Investor Spotlight: International Housing Solutions Fills South Africa’s Gap Housing Markets

Published: Thursday, August 30th, 2012 by Lenora

International Housing Solutions Fills South Africa's Gap Housing MarketsHow are the following three facts about cities, housing and investment in Africa related?

– Africa’s rapid urbanization currently includes 52 cities whose population numbers over 1 million.

– The African continent received USD 3 billion in private equity investment in 2011.

– The region’s housing deficit amounts to tens of millions of units needed by the second quarter of the 21st century, about 20 million in the four major investable markets alone.

It’s a trick question: they’re hardly related at all. Housing supply in each country only numbers tens of thousands units per year, of which lower and moderate income households receive a mere sliver. Mortgage finance on the continent accounts for a paltry low single digit percentage of GDP, primarily directed at higher-income, formally employed borrowers.

Still, if this sounds like a compelling impact investment opportunity, it certainly is – under the right management. While most investment in affordable housing in emerging markets has focused on housing finance, investors focused on the supply side – investing in developers and housing projects – have been more rare. International Housing Solutions (IHS) is bucking this trend as a focused, sophisticated and experienced niche player in a region that still lacks a critical mass of solid private equity fund managers.

Leading edge of the next wave housing investments. IHS’ South African Workforce Housing Fund, which had its first close in 2007, was the first fund to focus solely on this sector. In the past, investments in the affordable housing sectors of major emerging markets have been dominated by big US players like Equity International or real estate operating companies like Homex of Mexico, Cyrela of Brazil and Tata Housing in India, all of which market mainstream mass housing solutions in suburban and peri-urban areas.

IHS’ mission in South Africa taps into a massive underserved market opportunity of nearly 700,000 needed housing units in their target “gap housing market” (1), the net needs of which grow by 100,000 units per year. The undoing of decades of apartheid is fueling urbanization, drawing South Africans who were formerly restrained to rural areas into the cities in search of jobs and better living conditions. With economic growth and opportunity, working lower and moderate income households require improved housing, and the supply of new housing to these segments still falls short of households wishing to move out of informal tenure (25% of households). As city centers and urban housing stocks have been long neglected in South African cities, there is an opportunity to address the housing challenge with existing infrastructure.

IHS’ Hallmark Projects Photo credits: IHS

Impact infrastructure investments with healthy returns. The South African Workforce Housing Fund invests in project equity for developing lower and moderate income housing, including projects both for sale and for rental. Note IHS’ forward thinking: rental housing (including student accommodation) is a desperate need in developing cities but nonexistent due to its high perceived risk for even established local investors. In fact, investing in rentals has allowed the fund to hedge against contraction in mortgage finance markets. About one-third of the fund’s investments are for building rehabilitation; this intrinsically green investment avoids additional construction waste while revitalizing existing infrastructure and communities.

With this strategy, the company has successfully mobilized R1.9 billion (US$240 million) for investment into 26,000 units of urban affordable housing, primarily in the greater Johannesburg area but with projects nationwide. Even though IHS’ investment strategy aims at underserved lower and moderate income markets, the fund has targeted local-currency returns in the low 20%+ range – a compelling enough hurdle rate for mainstream  institutional investors like Citi South Africa, as well as policy lenders like the US’ Overseas Private Investment Corporation. In fact, 70% of investors come from outside Africa.

IHS’ Jabulani Heights project in Soweto Photo credits: IHS

Managing risk in nascent markets. Because IHS faces little competition in its strategy, the investment team can be highly selective. Even so, risk management is central to the fund’s success so far. The team’s experience leads the fund’s credentials, including veterans of US affordable housing and South African real estate from the Founding Managing Partners Soula Proxenos and Cathal Conaty and the local Managing Partner Rob Wesselo.

The fund’s approach is marked by intimate local market knowledge, rigorous due diligence, repeat developer relationships, and well-defined exits with clear contingencies in case of changing market conditions. Invested projects are short- to medium-term with an average life of 3-5 years, with rental projects sometimes generating operating free cash flow in less than a year. Management has also managed to minimize title risk to 0% and currently have developer risk in only about one-half of its projects.

The fund also controls key decisions that determine financing, appointments, investment programs, and use of funds, among others, in addition to including contingencies to benefit and shield the fund’s investors in case of adverse circumstances. The waterfall structure (2) ensures that developer partners take the first loss risk to incentivize their performance. Finally, despite some volatility and political risk, the South African rand is convertible.

Unprecedented study to highlight impact. Amid increasing investor interest to measure the environmental and social impact of investments, IHS took the step of commissioning a study of the projects it had financed. While measuring impact is becoming more common, publishing the results on a project-by-project basis is unprecedented, certainly in emerging affordable housing markets. Starting with job creation – both from construction and operation of rental units – IHS’ first fund created over 100,000 jobs about half of which long-term maintenance positions. Moving beyond job creation, the majority of buyers and renters were satisfied with their move with the highest levels of satisfaction with access to public transit, security and safety, community quality, and proximity to work. Overall improvements in lifestyle for satisfied households included quality of life for children, improved health, better housing, and more social life and leisure opportunities. Disruption of social and family ties from moving, distance from economic opportunities and access to schooling options count among the challenges to be balanced in future projects.

IHS’ insights into the broader effects of housing on social welfare give it an advantage – and not just the impact investment world. Knowledge where improvements can be made also gives the fund and its partners privileged information to grow and build brand equity in future.

Looking ahead. With the success of the first South African Workforce Housing Fund, the IHS team looks to leverage its experience in South Africa elsewhere in Africa in its future funds. Watch for our feature conversation with Soula Proxenos about IHS’ coming funds and perspectives on investing in affordable housing in Africa.



(1) The “gap market” comprises those homebuyers left unserved because their incomes exceed levels that qualify for government subsidies but are lower than market rate developers have been willing to serve.

(2) The fund’s waterfall structure refers to the order in which cash returns from investments, in this case profits from rental housing and from sales of housing units, are distributed first back to the fund and then to developer partners.