Cytonn Weekly Update #16 with a focus on Joint Venture Agreements for Landowners

By Cytonn Research Team, Apr 24, 2015

Cytonn Weekly

Executive Summary:

  • Fixed Income: Market continues to seek direction on interest rates, but key risk of a rate increase remains due to possible Shilling volatility;
  • Equities: The market remains relatively flat as stretched valuations and lower earnings growth rates dampen investor return expectations;
  • Real Estate: House prices continue to increase in secure and well-planned residential dwellings;
  • Private Equity: Public - Private Partnerships focused on basic services continues to be an emerging trend, based on Kenyatta National Hospital seeking private capital;
  • Focus of the Week: In our opinion, Joint Venture Agreements are the most optimal form of partnership to connect landowners to sources of financing, and we give our recommendation on the 7 issues to consider when entering such a partnership;
  • Company Updates: 

Fixed Income Update

There was tight liquidity in the market due to corporate tax remittances, leading to T-bill undersubscription with the 364-day worst hit at 38%. Yields however remained unchanged at 8.4%, 10.3% and 10.6% for the 91, 182 and 364-day papers, respectively; investors are still seeking signals on the direction of interest rates movement.

The Kenya Shilling continued to record losses against the Dollar to close at a 3-year low of 94.0. The poor performance was attributed to heightened Dollar demand by corporates to pay dividends to foreign shareholders. As expected in our previous reports, the Central Bank was active in the market supporting the Shilling, and this is expected to continue given the high reserves amounting to 4.5 months of import cover, which is well above the East African Community?s required minimum of 4.0 months.

The Kenyan Government released FY 2015/2016 expenditure estimates, which showed public expenditure will rise by 25% to Kshs 2.17 trillion. Energy, Infrastructure and ICT sectors, combined, will for the first time overtake Education, having been allocated 27.3% (Kshs 385.4 bn) of the budget compared to 21.7% (Kshs 256.8 bn) previously. National Security share of the budget will also rise to 8.2% (Kshs 114.07 bn) from the current 7.7% (Kshs 90.72 bn). This signals emphasis on infrastructure investments and improving security, which are critical to long-term economic growth.

In the near-term, we see risk of rates going up due to market uncertainty. We would be biased towards short durations.

Equity Market Update

The markets ended relatively flat, with the NASI declining by 0.3%, while the NSE 20 declined by 0.6%, as a result of declines in large-cap counters including Britam and EABL, which fell 10.8% and 4.5%, respectively. 

On the earnings front, there was only one significant reporting by Transcentury, which reported a loss of Kshs 8.43 per share, compared to earnings of Kshs 1.04 in 2013. The company sold its 34% stake in KU Railway Holdings Limited, which saw it earn 21% less than its fair value of Kshs 4.8 billion, booking a Kshs 1 billion loss. Revenues also declined 13%, affected by a delay in projects that have since commenced this year. The company is heavily invested in power, and is set to benefit from the commissioning of its new power plant in Q2 2015.   

The Competition Authority of Kenya (CAK) has set a 10-month deadline that requires trade associations in the Financial Services and Agriculture sectors to align their operations with the competition law and stop price fixing. The Kenya Bankers Association, the Association of Kenya Reinsurers, the Association of Kenya Insurers and the Kenya Forex Bureaus Association will all be required to re-evaluate their practices; it is not clear how CAK will get these trade associations to comply. 

The stock market continues to be driven by corporate news and actions, with counters in the Banking sector trading broadly lower as they approach their ex-dividend dates. We remain neutral on equities given stretched valuations and lower earnings growth prospects. The market continues to be a stock-pickers market to derive value. 

Real Estate Update

House prices increased by 2.8% in Q1 2015, compared to Q4 2014?s 2.2%, on the back of increased demand for apartments according to the Kenya Bankers Association?s Q1 Housing Price Index. Demand for apartments is driven by desire for convenience and security.

Due to (i) rapid urbanisation outpacing infrastructure development and (ii) increased insecurity, there is preference for community living such as apartment complexes and gated communities. Key drivers for price were, among others: size of the house, access to social amenities, the ease of redevelopment, and security. 

Dormans Coffee Group is reported to have acquired 10 acres of land in the 2,500 acre Tatu City development for the construction of its headquarters. The company intends to spend Kshs 650 million to move its coffee roasting factory and head office into the new headquarters, as it follows other companies seeking to move to less congested neighborhoods, which goes to highlight the market opportunity that exists for masterplanned developments. However, the success of such gigantic masterplanned developments such as Tatu City and Konza City remain to be seen in Kenya.

Private Equity Update

Kenyatta National Hospital (KNH) is reported to be seeking private funding under the Public - Private Partnerships (PPP) framework to build Kenya?s first public pediatric hospital. The emerging trend of PPP initiatives targeted at providing basic services like education and healthcare highlights the opportunity to deploy private capital in these sectors. For example, earlier in 2013, Abraaj group?s Africa Health Fund and Sweden?s Swedfund had announced an investment of USD 6.5 million into Nairobi Women?s Hospital. 

Focus of the Week: Why Land owners should consider Joint Venture to develop their land

Every week we pick a topic that has either been trending in the financial press or that is relevant to investments and focus on it, hence the ?Focus of the Week.? 

While discussing high level investment opportunities for this week, the Investment Team realized that with stretched valuations in equity markets and rates uncertainty in fixed income markets, we thought we?d analyze further into how investors can get more exposure to alternative assets such as Real Estate. 

The most fundamental building block of any Real Estate development is land. Ironically, many landowners (?LO?) tend not to have the next two essentials of development, (i) the finances and, (ii) the development expertise. On the other hand, those with development expertise and finances tend to be limited in terms of suitable land for development. Consequently, a win-win solution is for LO?s seeking development expertise and finances to partner with institutions that possess development expertise and can access financing from investors.

The partnership can usually take any form, but the most optimal form we recommend is to enter into a Joint Venture Agreement (?JVA?); where the LO?s duty is to contribute land, and the development partner?s duty is to source financing and take responsibility for all that pertains to executing the development from start to finish. 

However, several JVA?s have run into trouble with some making news headlines. Below we highlight 7 issues for LOs and developers to keenly consider when evaluating a JV partner:

  1. Shared Vision: Is there a shared vision between the LO and developer? If one party desires an aspirational master-planned development and another desires a simple parceling and selling project, then there is no shared vision. It is important to spend time and get on the same page with regards the goal of the development.
  2. Counterparty Risks: How is the potential partner likely to behave in difficult situations. What is their history and standing in the community? Are they litigious? What do people who have had previous deals with the potential partner say about them? Avoid dealing with a partner with a history of trouble making, as it saves a lot of headache and heartache.
  3. Rights and Obligations: The rights and obligations of each party should be clearly spelt.
  4. Management and Control: It should be clear how decisions would be made. Especially, issues that require approval of all parties and those that can be left to the managing party should be clearly defined.
  5. Profit Sharing: The participants' share in any cash flows arising from the development should be clearly specified, and even clearly illustrated.
  6. Exit Mechanism: A device or a procedure for liquidating an investment in the JV and ending a venture?s involvement should be clear. 
  7. Dispute Resolution: It should be clear how disputes are resolved. Most development projects, once started, have to be finished to preserve value because development involves a lot of upfront expense, such as legal expenses and stamp duty, which consume huge amounts of capital upfront. These expenses can only be recovered upon exit or renting the development. For example, stamp duty alone costs 4%, and for a piece of land valued at Kshs. 1 billion the stamp duty is Kshs 40 million; which means the moment land is transferred to a JV, the liabilities are going to outweigh the assets by Kshs 40 million. Hence, if the land does not proceed to create value through development, unwinding the JV will leave a Kshs 40 million hole. We recommend that the first course of dispute resolution is to seek mediation, which is aimed at assisting the partners attain the original intention that brought them together. Should mediation fail, we recommend arbitration; however only where significant amounts are involved. In addition, we strongly recommend that the arbitration be done in a foreign jurisdiction that is not subject to manipulation. 

Cytonn?s Real Estate and Investment Team has over Kshs 8 billion of Real Estate JV experience, both in terms of advisory and capital commitments:

  • To partner with Cytonn as a landowner, you can contact our Real Estate Services Manager, Johnson Denge, at 
  • For JV advisory services to ensure that you are getting the very best deal as a landowner participating in a JV, you can contact our Investment Analysis Associate, Shiv Arora, at
  • For general Real Estate inquiries, email the team at


Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.