May 2016
Currencies and Rents:
The Commodity Impact on
Sub Saharan Africa Real Estate
ACTIVATING
INSIGHT
THIS IS
THE EDGE
Executive summary
In this paper we identify Sub-Saharan Africa (SSA) countries which are the most exposed to currency pressures as a result of
recent commodity price volatility and consider the implications for their real estate leasing markets based on our experiences in
other developing economies.
Nigeria, Angola and Zambia have been the most exposed countries, given that they are large exporters of commodities and
possess developed real estate markets. Ghana is less vulnerable from a commodity perspective but has experienced major
devaluation, also due to its current account deficit.
The countries in our study have all allowed their currencies to depreciate to a greater or lesser extent. Zambia has done the most
to align itself with market pressures. Nigeria, arguably, has not done enough.
We also look at the experience of Russia, another transitioning economy that is heavily reliant on the price of exported commodities,
and consider how pressures on the ruble have impacted real estate markets in SSA, which largely function in USD.
The Russian experience suggests that sentiment and USD funding issues will put upward pressure on yields, though to a
comparatively limited extent.
In the SSA countries’ office markets there will be pressure on landlords to switch to local currency lease agreements, though
again this may either be impractical or short-lived. Landlords (and tenants too) may prefer instead to remain in USD though with
a slightly discounted rate or with greater incentives.
If the experience of Russia is a blueprint and rents have to be renegotiated, the impact is short term and in a market of limited
supply of quality stock they can rebound surprisingly quickly. The window for renegotiation can be surprisingly narrow.
That said, the retail market is likely to stay under pressure for longer than the office market as the consumer has to digest the
impact of higher-priced imported goods and falling real wages.
Oil Rig, Nigeria
The impact of falling currencies
on real estate markets in
commodity-dependent
Sub-Saharan Africa countries
The fall in oil prices from over USD110/
bbl to below USD30/bbl by January
2016 has had important implications for
the economies of commodity-exporting
markets. Those economies, particularly in
developing markets that are struggling to
fund state budgets as export earnings dry
up, have suffered from major speculative
pressure on their local currencies. In turn,
this build-up of pressure has had significant
repercussions for commercial real estate
markets, where leases are quoted in FX
terms (typically USD) and in most instances
paid in local currency.
In this paper we draw on our experiences
in other developing markets with large
commodity exposure, notably Russia, to
come to some broad conclusions as to
what the impact of this dislocation could be
for those commercial real estate leasing
markets in Sub-Saharan Africa (SSA)
that share some similar macroeconomic
characteristics and how the complex issues
that arise from it might be navigated.
As a caveat we understand that any
analysis should be cautious when
comparing apples with oranges, and
we acknowledge that the extent of
homogeneity between SSA countries, let
alone with economies on other continents,
is limited. Nonetheless, in this research
it is our aim to identify unifying features
between their economies and real estate
markets, which means that the experiences
of Russia in the last decade or so can
provide constructive guidance for countries
which share similar characteristics. This is
namely a heavy reliance on the export of
commodities to support budget revenues
and a developing real estate market which
is largely supported by USD financing and
lease terms.
Selecting markets
As stated before, since we are primarily
interested in the impact of weakening
currency dynamics due to lower commodity
prices in selected countries in SSA, our first
task is to identify those countries that are
most vulnerable to falling commodity prices.
Therefore, we have decided on those that
are large net exports of commodities (where
commodity exports >10% of GDP). This
yields us a broad focus group of seven
SSA countries: Equatorial Guinea, Gabon,
Angola, Nigeria, Ghana, Zambia and Chad.1
Within that group, we are focused on those
economies that have meaningful consumer
spending power; we therefore screen
according to GDP per capita. The very
small oil-exporting countries of Equatorial
Guinea and Gabon are clear outliers here,
with GDP per capita levels well in excess
of the SSA average. However, with a
combined population of below 2.5 million
people, we include them in our analysis for
comparison only.
Furthermore, since we are mainly interested
in the impact of currency depreciation,
the CFA franc peg makes analysis rather
a moot point, since the currency is tied to
the euro rather than influenced by local
central banks. As such given its currency
and relatively low GDP per capita, we also
exclude Chad.
Therefore, we narrow our attention to
Angola and Nigeria, which are the two
SSA countries where commodity exports
comprise more than one-third of GDP, and
which both have meaningfully powerful
domestic consumers (GDP per capita
above USD6,000) and sizeable populations.
Importantly, they also have central banks
which have control over monetary policy.
We also consider Zambia and Ghana
which are both heavily reliant on commodity
exports (25% and 13% respectively) and
have active and relatively developed
real estate markets. Significantly, as the
region’s second largest copper producer,
Zambia has been heavily impacted by
greatly depressed copper prices (though the
kwacha has enjoyed some recent gains).
Ghana, while also dependent on commodity
prices, is likewise under pressure due to
its large fiscal deficits, which have left it
particularly vulnerable to external shocks.
Its 2016 budget aims to narrow the deficit
to 5.75% of GDP. However, many
analysts would acknowledge this looks
a little optimistic.
Table 1: Macro Indicators
Currency LTM Currency Commodity GDP per
Current account Population Unemployment Gov Balance, FX reserves, Months of
Depreciation
Exports, % capita US$ balance, % GDP (mn)
%
GDP
US$
Import
vs US$
of GDP
(ppp)
Cover
Equatorial
Guinea
CFA
3.7
75.8 34,827.2
-10.0
0.8
4.3 n/a
1.4
n/a
Gabon
CFA 3.7
34.9
19,497.2
8.31.6
Angola
Kwanza 49.153.8
7,316.5
-1.524.4
1.7
-3.74
1.99.4
Nigeria
Naira
-1.2
34.5
Ghana
Cedi
4
12.7
7.9 Zambia
Kwacha
57.6
Chad
CFA
3.7
5,932.9
0.2
173.9
7.5
-4.64
23.613.6
4,048.9
-9.6
26.2
25.0
3,905.1
-1.4
15.0
7.9
34.7
2,178.1
8.9
11.3
3.7
-3.11
17.0 -7.52
29.3
6.9
3.9
4.2
-8.18
2.5
4.2
-3.68
0.2
2.4
Source: Economist, Oxford Economics, Bloomberg, IMF
Data as of end March 2016
1. Kenya and South African are excluded from this report as the former is a net importer of commodities (6.2% of GDP) and this (in theory at least) should benefit from weaker commodity prices. South Africa
is a net exporter of commodities (2.2% of GDP) though has a larger more diversified economy. Mozambique, similarly, is a net export of commodities, though at 5.5% of GDP falls outside of our scope.
Currency pressures
The main reason for choosing Russia
for comparison is that the common
characteristic of all the countries in Table 1
is that their currencies import volatility
through commodity price movements.
Generally speaking, when faced with the
pressure of falling commodity prices,
central banks can take one of two routes.
They can spend their foreign currency
reserves to defend the currency and keep
it artificially competitive. This can prove
expensive and is risky when the country
is also suffering from budget and current
account deficits caused by falling FX
revenue streams. Furthermore, as foreign
currency reserves are depleted, so too is
the credit rating of the country put under
pressure, further pulling up the cost of debt
and hindering inward investment, thereby
undermining the benefits of maintaining an
artificially strong currency.
Alternatively, central banks can let the
currency respond to market pressures,
deciding instead not to defend it and to let it
float freely. In developing markets this step
into the unknown also carries considerable
risks, including more volatility and the
danger that consumer spending power
will be significantly eroded, particularly in
countries which import large amounts of
consumer goods. Inflation feedthrough from
FX depreciation can also be aggressive
and can present a major threat, particularly
as it constrains the central bank’s ability to
keep policy rates loose to encourage growth
further down the line. It also implies a major
hike in policy rates at some point in the
future in order to contain inflation.
These are issues that Russia has faced
twice in the last decade, and has responded
to by using both routes. In 2008 the central
bank defended the Russian ruble when the
oil price fell to USD35/bbl.
Graph 2: Nigerian Naira vs Oil
100
30
120
20
140
Ruble
Brent, US$/barrel
Source: Central Bank of Russia
The two largest economies in our scope
of study, Nigeria and Angola, face the
same issues. Indeed, given that both are
larger exporters of commodities, 35% and
54% of GDP respectively (versus 17.4%
for Russia), and have far smaller foreign
exchange reserves (Russia, unlike Nigeria,
0
weaker
20
Parallel rate, 23/03/16 = 323/US$
40
190
60
180
80
170
100
160
120
stronger
150
Nigeria Naira
Sep 15
Mar 15
Sep 14
Mar 14
Sep 13
Mar 13
Sep 12
Mar 12
140
Mar 11
Feb 16
40
Dec 15
80
Oct 15
50
Aug 15
60
Jun 15
60
Apr 15
40
Feb 14
70
Dec 14
200
Oct 14
20
Aug 14
80
Jun 14
210
Apr 14
0
Feb 14
90
Sep 11
Graph 1: Russian ruble vs Oil
This led to Russia spending some
USD150 billion of its USD500 billion
foreign exchange reserves before finally
giving up. These reserves were not
replaced until the oil price recovered
through 2009-2014. In 2014, understanding
the expense and limitations of intervention,
the central bank chose the alternative route
in order to keep their reserves powder
dry, and it let the currency trade in line
with market pressures as dictated by the
oil price. In doing so, the Russian ruble
weakened from some RUB 35/USD to over
RUB 80/USD. Though the central bank
has retained its foreign currency firepower,
it has come at the cost of major societal
disruption. Salaries in USD terms have
effectively halved and inflation is eroding
real wage growth which stood at almost
-10% in 2015. Imported goods are a luxury
for the wealthy and the rest of the country
has had to rely on a process of faltering
import substitution.
Brent, US$/barrel
Source: Bloomberg, IEA
saved up in the good times to create a
war chest to help defend itself against
future commodity price falls – currently
some USD380 billion), the impact of falling
commodity prices is likely to be even more
acute. The Central Bank of Nigeria (CBN)
responded to these pressures by allowing
the naira to weaken in a one-off step in
March 2015 to trade in a band between
NGN 197-199/USD. As the oil price has
stayed in the USD30-40/bbl range, the
continued pressure on the country’s
economy has led to growing calls that the
CBN should let the naira weaken further.
It is difficult to argue against this given
that the Nigerian government expects to
see earnings from oil exports fall from
USD19 billion in 2015 to USD4 billion in
2016, and even admits to facing a USD11
billion budget deficit in 2016, which greatly
increases its vulnerability to external shocks.
The current parallel market rate, which
is a reasonable (although illiquid and
inaccessible) reflection of the true oil-price
implied value of the naira, is some 60%
above the official central bank rate.
This puts it broadly in line with the
movement in the country’s real effective
exchange rate which is currently trading
at some 28% above its 10-year average.
In the absence of a stronger oil price, as
the widening gap between the spot price
and the futures market suggests, pressure
on the naira appears inexorable.
Graph 4: Current Real Effective Exchange Rate vs 10 year average
Graph 3: Nigerian Naira/US$ spot vs 3M FWD.
220
30%
weaker
210
25%
20%
200
28%
overvalued
15%
10%
190
6%
5%
180
0%
-5%
170
Nigeria
undervalued
-16%
Feb 16
Dec 15
Oct 15
Aug 14
-20%
Jun 15
Apr 15
Feb 15
Dec 14
Oct 14
Aug 14
Jun 14
Naria 3M FWD
Zambia
-13%
-15%
stronger
150
Ghana
CFA
Angola
-10%
160
5%
Source: breugel
Naira Spot
Source: Bloomberg
It’s a similar story for Angola, which has
been one of Africa’s fastest-growing
economies over the last decade, but is
now likely to see revenues from oil exports
almost half in 2015 from USD60 billion in
2014 and, like Nigeria, is facing a major
USD liquidity crunch. With GDP forecast
to come in at 3.4%, its lowest growth rate
in 16 years and less than half the 10-year
average GDP growth rate of 8.7%, there
is a comparable level of pressure on the
kwanza. The government has slashed its
spending, has been relatively successful
in raising external funding, the kwanza
has been devalued a number of times
from AOA 98/USD to AOA 158/USD.
However, with parallel market rates well
above this, there is likely to continue to be
considerable pressure on the authorities to
let the currency weaken further.
Zambia has similarly faced major USD
liquidity constraints, though the pressure
that has been building on the economy has
to an extent been tapped by the largest
currency devaluation in Africa. Aggressive
rate hikes to contain rampant inflation have
done much to keep further devaluation
under control, but the government’s budget
still faces huge challenges, largely due to
its continued policy of fuel subsidisation and
expensively contracted electricity imports.
Saying that, since the start of the year, the
kwacha has experienced a sudden burst of
energy. From being the worst performing
currency in the world last year, it is the
strongest so far this year ahead of potential
IMF support in August and on the back of
supportive metals prices.
Graph 5: Angolan Kwanza vs Oil
Graph 6: Zambian Kwacha vs Copper
120
80
110
100
100
90
stronger
80
120
Angolan Kwanza
Source: Bloomberg, IEA
Brent, US$/barrel
Sep 15
Mar 15
Sep 14
Mar 14
Sep 13
Mar 13
Sep 12
Mar 12
Sep 11
Mar 11
140
200
9
250
8
300
7
6
350
stronger
5
4
400
Zambian Kwacha
Source: Bloomberg, LME
US$ Copper (1M)
Mar 14
130
60
11
10
Sep 13
40
Mar 13
140
150
12
Sep 12
Parallel rate, 23/03/16 = 400/US$
weaker
weaker
13
Mar 12
20
Sep 11
160
100
14
Mar 11
0
170
150
Ghana, which is one of the few SSA
countries to be a net exporter of foods
(7.2% of GDP), has been hurt by poor
cocoa production as well as the broader
impact of weaker commodity prices, being
a net exporter of both oil and metals.
However, the currency has held up
reasonably well, supported by inflows of
external debt. Nevertheless, with policy
rates already at 26%, the scope for the
central bank to use monetary policy tools
any further may be somewhat constrained.
Graph 8: Real Effective Exchange Rates (Jan 1, 2008 = 100)
20
160
80
80
Depreciating
Brent, US$/barrel
Angola
CFA
Ghana
Nigeria
2016
2015
2014
2013
0
Sep 15
Mar 15
Sep 14
Mar 14
Sep 13
Mar 13
Sep 12
Mar 12
Sep 11
Mar 11
Ghana Cedi
20
2011
140
1.0
40
2012
1.5
120
2010
stronger
60
2009
100
2.0
2008
2.5
100
2007
3.0
120
60
2006
3.5
140
2005
40
Appreciating
2004
4.0
180
2003
4.5
0
2002
weaker
2000
5.0
2001
Graph 7: Ghanaian Cedi vs Oil
Zambia
Source: Bloomberg, IEA
Source: breugel
Since central bank policy rates are already
pretty tight, the options available for the
central banks in both Angola and Nigeria
are limited, which has added pressure
to devalue their currencies. This is even
more so the case for Zambia and Ghana,
which have been aggressively hiking
rates through the recent commodity
price weakness.
Graph 9: Nigeria, Angola, Ghana and Zambia Policy Rates
30
25
20
15
10
5
If we look in more detail at the direct
impact of local currency devaluation in
markets where deals are often fixed in
USD, the recent exchange rate weakness
has, generally speaking, caused concern
among tenants who generate revenue in
local currency and have costs in USD,
and who expect to see margins come
under pressure in light of the economic
downturn.
On the other hand, landlords are worried
that the costs borne by tenants will
ultimately be passed on to them through
rental negotiations, either to reduce the
USD rental rate or to introduce a cap on
the local currency rate, protecting the
tenant from further currency weakness.
In the following sections we consider
how we expect the relationship between
the landlord and tenant to develop in
the occupier market, and also the likely
impact of currency devaluation on the
transactional market.
Angola
Ghana
Nigeria
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
Impact of currency weakness
on real estate markets
0
Zambia
Source: Bloomberg, IEA
“The recent exchange
weakness has caused concern
among tenants who generate
revenue in local currency but
have costs in USD, and who
expect to see margins come
under pressure in light of the
economic downturn”
Capital markets
The impact of a weaker currency clearly
has important implications for transactional
activity and is transmitted in two ways.
The first is through sentiment - investors
are less likely to be reassured by a market
which is experiencing current account and
budget deficits slide into the red and for
whom GDP is contracting. As Graphs 10-13
show, Nigeria, Angola, Zambia and Ghana
are expecting GDP rates well below their
historic 10-year average, which is likely
to remain a headwind for investment in
the short term. However, it is worth noting
that despite the current pressure on their
economies, in both Zambia and Ghana the
medium term forecast growth rate remains
well above the developed and emerging
markets average of 4.8%.
Graph 10: Nigerian GDP Growth, %
Graph 11: Angola GDP Growth, %
9
8
3.8
3.1
5
4
3.5
Graph 12: Zambia GDP Growth, %
Graph 13: Ghana GDP Growth, %
12
2020
Source: Oxford Economics
2019
Source: Oxford Economics
10
3.4
4.3
2018
2010
2020
2019
2018
2017
2016
0
2015
0
2014
1
2013
1
2012
2
2011
3.4
3.9
4.7
3
2
2010
4.4
3.9
2017
2.7
4.3
2016
3
4.6
4.4
2015
4
4.3
5.4
5.2
2014
4.9
6
2006 - 2015 average
5.4
2013
6
6.8
7
6.3
2012
7
5
2006 - 2015 average
2011
8
9
7.8
2006 - 2015 average 6.4
6.6
16
10.3
14.0
14
12
8
6.3
6
6.7
2006 - 2015 average
6.7
5.6
5.3
3.7
4
6.0
6.2
6.9
10
9.3
7.9
8
7.3
6
3.4
4.0
4
2
3.7
5.3
4.4
5.8
2
2018
2019
Aug 15
Nov 15
Source: Oxford Economics
Source: Oxford Economics
The second is through the availability
(rather than the cost) of USD debt.
Russia saw a major decline in direct
real estate investment volumes in 2015
to USD2.3 billion from USD8.2 billion
in 2013, though it is difficult to attribute
this entirely to the fall in the price of oil,
rather that sentiment for Russia was
largely also defined by its foreign policy
agenda at the time (and continues to be).
Instead, we think it is the availability of
USD funding which is the primary concern.
It is interesting that in both Angola and
Nigeria (rather like in Russia), long-term
sovereign Eurobond yields have remained
comparatively tight. Angola, for example,
was able to raise some USD10 billion
in external financing in 2015 and some
USD14.5 billion for 2016. Similarly for
Russia, long-term Eurobond yields have
remained below 6.5%, even at the peak of
its recent crisis.
Graph 14: SSA Long Term US$ Eurobond yields
2020
2017
May 15
2016
2015
2014
2013
2012
2011
2020
16
14
12
10
8
6
Angola
Ghana
Source: Bloomberg
Nigeria
Feb 15
Nov 14
Aug 14
May 14
Feb 14
Nov 13
Aug 13
4
Zambia
Feb 16
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2010
0
0
Current financing issues
in SSA
In the case of SSA, the majority of
developers and investors similarly prefer
to secure USD funding, due to more
favourable interest rates to support IRRs.
The acute shortage of USD in Nigeria and
Angola, Sub-Saharan Africa’s first and third
largest economies, along with the significant
currency devaluation, has resulted in two
significant financing challenges.
First, landlords cannot in general convert
their local currency earnings into the hard
currency which is required to repay their
debt obligations. Second, the volatility
in local currency markets makes the
debt repayment amounts unpredictable
and creates difficulty from a cash
flow perspective. This is a very recent
phenomenon that banks have been faced
with, and it is putting pressure on the way
real estate has traditionally been financed
in these markets.
In the short term the reality is that banks
need to be flexible by dealing with each
case individually and they may have to
accept part of their loan repayments in
local currencies; as a result, necessary
innovations on how projects are financed
are needed.
Graph 15: Russia Long Term US$ Eurobond yields
8%
7%
6%
5%
4%
3%
2%
1%
Feb 16
Nov 15
Aug 15
May 15
Feb 15
Nov 14
Aug 14
0%
May 14
The situation in Russia has meant that
capitalisation rates which are calculated on
the basis of USD funding (and that assume
a prime asset in a CBD location) have not
moved out as much as the dislocation in the
economy might suggest. However, again, the
question is one of liquidity. So far the main
Russian state lenders have been quite flexible
in their refinancing terms, which has meant
that up to now there has been relatively little
distress in the market. Rather, assets have
simply not been trading, which has meant
that office prime yields have moved out only
from 8.75% to 10.5%. In short, good-quality
assets in good-quality locations with debt in
place have remained competitively priced
but relatively inaccessible. Importantly, the
lesson from the Global Financial Crisis (GFC)
is that though market dislocation can be
brutal in commodity-exporting countries when
commodity prices fall - certainly in terms of
economic output and there can be a sharp
painful correction in real estate markets - it
does not necessarily have to be protracted.
In Moscow, with a nascent market and tight
supply, yields had returned close to pre-GFC
levels within 18 months of reaching their peak.
Russian, 30-Year Bond Yield, US$
Source: Bloomberg
This may prompt project promoters to
start obtaining funding locally or through a
combination of local and hard currencies
which will bring about higher blended
finance costs. Furthermore, it also means
that real estate developers will be required
to deliver higher-quality projects; that is
to say functional and efficient buildings
situated in prime locations with the ability
to attract quality tenants over the long
term, thereby creating sustainable income
streams in order to attract and service
favourable loan terms.
The future dependency on commercial bank
debt may also come into question. Banks
will have to be more cautious on the type of
projects they finance and may well require
a higher proportion of equity funding as
they become more conservative on LTVs.
If funding issues are inhibiting the roll-out
of good real estate projects, alternative
sources of funding should be explored.
Pension funds, which are typically underallocated to real estate in emerging markets,
have long-term investment horizons and
no currency challenges, and this makes
them an ideal capital provider. The added
advantage is that it gives pension funds
the ability to deliver quality assets to serve
the local communities in which they have a
vested interest.
At this stage it is probably fair to say that
no one has a clear, co-ordinated medium
to long-term solution to these funding
issues, though interestingly a leading bank
in SSA has made efforts in addressing
the issue by introducing, in the interim, a
‘dual currency structure’ whereby debt is
accessed through a combination of USD
and local currency. The mechanism allows
for a local currency facility to be accessed
in periods of economic uncertainty and
currency devaluation, and once the market
stabilises the local currency exposure can
be refinanced back into USD currency.
(An overall blended interest rate of local and
hard currencies is charged.) Uncertainties
exist around some of the practicalities of
the funding model; however, it seems to be
the only solution that a bank with local retail
presence can offer at present.
“The future dependency on
commercial bank debt may
also come into question.
Banks will have to be more
cautious on the type of
projects they finance”
Impact on the office market
In Lagos and Luanda, like Moscow, most
high-quality office rents are fixed in USD
and are leased for typically five or more
years. Where the contract is fixed, the
tenant may find that they have little recourse
to force a decrease in rents in FX terms.
As a consequence, the fall in the local
currency and the subsequent necessary
increase in local currency payments to the
landlord will have a significant impact on
the tenant’s margins. Of course, businesses
that generate the majority of their revenues
through exports are more likely to able to
absorb the impact of these extra costs,
putting them in a far stronger position than
tenants like FMCGs who generate their
revenue in local currencies and who rely
heavily on imports.
In efficient markets, and assuming the
supply/ demand equation is in balance,
tenants should react quickly to currency
pressures. In the case of Russia in 2014,
when the oil price started to fall, we were
generally less surprised at the pace at
which the market reacted (since occupier
sentiment merely reflected the movements
in the local currency) and rather more by
the pace at which rents switched to local
currency as tenants sought to reduce their
FX liability. Assuming that banks are able
to accept a degree of flexibility in local
currency funding, broadly speaking we see
two types of discussion between landlords
and tenants - stay in USD or switch to local
currency rents:
Graph 16: Moscow prime yields
Graph 17: Moscow Class A office rents
US$/sq m/year
18%
15%
1,400
12%
16%
9%
1,200
14%
6%
0%
10.75%
-3%
800
10%
-6%
8%
600
10.5%
-9%
-12%
Shopping centre
Office
Source: JLL
Stick in USD - Renegotiating an existing
lease but keeping it in USD terms has some
major advantages for both parties. Most
importantly, landlords ordinarily have FX
denominated debt and have assets that are
valued in FX, which means they want USD.
Landlords may be willing to accept a local
currency lease in the short term to boost
occupancy rates and cover their liabilities;
however, by doing so they will feel an impact
on their NOIs and thus on the valuation of
their assets. In our view, occupiers therefore
have a far stronger negotiating position,
both in terms of rates and in terms of length
of lease, if they are willing to accept lower
USD terms now. Markets do, after all, settle
over time and the funding constraints of
today imply that there will be an even more
constrained supply response tomorrow
when the broader market has recovered.
Renegotiating a long-term, USD-based
lease on favourable terms (as well as
probably supporting a good relationship
400
-15%
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Q1 2016
Q3 2016
Q1 2017
Q4 2015
Q4 2014
Q4 2013
Q4 2012
Q4 2011
Q4 2010
Q4 2009
Q4 2008
Q4 2007
Q4 2006
Q4 2005
Q4 2004
Q4 2003
6%
Q4 2002
3%
1,000
12%
Class A rent
GDP growth, YoY
Source: JLL
with the landlord in the short term) may well
put the tenant in a favourable position for
when the market and vacancy rates have
recovered and the advantage is no longer
with the tenant.
Switch to local currency - Switching to
local currency leases has some attractive
short-term benefits for the tenant, though at
the expense of the owner who has to defend
NOIs. In the Russian experience, most local
currency deals that are struck hold for only
two years, so the short-term solution looks
favourable; on the other hand, when the
economy has recovered in a few years and
the market is tight, the tenant could find
themselves at a big disadvantage when
renegotiating the lease.
It is unlikely that the market will be as
favourable in two years as it is now and
the negotiating power of the tenant will be
significantly reduced. Another consideration
is that currency movement is not a one-way
street and occupiers who are negotiating for
local currency leases should be aware that
currencies can oversell and then strengthen
again, particularly in economies that are
based on the export of commodities.
This has certainly been the case in
Zambia where the kwacha, after being the
worst performing currency in 2015, has
been the best performing so far in 2016.
Occupiers should therefore be cautious in
their assumption that it necessarily makes
sense to fix lease terms in local currency.
Moreover, local currency leases imply local
currency indexation. Inflation will remain
elevated (in the case of Nigeria, given that
the currency could well devalue markedly,
inflation could well climb sharply) for the
foreseeable future and tying a lease to this
uncertainty could erode a lot of the shortterm gains associated with the lease.
Impact on the market - In this environment
we would typically expect a widening
division between prime and non-prime or
the best-quality and lesser-quality assets.
Prime assets in prime locations have
retained, in Moscow at least, much stronger
pricing power and have been generally
more capable of retaining leases in USD
terms. To provide an idea of the extent of
the impact, in USD terms average rents for
quality offices in Moscow between 2014
and 2016 slid from USD850/sq m/year to
USD600/sq m/year with new deals largely
in local currency terms. Within that period,
prime rents have slipped from USD1,100 to
USD800-900/sq m/year, though importantly
have still been negotiated in USD terms.
Importantly, we would expect that with the
slowdown in completions the market can
quickly recover to favour the landlord once
again. Even in Russia, we think rents will
start to recover by the first quarter of 2017.
It is perhaps a little too early to predict when
rents in Lagos and Luanda will start to
recover, though there are some similarities
with the Russian experience. For offices
on Victoria Island in Lagos, which is to all
intents and purposes solely a prime market,
new leases have remained in USD with
expectations of around a 25% haircut on
previous levels. Landlords are willing to
accommodate new tenants’ demands to the
extent that they may offer better incentives
(longer rent-free periods, quarterly payments
rather than annual, and/or free parking),
however there is little evidence of a shift to a
local currency market.
In the absence of a truly effective arbitration
process, the most active negotiations
between landlord and tenant are on which
naira rate a lease should be pegged:
either the central bank rate (as has been
typical) which favours the tenant, or the
black-market rate which favours the
landlord. Anecdotally at least, it appears
that landlords and tenants are meeting
somewhere in the middle.
Outside of prime though, where rents have
historically been much more likely to be
negotiated in naira and where there is still
considerable oversupply with rents very
low, there has been little change to the
status quo. Rather like the Moscow market,
the trend has been towards increasingly
divergent, fragmented segments within
the market where prime assets in the main
defend USD rents at a slightly discounted
level, and anything outside of prime
struggles to break out of the cycle of being
low rent and under-occupied.
In terms of occupier activity, it appears that
the majority of tenants are in ‘wait and see’
mode. With the macroeconomic instability,
there is little argument for increasing floor
space and, arguably, prime rents have not
necessarily fallen enough to encourage
tenants to use the current market conditions
to upgrade or consolidate space. However,
if the experience of Russia is anything
Graph 18: Russia retail turnover vs real income growth
to go by, the window of opportunity to
renegotiate or move to new space can
close quite quickly, so tenants may prefer
to wait for some stability in the economy
or in commodity prices before starting
negotiations.
Shopping centres
Shopping centre rents are also heavily
impacted by local currency weakness.
The market is not developed enough yet for
leases to be determined by turnover volume,
as is the case in Russia; nonetheless, rental
levels will be strongly tied to retail sales
and the broader economic health of
the consumer.
This means that inflation feedthrough from
a sharp devaluation, which is typically very
aggressive in developing economies, is
a major risk. This has been particularly
apparent in Zambia, but is also a feature of
all the countries in the SSA region.
A spike in inflation will put further pressure
on consumer spending power which will
be transferred directly through to retailers’
margins. Initially we would expect retail
sales to hold up as consumers spend local
currency to buy white goods before the
impending devaluation. This can create the
impression that the retail sector is more
robust than it is in reality. The Russian case
shows that strength in consumer behaviour
at the end of 2014 was then followed by one
of the weakest quarters on record.
Graph 19: Moscow shopping centre rents vs retail sales growth
US$/sq m/year
18%
12%
6000
20%
5500
15%
5000
6%
10%
4500
5%
4000
0%
0%
3500
-6%
-5%
3000
Retail turover growth, YoY
Real income growth, YoY
Source: JLL
Depreciation has a direct effect on retailers
who buy imported goods in foreign currency
and then sell on in local currency. As retail
margins suffer, the impact is passed on
to landlords as soon as retailers ask for a
rental discount. This is clearly a threat to
those landlords who already have a large
amount of foreign currency debt which they
have to service, but it is one that landlords
are likely to have to endure if they wish to
retain occupancy rates.
Dec 15
Jun 15
Dec 14
Jun 14
Dec 13
Jun 13
Dec 12
Jun 12
Dec 11
Jun 11
Dec 10
Jun 10
Dec 09
Jun 09
Dec 08
-18%
2500
-10%
2000
-15%
1500
-20%
Q1 2008
Q2 2008
Q3 2008
Q4 2008
Q1 2009
Q2 2009
Q3 2009
Q4 2009
Q1 2010
Q2 2010
Q3 2010
Q4 2010
Q1 2011
Q2 2011
Q3 2011
Q4 2011
Q1 2012
Q2 2012
Q3 2012
Q4 2012
Q1 2013
Q2 2013
Q3 2013
Q4 2013
Q1 2014
Q2 2014
Q3 2014
Q4 2014
Q1 2015
Q2 2015
Q3 2015
Q4 2015
Q1 2016
-12%
Prime Rent
Retail sales growth, YoY
Source: JLL
Given that the relationship between tenants
and landlords is somewhat symbiotic,
landlords are far more likely to agree to
share retailers’ losses and look for ways to
negotiate with each other in order to protect
margins. Retailers, for example, may not
want to increase sales prices in order to
maintain volumes at the expense of their
margins. In doing so, they are de-facto trying
to share their losses with the landlord by
asking them to decrease the rents.
With imports increasing in cost in local
currency terms, an environment is being
created in which it is very difficult for the
landlord to maintain current rental rates;
indeed, with retail sales coming under
pressure, the risks are heavily to the
downside. In Moscow, the fall in shopping
centre rents has lagged that of offices by
some six months, and is likely to take longer
to recover.
Conclusions
The major challenge for the countries
discussed in this paper is that until they
can diversify their economies away from a
reliance on the revenues generated from
the export of commodities, they will remain
importers of volatility through commodity
price fluctuations which they cannot control.
Allowing a floating exchange rate does
provide a cushion, but the longer-term
solution is to alter the balance of trade by
promoting a local manufacturing base and
reducing the dependence on imports of
consumer goods.
Until that can happen, inflation and interest
rate policy will remain too uncertain for
real estate developers to fund themselves
in anything other than FX terms, at least
until a country’s structural inefficiencies
have been resolved. Over the longer term,
therefore, and in the absence of predictable
monetary policy, capitalisation rates are
likely to continue to reflect FX lending which
will require FX denominated leases.
The implication for capital markets is that
we would expect the market to consolidate
around developers who have either external
funding sources and or favoured status
among local lenders.
All things being equal, in a tight market
with a lagged supply response to demand
(which is typical in developing markets),
the advantage is usually with the developer,
who can pass these currency risks on to
the tenant. This advantage for the landlord
breaks down when commodity prices crash,
but recovers quickly once they recover.
Therefore, in the office market in particular,
though we may see a short-term push
towards local currency leases, for offices
outside of prime locations where supply is
less tight, we would not expect it to become
the norm in the longer term, specifically if
their economies remain largely dependent
on commodity exports. Given the impact
on consumer spending power, it is likely
that it will take longer for the retail market
to recover. Until that point, retailers and
especially smaller retailers are likely to
continue to push for local currency leases
with an emphasis on turnover rent in order
to balance the losses that they incur from
the increased cost of imports.
Of course, each occupier will be driven
by the subtleties of their business model
and the balance they strike between their
revenues and their costs. Whether a tenant
believes that the right approach is to adopt
a shorter-term local currency lease or a
longer-term USD lease, it is clear that now
is the time, at the very least, to be having
the discussion.
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To find out how JLL can assist you in making real estate decisions in Africa, contact:
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+27 71 860 7926
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Contributing Authors
Tom Mundy
Director
Research European
Capital Markets
[email protected]
Fadheelat Noor Mohamed
Associate
Research Sub-Saharan Africa
+27 76 204 1562
[email protected]
www.africa.jll.com
COPYRIGHT © JONES LANG LASALLE IP, INC. 2015. This report has been prepared solely for information purposes and does not necessarily purport to be a complete analysis of the topics discussed, which are
inherently unpredictable. It has been based on sources we believe to be reliable, but we have not independently verified those sources and we do not guarantee that the information in the report is accurate or complete.
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