dividends.

In Kenya, REITs must pay out at least 80% of their taxable income to
shareholders. In turn, shareholders pay income taxes on those dividends.
REITs (or mortgage REITs) don’t own real estate directly, instead they
finance real estate and earn income from the interest on these investments.

TYPICAL REITS STRUCTURE

Based on the above structure, a REIT will be issued for development and
income generating real estate stocks. These REIT will be listed on the NSE
making them tradeable and liquid for investors.

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REITS is able to solve mitigate the challenges and make it possible to
deliver affordable housing as follows:

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I. REQUIRED ENABLERS

1. A further tax relaxation of the VAT tax exemptions on affordable

housing raw materials to include services

2. A reduction of the withholding tax on interest from housing bonds from

10% to 5%

3. Removal of the tax on the 40% allowable withdrawals of pension

accrued benefits for the purchase of a home

4. Allow a charge on land provided by the government for the affordable

housing in favour of the debt and/or equity holders

5. Non-monetary guarantees from the government in various forms or

shapes

6. Government to subsidise the horizontal infrastructure such as roads,

sewer, electricity, water and security

7. Gradual and intentional reduction of prevailing interest rates to enable

favourable offtake of financing securities as the proposed REITS and
ABS instruments

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J. THE WAY FORWARD

We request the government identify affordable housing and infrastructural

projects on a priority basis for the industry to execute the proposed
solutions.

Whereas the proposed structure has recommended REITs as the

fundraising mechanism, other solutions such as Collective Investment
Schemes, Shariah compliant framework for I-REITS and a Kenya Pension
Housing Fund special purposes vehicle to aggregate share capital from
pension funds among others were suggested for consideration and may be
revisited along the way if circumstances require.

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K. APPENDIX

REITS HISTORY AT THE NAIROBI SECURITIES EXCHANGE

The maturity of the vanilla debt instrument market in Kenya has led
stakeholders to look for more innovating instruments, such as REITS, Green
Bonds and Euro Bonds, most of which have been received well. The REIT
shows how innovation within the alternative funding market can be very
beneficial in attracting a wide range of investors.

The first REIT issued in Kenya was an I-REIT aimed to raise KSh. 12.1
Billion in 2014. It got a 29% subscription rate, with the low uptake
attributed to it being a relatively new market segment, inadequate investor
awareness of REITs and regulatory hitches. The REIT currently has a
market capitalization of KSh. 1.1 Billion. This REIT was aimed at financing
off-take (demand side) of commercial real estate, and demonstrated the
ability of the structure to solve longer funding needs.

The second REIT to be issued was a D-REIT in 2021, which aimed to solve
the supply side of residential real estate. it raised c. KSh. 2.3 Billion by
way of a private placement and listed the REITS units on the NSE Unquoted
Securities Platform which is private platform for trading shares. Over the
last one year, the units have traded c. KSh. 1 Billion in turnover. It plans
to raise further capital in 2022 to finance development projects.

The summary of REITS performance at the NSE is as below:

With the interventions and enablers, the yield would improve to provide for
an Investment Grade REIT.

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