Risk Analysis and Challenges for Deal Structuring in Africa Real Estate

Over the past few years, there has been a growing focus on Africa as international investors increasingly see the opportuni ties in resource-rich, consumer-driven economies of the second largest continent in the world. Sub-Saharan Africa is now viewed as one of the world’s last investment frontier markets but there lingers a percep tion that the risks in investing in Africa are higher than in other emerging markets such as China and India.

This perception of risk is, however, not held by those who are active and experi-enced investors on the continent and who feel that such perceptions are outdated. A number of real estate investors have been active on the continent for many years and have developed strong track records in real estate development and have to some extent enjoyed the benefits of an uncrowded mar¬ket. We are now seeing a growing recogni¬tion of the opportunities in Africa from a broad range of investors from private equity funds, property developers and financiers.

Many of the perceived risks such as political risk, corporate governance, trans-parency and the like are not necessarily peculiar to Africa and are generally found in all emerging markets. However there are some fundamental ‘must haves’ when considering any investment. Choosing the right local partner is key to any investment in Africa. Extensive due diligence on the market and your partner is vital, in particular to conduct background checks on individu¬als and their position and reputation in the local business community through the use of risk consultancy advisers. If one is dealing with government, it is also important to assess fully country and political risk and to evaluate the impact of regime change on your project.

The debate about the risks of invest¬ing in Africa is often too generalised - as if Africa were one country. The reality is that it is a continent of 54 countries, each of which has its own mix of political, cultural, religious and language factors. From a legal perspective, there are many different legal systems in place. The underlying influ-ence in those systems is often linked to the country's colonial past and so one sees the influence of common law in East and some parts of West Africa, civil law in Francoph¬one Africa, Lusophone Africa and North Africa and Roman Dutch law in Southern Africa. These systems are then overlaid with local customary or indigenous laws and in some parts of Africa sharia law, and often incorporate legal concepts from other inter¬national jurisdictions.

Each country has its own legal system and its own laws governing the ownership and the taking of security over real estate. There are many examples of African coun¬tries that have no system of freehold owner¬ship. In some of these countries all real estate vests in the state and the right to use and develop it are granted under leasehold (such as Angola and Ethiopia).

In other African countries where real estate vests in the state (or the governor or the president as is sometimes the case) the right to use or develop it is granted by way of concession or a right of occupancy (in for example, Mozambique and Nigeria). Some countries may allow for more than one form of title which would vary depending on the rights held by the current owner. Ethiopia, by way of example, has four land tenure forms, namely customary, freehold, mailo (similar to full freehold but with limi¬tations) and leasehold.

Almost all African countries limit foreign ownership in real estate, either by limiting the duration of rights granted to foreigners or foreign entities or by imposing other restrictions limiting ownership rights. An example would be limitations in the case of companies acquiring rights to land, requiring a certain percentage of the share¬holding to be held by local citizens. Tanzania requires 51% of the shares in any company owning land to be held by Tanzanians.

Most African countries have legal systems which permit the taking of security over leasehold or other rights. Most com¬monly security would take the form of a mortgage. Each country has rules governing the registration and enforcement of security interests. The ease with which security can be obtained or enforced differs from state to state and needs to be carefully considered as part of a comprehensive risk analysis.

One of the challenges seen in struc¬turing real estate investments in emerging markets is trying to use structures and in¬vestment instruments which are commonly used in developed markets where the law or regulatory framework in the host country does not allow or envisage such structures to be used. Much patience and out-of-the¬box thinking is required in dealing with regulators who can be reluctant to embrace innovative deal structures.

A KEY ELEMENT OF ANY DEAL STRUCTURING IS TAX

The structuring solutions developed in other parts of the world to optimise tax efficiencies for real estate investors do not necessarily work well in an African context. Because real estate investment is relatively new to many African countries and some tax systems in Africa tend to be relatively unsophisticated in global terms, certainty with regard to tax treatment can be difficult to attain.

African countries tend to impose high levels of withholding tax on cross-border cash flows, including dividends, interest and management or advisory fees. Minimising these taxes through the use of appropriate tax treaties can present challenges because, with a few notable exceptions, most African countries have very few tax treaties. As with the legal systems generally, the influence of the colonial past can often be discerned in the choice of treaty partners and many of the treaties are very old.

Mauritius has deliberately sought to build an attractive treaty network with Afri¬can countries and to date has been successful in this regard, although its treaties with some of these countries with robust economies such as Nigeria and Zambia are at the time of writing, signed but not yet in force. As a result of this and other attractive tax features, Mauritius is often chosen as a gateway into Africa (especially sub-Saharan Africa) by investors. If Mauritius can maintain its momentum in building its African treaty network, it will continue to be a dominant player, particularly in the private equity arena. In support of this objective, Mauritius has also been focusing on the development of partnership vehicles with legal character¬istics designed to attract fund monies.

South Africa is seeking to compete with Mauritius in terms of making itself attrac-tive as a gateway into Africa for investors. Recent legislative measures to achieve this include the introduction of a headquarter company regime, under which many of South Africa's more onerous tax provisions relating, for example, to transfer pricing, thin capitalisation restrictions on the deduct¬ibility of interest, and imputation of income under controlled foreign company rules, are switched off for qualifying companies.

Frequent legislative changes, sometimes (as in the example given above) with no advance warning, and measures designed to ensure that foreign investors pay local taxes at least equal to, and sometimes greater than, those borne by local businesses or individu¬als are unfortunately not exceptional in Africa.

Nonetheless, with appropriate advance planning and a detailed understanding of the tax playing fields in the target jurisdiction, it is possible to design relatively tax-efficient deal structures for African investments. It is a virtual certainty, however, that established strategies which work well in the context of investments in North America, Europe or Asia, cannot successfully be imported wholesale into an African environment.

Roddy McKean heads up Webber Wentzel’s Africa Group and has overall responsibility for the firm’s practice on the African Continent (outside South Africa). He has over 20 years experience in mergers and acquisitions, private equity, restructur¬ings, joint ventures and other corporate transaction¬al work in emerging markets around the world.

Since joining Webber Wentzel, he has been involved in a number of projects for major clients of the firm in South Africa, Botswana, Ghana, Kenya, Malawi, Mauritius, Mozambique, Nigeria, Rwanda, Tanzania, Tunisia, Uganda, Zambia and Zimbabwe.

One of his key industry focuses during his career has been in the real estate, hotels and leisure sector where he has advised a range of clients from listed property companies, developers, international hotel groups, real estate funds to financiers in a broad range of real estate transactions and develop¬ments in the retail, office, industrial, mixed-use, hotels, leisure, gaming and agriculture sectors.

Mark McIntosh is the Head of the Real Estate Practice at Webber Wentzel and is an experienced Property lawyer with expertise in township es¬tablishment, subdivisions, consolidations, sectional title schemes, mixed-use schemes, and all aspects of commercial property, including registration of security on behalf of financiers. He provides services to a wide range of local and international clients including clients with mining, hospitality, gaming, property and industrial interests. He has had exposure to real estate projects in Seychelles, Zambia, Nigeria and Kenya.

Published in Africa Real Estate Magazine, June/July 2012