Gilbert Muponda and Francis Chinjekure
Financial engineering is a sophisticated and mathematically based modern finance, which seeks to provide synthetic products designed to mimic an underlying financial instrument so as to eliminate a
credit risk associated with the original asset/financial instrument whilst creating a predictable cash flow.
Financial engineers create derivative financial products aimed at enhancing a business’s performance while reducing or managing risk. Current difficult business environments globally and in Zimbabwe call for financial innovation which allows companies not only to survive but to grow and expand using underutilised assets which they may have such as real estate.
This strategy partly relies on similar awareness and collaboration between fund managers of institutions such as NSSA, Old Mutual, First Mutual, Pearl, Dawn, etc and business leaders from the industrial sector collaborating to create new financial products and transactions that create mutually beneficial outcomes. Other financial intermediaries have a crucial role to support the success of this effort to unlock liquidity and value.
Portfolio optimisation finds an investment strategy that best fits a fund manager’s financial goals and preferences. Derivative securities, such as property/stock options, REITs and commodities futures, have pay-offs that are related to the value of an underlying asset, such as a property, stock or a commodity.
Financial engineering helps to find the relationship between the derivative security’s price and that of the underlying asset. These include equity, fixed income such as bonds, commodities such as oil or gold, as well as derivatives, swaps, futures, forwards, options, and embedded options
Considering the current liquidity constraints on the Zimbabwe capital markets most industrial and manufacturing companies should consider sale and lease back structures backed by options. “Sale-and-leaseback” is a financial transaction where one company sells an asset (property for example) and leases it back for the long term; therefore, the company continues to be able to use the property but no longer owns it.
The company raises capital through the sale and can reduce its borrowings and cost of funds plus create a more predictable and preferable cash flow. The transaction is generally done for fixed assets, notably real estate, planes, cars, plant and equipment.
A practical example is Air Zimbabwe which does not really need to own a plane to fly one. The national airline can simply sell its planes and raise cash, then lease the same planes for monthly payments.
In recent months some of Zimbabwe’s iconic firms David Whitehead and CAPS Holdings have been on the brink of collapse and closure despite owning significant real estate. Obviously, a financial engineering solution could have addressed some of the problems with management selling real estate to an institution such as NSSA thereby get cash and then rent the premises from the authority.
Such a sale and lease back structure can be backed up by writing an option which would allow CAPS/David Whitehead an option to buy back the premises should their fortunes change.
Such pre-emptive actions will ensure that the company remains viable and avoids forced sale situations whereby creditors end up obtaining court orders and seize such property.
Specialist property firms such as Dawn Properties, Pearl and Mashonaland Holdings can play a leading role in injecting liquidity this way. The industrial firm sells its corporate real estate assets to a specialist property firm or an institutional investor, or a real estate investment trust (REIT), and then leases the property back at a rental rate and lease term that is acceptable to the new investor/landlord.
The lease term and rental rate are based on the new investor’s required rate of return costs, the seller’s credit rating and cost of funds, based on the initial cash investment, i.e. the purchase price paid by the new investor.
Advantages for a company are varied, including:
- finance expansion and invest in new business opportunities.
- pay off debt and clean up the company’s balance sheet.
- improve the company’s business income tax position.
The advantages for an investor include:
- Acceptable return on the investment and ownership of a depreciable asset .
- Long-term asset with a guaranteed revenue.
- For tax purposes, the investor/landlord can take an expense deduction .
The new and improved product created by the financial engineer is simply a repackage of several independent but complementary products made available to ensure a company’s survival and growth.
In order to mitigate the liquidity crisis securitisation of property is another practical technique which Zimbabwean firms should pursue. Securitisation can be simplified to be “like imposing a corporate finance structure on property” Isaac (2003 p.198).
This corporate finance structure “is the conversion of an asset into tradable securities (these are certificates of ownership or right to income)”, Isaac (1998 p.257). The objective of property securitisation is to help increase property investments, through an indirect investment approach. This serves to broaden and deepen the capital markets and mobilise financial resources for optimal distribution for competing needs.
Market overview
The property market in Zimbabwe is still going through a recovery process since 2009 after dollarisation when activity rebounded from a decade old meltdown in market performance. Continued growth is mainly driven by the earning capacity growth in the retail and service sectors. Retail space demand is very high in the CBD of Harare with retail prime rents managing to push 60 percent up in 2012.
Housing units in newer sought after areas continues to lead the market and properties below US$50 000 market value are selling very well above all. However, property values in comparison with the regional prices are still very low as evidenced by low prices and forced-sale values.
The market continues to gain ground in 2013 but this time at a slower pace than a leap experienced in the 2009-2011 financial years. The most notable difference in 2013 is that the market is showing signs of maturity across all facets of the sector. It has been a nightmare to sell an up market property in the previous years.
However, as the market is gaining pace some up market properties have changed hands recently with Pomona shopping centre in Borrowdale changing hands for $7.8 million and Starafricacorporation Headquarters also sold for US$3.55 million.
This indicates that the market is taking on “a semblance of normalcy” as more sales occur under conventional conditions with activity taking place across the whole market.
Statistics are showing that there is still perceived high risk in the market. Capitalisation rates in Zimbabwe averages 11 percent which is still a long way to go to achieve an optimum rate of 9 percent for the region. In South Africa the capitalisation rate is at 9.82 percent.
The state of affairs shows several new signs that the property market is well on its way to recovery from the property bust. The market is slowly drifting towards regional parity. Rentals and property prices as compared to regional proxies are still very low in Zimbabwe, below those being attained in the region.
If it is to be that the market maintains or improves its pace of healing chances are high that by 2020 the market will be performing within or above regional standards.
Property funds and Investor hubs are the way to go. The emergency of Ascendant Property Fund is set to give light to other investors on the best way to go. Property funds are a good counter for the current liquidity challenges slowing the market. They provide a ray of opportunities to acquire quality assets at a lower price than could be acquired elsewhere in Sadc region.
Property prices in Zimbabwe are at their lowest hence first movers are going to enjoy the advantage of buying at a depressed value and in the near few years prices are expected to appreciate giving investors better returns in terms of appreciation in value.
Once one has such quality Property on the books they can deploy financial engineering techniques above to unlock both value and liquidity.
As the Zimbabwe property market continue to develop and become more significant on the financial markets investor hubs should be encouraged. These are an innovative way of investing that offers a huge purchasing power to the group of investors who form the hub and also offers advice on the best positions to take in the market.
There investment strategy is not much different from that of property funds, Its only that most of them spans across borders to members in different countries.
Disclaimer
At GMRI Capital, we pride ourselves on the quality and depth of our research and analysis. This means digging deeper than our competition for information and generating more useful reports.
This article is provided “as is” for informational purposes only, not intended for trading purposes or advice. Prior to execution of any security trade, you are advised to consult your authorised financial advisor to verify the accuracy of all information. Neither GMRI Capital nor any independent provider is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein.
Francis Chinjekure is a Financial Engineering student, Harare Institute of Technology and was attached at GMRI Capital
Contact ; 4 Dan Judson Road, Milton Park, Harare. Facebook ; http://www.facebook.com/GMRICAPITAL
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