Capital market offers developers cheaper options amid funding challenges

EDIDIONG IKPOTO examines how property developers could take advantage of the capital market to raise construction finance

In 2022, the subscribers of the ill-fated skyscraper, which collapsed on Gerrard Road, Ikoyi, Lagos, instituted legal action against the Lagos State Government for attempting to take over the property.

The claimants argued that any compulsory acquisition of the property by way of forfeiture in favour of the Lagos State Government would amount to rewarding the government, making it take benefit from the negligence of one of its agencies and in complete disregard of the equitable interest of the applicants, which was worthy of protection by the court.

 

The kernel of the suit by the subscribers to the ill-starred project stemmed from the loss incurred after the collapse of the building.

Like most commercial construction projects in the country, the building was financed primarily via subscriptions from subscribers; hence, the moment the developer, Mr Femi Osibona perished in tragic circumstances beneath the debris of the collapsed building, recovering the investments was going to be a tall order.

The instance of this case-in-point puts the spotlight on the underlying problem property developers in Nigeria face vis-à-vis construction finance, despite the veritable platform provided by the capital market.

While commercial banks and financial institutions in Nigeria have been known to offer construction loans for property development, property developers have often found it difficult to raise funding through this option due to high-interest rates and strict criteria attached to it.

Another means through which property developers have resorted to raising capital is crowdfunding, which allows individuals to diversify their investment portfolio and participate in projects that were previously only available to institutional investors.

However, the success of real estate crowdfunding investments depends on the credibility and reliability of the crowdfunding platform. Real estate crowdfunding investments are also typically illiquid, meaning that it may be difficult to sell or exit the investment before the project’s completion.

For property developers, the source through which a project is funded will typically determine profitability since some of these sources would usually impose pressures on how and when to sell.

For instance, a developer who finances construction via off-plan subscriptions has indirectly given up the right to price the property upon its completion; hence, losing out on any possible windfall which presents itself as market conditions continue to change.

For experts, the inadequacies replete in many of the more conventional sources of construction finance add credence to the veritable platform provided by the capital market to raise funds for construction purposes, a platform which gives the developer more control over the development project.

The argument is that the capital market is a critical pillar of long-term fund mobilisation needed for capital formation to fast-track economic growth and development.

The capital market is the market for securities, where companies and governments can raise long-term funds.

The main function of the capital market is to channel investments from the investors who have surplus funds to the investors who have deficit funds.

The different types of financial instruments that are traded in the capital markets are equity, debt, hybrid, insurance and derivative.

It consists of the primary market, where new issues are distributed to investors, and the secondary market, where existing securities are traded. Usually, the capital market provides a relatively cheaper source of funds.

Experts also view the short-term funding profile of the money market as unsuitable for project infrastructure investment as against the capital market which creates an enabling environment for the generation of long-term financing and active private sector participation in infrastructure development.

Also, the nature of the capital market is designed to provide a variety of financing instruments and investor categories which could lead to a larger pool of funds than other financing options.

However, despite the advantages of leveraging the capital market for construction finance, there has been minimal activity, especially by the private sector in this regard.

In 2007, the first mortgage-backed security by the Federal Mortgage Bank worth N100bn (about $670m) was issued for residential houses.