Investor Interview: Soula Proxenos of International Housing Solutions

Published: Monday, September 24th, 2012 by Lenora

Soula Proxenos, IHS

In the second part of our profile of International Housing Solutions, DSC talks to Managing Partner Soula Proxenos, who is responsible for capital raising and business development, as well as a member of the Investment Committee which approves fund investments.

International Housing Solutions invests in housing for rent and for sale aimed at lower and moderate income households. The firm is currently planning for future funds focused on workforce housing.

DSC: The first South African Workforce Housing Fund seems to have been a success. Have the fundamental drivers of IHS’ investment mandate changed or will new funds be riding the same wave as the first?

The investment drivers for our first fund have evolved in ways that benefit our strategy. IHS’ target market comprises about 30% of South Africa’s population. Those are the households that have enough income to buy, but for whom there’s little or no supply – as compared with the 60% that can’t afford a house and need a government subsidy. In fact, that “gap market” has grown since our launch in 2006. The need is growing faster than supply with 600,000 units needed currently. This number is growing by 100,000 per annum.

The good news is that demand is driven by urbanization and growth in the middle class. The bad news: the mismatch suggests the top end are being serviced while the bottom end are not. We’ve also seen higher household formation and diminishing household size from five people per household to a little under four over the past few years.

IHS’ opportunity has been to serve the market across the spectrum because of the different products we invest in. Units for sale may range from R300,000 (about US$37,500) to R700,000 (about  US$87,500), so there’s a huge spread. Likewise, the spread on rental side ranges from a small but safe inner city bachelor apartment renting for R1800 (about US$225) per month to other units as much as R6000 (about US$750) per month.

Another evolution in our strategy relates to rental. In our first fund, we underestimated how much rental was needed. Because that demand is far less quantified, we learned through experience that households weren’t qualifying for home purchase but were able to support a rental unit.

DSC: As you interface with investors regularly, you know what an extraordinary achievement it is to sell a private equity fund in an underinvested market sector with an underserved client segment against the backdrop of an unsettled global market environment and South Africa’s challenging political conditions. How do investors frame risk and return in these markets? How does social impact figure into that?

IHS is certainly too niche and frontier for many investors. Most of our investors have come in to our fund as their first foray into Africa and were able to do so because we offered them a more institutional entry point, a fund with strong governance practices with a team that can manage the phenomenal due diligence required to get to that comfort level.

In terms of South African risk, for all the country’s problems, it still has a first world banking and finance infrastructure, sound banks, transparency, solid corporate governance at the board levels. North American investors that came into our first fund but hadn’t invested in Africa before are now more comfortable with investing in other sectors. IHS offered a softer landing pad.

As far as our market niche, we have been able to disprove the perception that you couldn’t make money in affordable housing. IHS filled a gap in the market in a way that investors didn’t initially get. Finally, all of our international investors understand real estate investment, so this was a key element of our dialogue with these investors.

DSC: To make a substantial social impact, rental housing in developing markets is a much greater need than units for sale. Yet, there are precious few investment opportunities. Why and how has IHS managed to invest in rental housing where others haven’t? In particular, longer-term maintenance has been an issue the world over. How does IHS manage this thorny challenge?

The rental markets have really been like the ugly step-sister despite the opportunity and the need. Many governments are home-ownership oriented, as is the case in South Africa. With financiers requiring higher credit scores and down payments, investing in affordable housing for sale is more challenging. Yet, a lot of capital is short-term. Finding the ten-year money that’s required for rental housing is harder. Given that private equity funds tend to have longer investment horizons, this has worked for us.

More importantly, IHS’ team understands asset management extremely well. We work with great property managers. We have invested in building the capacity of property management in the country. Whereas most managers are small and managing assets for their own books, property management has to scale. We act as the link between institutional investors and that process.

Another reason why rental is hard is that laws are pro-tenant, so there can be major issues with eviction and legal process. However, if you run a property very professionally, then there’s enormous demand, and a good manager can detect problems early. People want to have a good home and respectful management. It’s unbelievable, for instance, how much our tenants appreciate security measures, like biometric entry systems in Johannesburg downtown apartments. Residents value knowing that it’s a safe environment and they respond accordingly. The product, service and skill set all fit together.

IHS Investments in Student Housing. Photo credits: IHS

DSC: The student housing opportunity in South Africa is one that local developers seem to have seized on. How does that fit in with IHS’ strategy?

Suitable student accommodation is in very short supply in our cities, especially Johannesburg, where the gap is in the high tens of thousands. IHS has about 1500 units of student housing in the fund, so that’s substantial exposure. People expect student housing to be full of horror stories and an asset that has to be managed even more closely than residential. We’ve had a positive experience by contrast. No horror stories. Again, people value that they’re being treated well. Parents appreciate that their children are in a safe place. Being located close to a  university is likewise a major asset. If the building is further away, we supply a shuttle service.

DSC: Why don’t developers ramp up to serve the gap markets targeted by IHS more efficiently if the market opportunity is so compelling? What are the bottlenecks?

This is a nascent market environment, a very niche investment theme and a difficult business. Ours is the first equity fund in South Africa in real estate as well. We had to explain equity to people because they were used to debt. We also haven’t had more competition because of how tough it is. It is not  trivial to manage these assets in their development phase or in their stabilization phase. There are comparable organizations that do the same in Latin America and Asia but few in our market niche. Many of those aiming for bigger scale, likewise, struggle to get their money out the door by participating throughout the entire capital stack, which makes it harder to partner with banks – not to mention that bigger projects are harder to implement. We have managed to bring in projects at the small end with the smallest being about 150 units and, at the other side, with our largest project at 9000 units.

DSC: The stereotype of affordable housing investment is that it’s about cheap land far outside major cities with little transportation and mass construction. Is IHS any different?

We have to be careful about where we pick our sites. We look at employment opportunities, good social services and transport links. People may be able to afford living further out, but they’ve got to be able to afford what goes around it. Our customers are very sensitive to location, in fact, especially to have access to education and get their kids to school. Our investments have been mostly close to city centers but not necessarily in the CBDs, where rentals are usually located more than homes for purchase. We have done suburban sites like Randburg, but there are corporate headquarters out there. Farther flung projects may be a quick drive to the airport, so we have residents who are airport staff or work nearby. One of our student housing developments is right at the gates of the university of Bloemfontein. Essentially, our investments follow the development of South Africa’s urban microeconomies.

DSC: What compelled IHS to invest in a study to determine customer feedback and social impact of projects invested?

Our investors required IHS to report on certain standards. We were interested in getting at more qualitative understanding of our market. We also wanted criteria on which we could drive the business’ evolution so we could learn from past investments. This also gives us a baseline for understanding our clients. We also learned that we need to ask questions more effectively, which reflects in our questionnaires. As an example, in the open ended questions, residents mentioned improved health, which didn’t come out of the more structured questions. We were surprised by that because we assumed that residents were not coming from informal settlements. We realize that we simply don’t know and that this is the responsible and smart way of investing – to be aware of the issues that are unique to the population that we serve. Plus, we believe it will help us identify new opportunities to deliver into these markets. By the end of the year, we should have a new survey. We’ll be doing this kind of research regularly.