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Taxing landlords: Real estate should not be treated like fast moving consumer goods

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Given the typically high costs of investment in the real estate sector, most of the scale (medium to large) projects in Uganda are funded through borrowing (debt) from the financial sector. Due to this heavy reliance on loans for this sector, cognisance has to be made of the terms and conditions that come with these loans: currency being a key consideration.

Last week, the Senior Presidential political adviser on political issues, Moses Byaruhanga, wrote a piece in the Sunday Vision titled: “Rent in Dollars: Why was the decision to go shilling dropped? I was in two minds as to whether I should respond to this or not.

I decided that because I am passionate about property, and about the successful development of the property sector in my country Uganda, I will respond to clarify on many issues about property that were misrepresented and may mislead the general public.

To answer the question though, the decision to go shilling was dropped because it is not conducive to the successful development of a robust property market. Landlords cannot simply switch the income streams of their investment from one currency to another overnight because there are other parties like financial institutions who have first call on the property by virtue of the fact that they have provided the development finance for the property, and need to ensure that it is repaid promptly.

Where the financing has been done in shillings, this may not be an issue, however, for dollar funded loans, there is a bigger challenge to contend with. This being that the loan repayments in shillings will require the dollar rents to be converted into Uganda shillings at the recipient bank’s exchange rate and escalated by about 25% per annum (in line with the prime lending rate of the shilling) to be able to adequately cover the monthly equivalent of dollar rents in shillings.

Mental maths will tell you that this ends up being far more expensive than paying the dollar rent.

Byaruhanga asks an interesting question, “Coca Cola is investing an additional $51m in Uganda, should they start selling their soft drinks in dollars?” No they should not, and before I explain why not, I must make a clarification. Coca Cola is a fast moving consumer good (FMCG).

These are low-cost products that are sold quickly, replaced, or fully used within a year, usually in a matter of days, weeks, or months, i.e. soft drinks, airtime, and groceries.

Real estate is an immovable asset which is heterogeneous (unique) and no two properties are exactly identical, they are physically and geographically different.

The behaviour and decisions of property buyers and sellers are influenced by social, economic, governmental and environmental factors, which is less so for FMCGs. Coca Cola can produce and sell 100,000 cans of coke in an hour, but this is not the case for real estate. Hence, why the revenue streams and risk factor associated with these respective products are different and incomparable to a large extent.

Likewise, financing criteria for Coca Cola as an FMCG manufacturing company, is totally different to that of a real estate developer and will inform the currency in which the loan is repaid.

As is the case for other sectors in any Economy the Real Estate Sector is subject to the market forces of supply and demand. For purposes of this discussion I will focus on the supply which is essentially dependent on the level, propensity and ability to fund the investments.

Given the typically high costs of investment in the real estate sector, most of the scale (medium to large) projects in Uganda are funded through borrowing (debt) from the financial sector. Due to this heavy reliance on loans for this sector, cognisance has to be made of the terms and conditions that come with these loans: currency being a key consideration.

FMCGs are mass market products with fairly short turnaround times from production to consumption, usually 90 days from procurement of raw materials, production and finally distribution.

Real Estate, however, is a specialized product (doesn’t come off a production line), with a long gestation period from project design to construction and finally operation (up to 3 years), and this determines the lending criteria of the different investments.

Funding to the Real Estate sector is therefore a medium to long term project, whilst funding to the FCMG sector is short term, mainly for working capital, with one off capital expenditure funding usually for expansion of existing plant and machinery.

Financial institutions rarely finance 100% of a real estate project, in which case the developer or promoter is required to contribute equity into the project from other sources.

In many instances equity is acquired from institutional investors through offshore funds, and in order to ensure that their funds are safe, they require that the transaction is done in a fairly stable currency normally USD. Additionally, financing Institutions assess a real estate project on its ability to repay the loan, unlike a FMCG business where strong focus is placed on the nature of the product, its demand, and competition (market share).

The key barometer here is the cash flows, and their adequacy and sustainability to service the Loans. FMCG products, given their nature as explained above, are priced and sold in local currency ie UGX.

Real estate, loans are granted in line with the currency of their cash flows to mitigate the repayment risk due to an underlying currency (exchange) risk that would be brought on by a potential currency mismatch if the loan and cash flows were in different currencies.

The answer to your question, Byaruhanga, is that, the loan repayments for real estate developments is directly linked and secured against
the rental / income streams from the property over a long period of time. Therefore, you cannot lend in dollars and repay that loan in shillings, unless you charge exorbitant dollar equivalent rentals in shillings, escalated annually to hedge against foreign currency depreciation, inflation and currency risk.

The proposed bill is not only about whether to charge dollar or shilling rentals. The questions you should be asking is, how do we strengthen our local currency to make it more affordable and less volatile for borrowers and lenders alike?

Additionally, how do we draft a landlord and tenant bill that will stand the test of time, whilst enabling a conducive environment for the development and maturity of the property sector as a whole.

The proposed bill should not be for the sole benefit of a single interest group, but for the good of the property market comprising all stakeholders and parties.

The Writer is Judy Rugasira Kyanda MRICS, A Chartered Surveyor, And Managing Director, Knight Frank Uganda Ltd.

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