Joseph Wainaina

THE PROPOSED EXPANSION OF CENTRAL BANK OF KENYA PENSION HOUSE OFFICE DEVELOPMENT COST AND BENEFIT ANALYSIS May 2015 0 1 INTRODUCTION. The Central Bank Pension Fund is in the process of expansion and renovation of their existing office development, Central Bank Pension House, by putting up an ultramodern mixed use high-rise urban development at their plot of 0.712 acres located within Nairobi Central Business District along Harambee Avenue. This will comprise of office space and other auxiliary functions. The fund intends to lease this development to other government agencies and private sector entities as a way of contributing to the need for modern office space for government and related agencies and expanding their income streams. The project involves the development of a new wing that will include parking areas and the renovation of the existing property. 2 APPROACH Towards the construction of the office development, an analysis in to the financial feasibility is important to understand the viability of the project. Three approaches have been utilized in performing the analysis from a development and financing spectrum and a comparison included to determine the best alternative. 2.1 OPTION C This option shall have the fund renovate the existing facility with an area of 5,635 sqm as well as develop a new wing of five floors with a total built up area of 2,525 sqm. Consequently, the property will have a total combined area of 8,160 sqm. The total cost for the development and refurbishment shall amount to Kshs 498 Mn. In analyzing the viability we have evaluated its feasibility based on own developer financing and external debt financing from commercial banks. 2.2 OPTION D The option is based on the renovation of the existing facility and the development of a new wing that will culminate into the creation of 10 floors of space. This will include 2 basement parking areas, ground floor and 7 upper offices and parking areas. The total built up area will total to 24,160sqm. The estimated cost of the development will be Kshs 1.4 billion. A viability analysis has been performed on the financing mix to be adopted based on debt availability (levered) and developer financing (unlevered). 1 2.3 OPTION E Further in full optimization of the project site, this option examines the feasibility of renovating the existing facility and construction of a new office block. The new 24 storey block shall have a total built up area of 28,405sqm which shall comprise of parking areas and office space. The total built up area will be 34,040 sqm and will be developed at an estimated cost of Kshs 2.5 billion. A viability analysis has been performed on the financing mix to be adopted based on debt availability and sole developer financing i.e. levered and unlevered scenarios. 3 ASSUMPTIONS 3.1 Areas Below are the areas that have been assumed in developing the financial models. Figure 1: Lettable Areas OPTION C OPTION D OPTION E sqft sqft sqft - 120,557 120,557 360 360 NEW BUILDING Total Built up area Parking Parking No. Commercial office 27,169 61,624 125,993 Commercial retail - 17,222 51,667 Subtotal 27,169 199,403 298,217 EXISTING sqft sqft sqft Retail 10,975 10,979 18,514 Office 49,657 49,676 49,676 Parking No. 50 bays Sub total 60,633 60,655 68,190 Total area (sqft) 87,802 260,058 366,407 Total area ( sqm) 8,157 24,160 34,040 2 3.2 Debt Financing Where debt shall be used the project shall be financed at an interest cost of 10% p.a over the construction period and operational period for a period of up to 15 years. The project debt amount assumes 100% funding for construction cost and professional fees. The debt component shall be converted to a permanent mortgage from a construction loan upon completion of construction and repaid over the same period. 3.3 Equity finance The projects existing land value and buildings have been pegged at Kshs 850 Mn. The equity return assumes combined cash, land and buildings valuation in the computation of the internal rate of return. 3.4 Operations a. b. c. d. e. f. g. h. 3.5 Tax exempt status of the pension fund; Average occupancy rate of 87% p.a; Bad debt allowance of 2% p.a; Operating expense ratio of 10% p.a; Property management fees of 4% p.a; Capital expenditures of 8% after every 3 years; Rent escalation of 5% after every two years; Capitalization rate of 6%. Pricing The below table indicates the expected pricing structure. The pricing structure adopted is based on current market prices for similar properties within the projects investment grade and classification as a type A office space as specified. Figure 2: Parking prices Parking Rate per bay Rate per bay incl. VAT 10,000.00 11,600.00 The above lease prices have been selected based on current market prices as demonstrated by asking rents for class A properties. 3 Figure 3: Target lease rate assumptions Floor COMMERCIAL SHOPS COMMERCIAL OFFICE 3.7 Ground floor OPTION C Base lease rate/psf/mth 180 OPTION D Base lease rate/psf/mth 180 OPTION E Base lease rate/psf/mth - - - 1st floor 2nd floor 3rd floor 4th floor 5th floor 6th floor 7th floor 8th floor 9th floor 10th floor 11th floor 12th floor 13th floor 14th floor 15th floor 16th floor 17th floor 18th floor 19th floor 20th floor 21st floor 22nd floor 23rd floor 24th floor 180 Cost of construction and renovations Figure 4: Construction Cost per Square Meter Option C Kshs Option D Kshs Option E Kshs Office 107,984 107,984 107,984 Renovations 40,000 40,000 40,000 - 80,747 80,747 Parking 4 4. OPTION C This option evaluates the project based on a refurbishment and development/extension of a new wing by 5 floors above the existing right wing of the development providing 8160 sqm of space. Below is an analysis of the cost and return spectrum based on different methods of funding. 4.1 Scenario A: 100% Equity Funding (unlevered) 4.1.1 Project Cost The projected development cost for the development through this approach is estimated at Kshs 1.4 Bn. The project shall be completed within an estimated period of 12 months. The below table illustrates a breakdown of all cost components arising. Figure 5: Cost budget Kshs Land and buildings (existing) Construction Cost Construction Cost incl. Preliminaries and External works Licenses, Surveys and Approvals Surveys Geotechnical report Property Valuation Topographical Survey Feasibility report Approvals & Licenses Extension of User & Property Amalgamation NEMA consultancy fees NEMA application fees NC Architectural Submission Fees NC Civil & Structural Submission Fees NC Occupation, signboard, road access fee NC Infrastructure levy NCA compliance certificate Professional Fees Architects Quantity Surveyor Civil & Structural Engineer 850,000,000 498,059,240 450,000 250,000 150,000 450,000 500,000 1,223,545 249,030 24,902,962 24,902,962 9,961,185 8,965,066 Services Engineer Project Manager Miscellaneous Costs Legal Charges Marketing & Letting Total Estimated Project Cost 8,467,007 7,470,889 500,000 2,500,000 1,439,001,885 5 The structure above includes the hard and soft costs of the development of the new wing and the renovation costs to be incurred in the upgrading of the existing building. 4.1.2 Financing Structure The table below illustrates the expected financial structure for the development of the project based on the above cost budget. The project financing shall be through equity sources. Figure 6: Finance Structure Equity Finance Kshs Land and buildings 850,000,000 Cash 589,001,885 Total 1,439,001,885 Equity investment in the project shall be through the existing land and buildings contribution by the fund estimated at Kshs 850 Mn. In addition, the project shall require a cash equity injection of Kshs 589 Mn from the fund to cater for the construction costs, professional fees, approvals and licensing costs as well as other miscellaneous expenses. 6 4.2 Scenario B: Debt Financing Alternatively, the project can be funded using a mix of both debt and equity based on a 37% and 63% ratio respectively. The project budget and financing structure is shown below. The project cost includes additional financing costs which arise from the use of debt in the project financing. 4.2.1 Project cost Figure 7: Cost Budget Kshs Land and buildings(existing) 850,000,000 Construction Cost Construction Cost incl. Preliminaries and External works 498,059,240 Licenses, Surveys and Approvals Surveys Geotechnical report 450,000 Property Valuation 250,000 Topographical Survey 150,000 Feasibility report 450,000 Approvals & Licenses Extension of User & Property Amalgamation NEMA consultancy fees 500,000 NEMA application fees NC Architectural Submission Fees NC Civil & Structural Submission Fees 1,223,545 NC Occupation, signboard, road access fee NC Infrastructure levy 249,030 NCA compliance certificate 24,902,962 Professional Fees Architects 24,902,962 Quantity Surveyor 9,961,185 Civil & Structural Engineer 8,965,066 Services Engineer 8,467,007 Project Manager 7,470,889 Financing Costs Finance charges fees 11,084,806 Interest Charges 62,903,443 Miscellaneous Costs Legal Charges 500,000 Marketing & Letting 2,500,000 Total Estimated Project Cost 1,512,990,135 7 4.2.2 Financing structure Figure 8: Project Finance Debt Finance Kshs Total Debt Proportion 554,240,322 37% Equity Finance Land and buildings 850,000,000 Cash 108,749,813 Total 1,512,990,135 63% 100% From the above the project cost increases by Kshs 74 Mn owing to the financing costs arising from a debt amount of Kshs 554 Mn. A cash equity injection of Kshs 109 Mn will be required to meet financing cost and other soft costs including approvals and licenses and marketing costs. The loan shall be converted in to a permanent loan to be repaid over a 10 year period. As illustrated below we have deduced an operational cash flow forecast depicting expected profitability of the option. 8 4.3. Operations Figure 9: Statement of Income and Expenditure In assessment of the building performance over a 10 year period, we have provided a preliminary income and expenditure statement illustrating the potential net incomes to be achieved. The table is as shown below. INCOME & EXPENDITURE STATEMENT Q1 2018 Q2 2018 Q3 2018 Q4 2018 FY 2019 FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 FY 2025 FY 2026 FY 2027 Lease Rentals Revenues Occupancy Movement in space(sqft) Lease rental, office space/ Sqft/month Parking revenue Gross Potential Revenue 80% 70,241 80% 70,241 80% 70,241 80% 70,241 90% 79,021 90% 79,021 90% 79,021 90% 79,021 90% 79,021 90% 79,021 90% 79,021 90% 79,021 90% 79,021 48,045,036 48,045,036 48,045,036 48,045,036 216,202,660 216,202,660 227,012,793 227,012,793 238,363,432 238,363,432 250,281,604 250,281,604 262,795,684 1,392,000 1,392,000 1,392,000 1,392,000 6,264,000 6,264,000 7,203,600 7,203,600 7,203,600 8,284,140 8,284,140 8,284,140 9,526,761 49,437,036 49,437,036 49,437,036 49,437,036 222,466,660 222,466,660 234,216,393 234,216,393 245,567,032 246,647,572 258,565,744 258,565,744 272,322,445 988,741 988,741 988,741 988,741 4,449,333 4,449,333 4,684,328 4,684,328 4,911,341 4,932,951 5,171,315 5,171,315 5,446,449 23,421,639 23,421,639 24,556,703 24,664,757 25,856,574 25,856,574 27,232,245 9,368,656 9,822,681 9,865,903 Less: Operating Expenses Bad debt allowance Leasing commission 960,901 - - - 480,450 Operating expense 4,943,704 4,943,704 4,943,704 4,943,704 22,246,666 22,246,666 1,977,481 1,977,481 1,977,481 1,977,481 8,898,666 8,898,666 - Capital expenditures Property Management fees Total Expenses 18,737,311 9,368,656 20,685,260 10,342,630 10,342,630 10,892,898 8,870,826 7,909,926 7,909,926 7,909,926 36,075,116 35,594,666 56,211,934 37,474,623 39,290,725 39,463,612 62,055,779 41,370,519 43,571,591 40,566,209 41,527,110 41,527,110 41,527,110 186,391,544 186,871,994 178,004,459 196,741,770 206,276,307 207,183,961 196,509,966 217,195,225 228,750,854 50,333,751 46,400,920 42,056,270 37,256,679 31,954,507 26,097,129 19,626,407 12,478,115 4,581,305 SCENARIO A LEVERED CASH FLOWS Earnings Before Interest, Depreciation & Tax Interest Depreciation VAT Corporate Tax Principal Repayment Earnings After Tax 13,788,179 13,581,849 13,370,317 13,153,454 719,501 719,501 719,501 719,501 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 6,626,901 6,626,901 6,626,901 6,626,901 29,821,057 29,821,057 31,312,109 31,312,109 32,877,715 32,877,715 34,521,601 34,521,601 36,247,681 - - - - 8,184,801 11,246,827 8,391,131 12,207,727 8,602,663 12,207,727 8,819,526 12,207,727 37,558,169 41,491,000 45,835,650 50,635,242 55,937,413 61,794,791 68,265,514 75,413,805 65,800,563 66,281,014 55,922,425 74,659,737 82,628,668 83,536,322 71,218,441 91,903,700 83,310,616 101,733,249 SCENARIO B UNLEVERED CASH FLOWS Earnings Before Interest, Depreciation & Tax Depreciation VAT Corporate Tax Earnings After Tax 40,566,209 41,527,110 41,527,110 41,527,110 186,391,544 186,871,994 178,004,459 196,741,770 206,276,307 207,183,961 196,509,966 217,195,225 228,750,854 719,501 719,501 719,501 719,501 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 2,878,004 6,626,901 6,626,901 6,626,901 6,626,901 29,821,057 29,821,057 31,312,109 31,312,109 32,877,715 32,877,715 34,521,601 34,521,601 36,247,681 - - - - 33,219,807 34,180,707 34,180,707 34,180,707 153,692,484 154,172,934 143,814,345 162,551,657 170,520,589 171,428,242 159,110,361 179,795,621 189,625,170 The project achieves a positive cash flow stream under both scenarios of financing under this option. 9 4.4 Returns From the above table we can be able to deduce the project returns as shown below; Figure 10: Returns SCENARIO A 4.4.1 Unlevered IRR (10 YR) 13.8% Payback period 10 yrs SCENARIO B Levered IRR (10YR) 15.2% Payback period 11 yrs Interpretation Scenario A Based on a pure equity funding basis by the pension fund, the project provides an internal rate of return of 13.8% on a ten year investment horizon which represents the investment yield to the fund on their investment. The payback period rather lengthy as it stands at 10 years demonstrating the period to be taken by the fund to recover the equity investment in the project representing the ceiling in investment thresholds for project soundness. Scenario B Alternatively, using both a mix of debt and equity, the project generates an IRR of 15.2% as its investment yield. This higher return reflects the impact of financial leverage on the financing mix. The projects payback period increases to 11 years which is quite a lengthy period and outside the scope of the areas industry standards for a feasible project. 10 5. OPTION D This option looks at the feasibility of the project based on extension of the property through the construction of a new wing of 10 levels including basement parking bays and more office and parking space on the upper floors. In total the option shall provide 24,160 sqm of space. The project is estimated to take a period of 18 months for completion. 5.1 Scenario A: 100% Equity Funding (Unlevered) 5.1.1 Project cost Figure 11: Cost budget The total project cost stands at Kshs 2.5 billion and has been shown below. Kshs Land and buildings (existing) 850,000,000 Construction Cost Construction Cost incl. Preliminaries and External works 1,433,261,187 Licenses, Surveys and Approvals Surveys Geotechnical report 450,000 Property Valuation 250,000 Topographical Survey 150,000 Feasibility report 450,000 Approvals & Licenses Extension of User & Property Amalgamation NEMA consultancy fees 500,000 NEMA application fees 14,332,612 NC Architectural Submission Fees NC Civil & Structural Submission Fees 3,624,000 NC Occupation, signboard, road access fee NC Infrastructure levy 716,631 NCA compliance certificate 71,663,059 Professional Fees Architects 71,663,059 Quantity Surveyor 28,665,224 Civil & Structural Engineer 25,798,701 Services Engineer 24,365,440 Project Manager 21,498,918 Miscellaneous Costs Legal Charges 500,000 Marketing & Letting 2,500,000 Total Estimated Project Cost 2,550,388,831 11 5.1.2 Financing structure Based on a pure equity financing model the project requires a cash equity injection of Kshs 1.7 billion funded by the project developer. The amount will be used to fund construction costs, professional fees and other project soft costs. A breakdown of the expected funding structure is as shown below. Figure 12: Financing Structure Equity Finance Kshs Land and buildings 5.2 850,000,000 Cash 1,700,388,831 Total 2,550,388,831 Scenario B (Levered) Alternatively, utilizing a mix of both debt and equity in funding the project, the project cost budget shifts slightly upwards to Kshs 2.8 billion as a result of the financing cost and is as shown below; 5.2.1 Project cost Figure 13: Cost Budget Land and buildings (existing) Construction Cost Construction Cost incl. Preliminaries and External works Licenses, Surveys and Approvals Surveys Geotechnical report Property Valuation Topographical Survey Feasibility report Approvals & Licenses Extension of User & Property Amalgamation NEMA consultancy fees NEMA application fees NC Architectural Submission Fees NC Civil & Structural Submission Fees NC Occupation, signboard, road access fee NC Infrastructure levy NCA compliance certificate Professional Fees Architects Quantity Surveyor Civil & Structural Engineer Services Engineer Project Manager Financing Costs Finance charges fees 2% of loan amount Interest Charges @10% P.A during construction Miscellaneous Costs Legal Charges Marketing & Letting Total Estimated Project Cost 12 Kshs 850,000,000 1,433,261,187 450,000 250,000 150,000 450,000 500,000 14,332,612 3,624,000 716,631 71,663,059 71,663,059 28,665,224 25,798,701 24,365,440 21,498,918 31,898,661 242,338,190 500,000 2,500,000 2,824,625,682 5.2.3 Financing structure The resulting financing structure is shown below; Figure 14: Project Financing Debt Finance Kshs Total Debt Proportion 1,594,933,049 56% Equity Finance Land and buildings 850,000,000 Cash 379,692,634 Total 2,824,625,683 44% 100% The project financing incorporates a mix of 56% and 44% debt to equity ratio respectively. The debt amounts to Kshs 1.59 Bn representing 56% of the project budget. The loan amount upon conversion to a permanent loan on completion of construction will be repaid over a 15 year period at a projected 10% interest cost. Further, an infusion of cash equity shall be required from the project sponsors amounting to Kshs 380 Mn to complement the debt amount. This shall bring the total project cost to Kshs 2.8 Bn. 13 5.3 Performance Assuming the projects rental rates as shown in the earlier section, the projects performance is provided below. 5.3.1 Operations In assessment of the building performance over a 10 year period, we have provided a preliminary income and expenditure statement illustrating the potential net incomes to be achieved from both scenarios (levered and unlevered). The table is as shown below; Figure 15: Income and Expenditure Statement INCOME & EXPENDITURE STATEMENT Q1 2018 Q2 2018 Q3 2018 Q4 2018 FY 2019 FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 FY 2025 FY 2026 FY 2027 80% 80% 80% 80% 90% 90% 90% 90% 90% 90% 90% 90% 90% Lease rental, office space/Sqft /month 77,025,761 77,025,761 77,025,761 77,025,761 346,615,926 346,615,926 346,615,926 363,946,722 363,946,722 382,144,058 382,144,058 401,251,261 401,251,261 Parking revenue 10,022,400 10,022,400 10,022,400 10,022,400 11,275,200 11,275,200 11,275,200 11,275,200 11,275,200 11,275,200 11,275,200 11,275,200 11,275,200 Gross Potential Revenue 87,048,161 87,048,161 87,048,161 87,048,161 357,891,126 357,891,126 357,891,126 375,221,922 375,221,922 393,419,258 393,419,258 412,526,461 412,526,461 Bad debt allowance 1,740,963 1,740,963 1,740,963 1,740,963 7,157,823 7,157,823 7,157,823 7,504,438 7,504,438 7,868,385 7,868,385 8,250,529 8,250,529 Leasing commission 1,540,515 - - - 770,258 - Operating expense 8,704,816 8,704,816 8,704,816 8,704,816 35,789,113 35,789,113 35,789,113 37,522,192 37,522,192 39,341,926 39,341,926 41,252,646 41,252,646 Lease Rentals Revenues Occupancy Less: Operating Expenses Capital expenditures Property Management fees 28,631,290 31,473,541 3,481,926 3,481,926 3,481,926 3,481,926 14,315,645 14,315,645 14,315,645 15,008,877 15,008,877 15,736,770 15,736,770 16,501,058 16,501,058 15,468,221 13,927,706 13,927,706 13,927,706 58,032,838 57,262,580 85,893,870 60,035,508 60,035,508 62,947,081 94,420,622 66,004,234 66,004,234 Earnings Before Interest, Depreciation & Tax 71,579,940 73,120,455 73,120,455 73,120,455 299,858,288 300,628,546 271,997,256 315,186,415 315,186,415 330,472,177 298,998,636 346,522,227 346,522,227 Interest 39,776,856 39,483,403 39,182,552 38,874,118 152,253,648 146,660,176 140,480,994 133,654,771 126,113,753 117,783,092 108,580,102 98,413,439 87,182,193 - - - - - - - - - - - - - 10,624,243 10,624,243 10,624,243 10,624,243 47,809,093 47,809,093 47,809,093 50,199,548 50,199,548 52,709,525 52,709,525 55,345,002 55,345,002 - - - - - - - - - - - - - Principal Repayment 11,640,841 11,934,294 12,235,144 12,543,579 53,417,138 59,010,610 65,189,792 72,016,015 79,557,033 87,887,694 97,090,684 107,257,347 118,488,593 Earnings After Tax 9,538,001 11,078,516 11,078,516 11,078,516 46,378,409 47,148,666 18,517,376 59,316,081 59,316,081 72,091,866 40,618,325 85,506,440 85,506,440 71,579,940 73,120,455 73,120,455 73,120,455 299,858,288 300,628,546 271,997,256 315,186,415 315,186,415 330,472,177 298,998,636 346,522,227 346,522,227 Total Expenses Scenario A LEVERED CASH FLOWS Depreciation VAT Corporate Tax Scenario B UNLEVERED CASH FLOWS Earnings Before Interest, Depreciation & Tax Depreciation VAT Corporate Tax Earnings After Tax - - - - - - - - - - - - - 10,624,243 10,624,243 10,624,243 10,624,243 47,809,093 47,809,093 47,809,093 50,199,548 50,199,548 52,709,525 52,709,525 55,345,002 55,345,002 - - - - - - - - - - - - - 60,955,697 62,496,213 62,496,213 62,496,213 252,049,195 252,819,452 224,188,162 264,986,867 264,986,867 277,762,652 246,289,111 291,177,226 291,177,226 The project illustrates a positive cash flow stream over the analysis period under both scenarios. 14 5.4 Returns From the above table we can be able to deduce the project returns as shown below; Figure 14: Return Summary Scenario A Unlevered IRR (10 YR ) 12.4% Payback period 10 yrs Scenario B 5.5 Levered IRR (10YR) 14.0% Payback period 13 yrs Interpretation Scenario A The project provides an internal rate of return of 12.4% on a ten year investment horizon which represents the investment yield to the fund on their investment. The payback period is at 10 years demonstrating the period to be taken by the fund to recover the equity investment in the project which is at the brink of the feasible period for any project to remain feasible. Scenario B Using financial leverage within the financing mix, the project is able to achieve an internal rate of return of 14% to the pension fund. However, the payback period increases to 13 years as a result of debt service a payment which falls out of the scope for any feasible project. 15 6. OPTION E This option evaluates the project based on an optimal use of the project site. It involves the development of a 24 storey office complex and the refurbishment of the existing facility. The project is expected to take 26 months for completion. 6.1 Scenario A: 100% pure equity funding (Unlevered) Under this scenario the site will be developed and refurbished at a project cost of Kshs 3.8 Bn and provide 34,040 sqm of investment grade real estate under the first scenario shown below. 6.1.1 Project cost Figure 15: Project budget Kshs Land and buildings (existing) 850,000,000 Construction Cost Construction Cost incl. Preliminaries and External works 2,452,428,264 Licenses, Surveys and Approvals Surveys Geotechnical report 450,000 Property Valuation 250,000 Topographical Survey 150,000 Feasibility report 450,000 Approvals & Licenses Extension of User & Property Amalgamation - NEMA consultancy fees 500,000 NEMA application fees 24,524,283 NC Architectural Submission Fees NC Civil & Structural Submission Fees 5,106,000 NC Occupation, signboard, road access fee NC Infrastructure levy 1,226,214 NCA 122,621,413 Professional Fees Architects 122,621,413 Quantity Surveyor 49,048,565 Civil & Structural Engineer 44,143,709 Services Engineer 41,691,280 Project Manager 36,786,424 Miscellaneous Costs Legal Charges 1% of debt amt 27,172,905 Marketing & Letting 2,500,000 3,781,670,471 Total Estimated Project Cost 16 6.1.2 Financing structure The project based on the proposed funding structure will involve the infusion of Kshs 2.9 Bn in cash. The amount shall be used in the funding of the construction cost, professional fees, approvals and licensing as well as other miscellaneous costs. Figure 16: Finance Budget Equity Finance Land and buildings Cash Kshs 850,000,000 2,931,670,471 Total 6.2 3,781,670,471 Scenario B (Levered) Alternatively, the project can be financed through a mix of both equity and debt instruments. A project cost budget is shown below which shows the costs that include the financing costs totaling to Kshs 4.2 Bn under this scenario. 6.2.1 Project cost Figure 17: Project budget Kshs Land and buildings Construction Cost Construction Cost incl. Preliminaries and External works Licenses, Surveys and Approvals Surveys Geotechnical report Property Valuation Topographical Survey Feasibility report Approvals & Licenses Extension of User & Property Amalgamation NEMA consultancy fees NEMA application fees NC Architectural Submission Fees NC Civil & Structural Submission Fees NC Occupation, signboard, road access fee NC Infrastructure levy NCA Professional Fees Architects Quantity Surveyor Civil & Structural Engineer Services Engineer Project Manager Financing Costs Finance charges fees 2% of loan amount Interest Charges @10% P.A during construction Miscellaneous Costs Legal Charges Marketing & Letting Total Estimated Project Cost 17 850,000,000 2,452,428,264 450,000 250,000 150,000 450,000 500,000 24,524,283 5,106,000 1,226,214 122,621,413 122,621,413 49,048,565 44,143,709 41,691,280 36,786,424 54,345,810 384,870,886 27,172,905 2,500,000 4,220,887,168 6.2.2 Project Finance Using a debt to equity mix of 64% and 36% respectively it will see the project being funded by Kshs 2.7 million using debt finance from commercial sources. This amount will be used to finance the project construction cost and professional fees. The amount will be sourced at 10% interest cost during the construction period giving rise to a financing cost of Kshs 439 million. The loan will further be converted to a permanent loan to be repaid over a period of 15 years after construction and lease up. A further infusion of cash equity amounting to Kshs 653 million shall be required. The amount will be used to cater for the financing costs of the project as well as other soft costs arising including approvals and required permits, legal and marketing expenses. A breakdown of the project financing structure is shown below; Figure 18: Finance Structure Kshs Debt finance Proportion 2,717,290,517 64% Equity Finance Land and buildings 850,000,000 Cash 653,596,651 Total 4,220,887,168 18 36% 100% 6.3 Performance Assuming the projects rental rates as shown in the earlier section, the projects performance is provided below. 6.3.1 Operations In assessment of the building performance over a 10 year period, we have provided a preliminary income and expenditure statement illustrating the potential net incomes to be achieved from both scenarios (levered and unlevered). The table is as shown below; Figure 19: Income and Expenditure Statement INCOME & EXPENDITURE STATEMENT Q1 2018 Q2 2018 Q3 2018 Q4 2018 FY 2019 FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 FY 2025 FY 2026 FY 2027 80% 80% 80% 80% 90% 90% 90% 90% 90% 90% 90% 90% 90% Lease Rentals Revenues Occupancy Lease rental, office space /Sqft /month 127,337,524 127,337,524 127,337,524 127,337,524 573,018,859 573,018,859 581,614,142 610,694,849 610,694,849 641,229,591 641,229,591 673,291,071 673,291,071 Parking revenue 10,022,400 10,022,400 10,022,400 10,022,400 45,100,800 45,100,800 45,100,800 45,100,800 45,100,800 45,100,800 45,100,800 45,100,800 45,100,800 137,359,924 137,359,924 137,359,924 137,359,924 618,119,659 618,119,659 626,714,942 655,795,649 655,795,649 686,330,391 686,330,391 718,391,871 718,391,871 Bad debt allowance 2,747,198 2,747,198 2,747,198 2,747,198 12,362,393 12,362,393 12,534,299 13,115,913 13,115,913 13,726,608 13,726,608 14,367,837 14,367,837 Leasing commission 2,546,750 - - - 1,273,375 Operating expense 13,735,992 62,671,494 65,579,565 65,579,565 68,633,039 68,633,039 71,839,187 71,839,187 Gross Potential Revenue Less: Operating Expenses 13,735,992 13,735,992 13,735,992 - 61,811,966 61,811,966 Capital expenditures Property Management fees Total Expenses 50,137,195 5,494,397 5,494,397 5,494,397 5,494,397 24,724,786 24,724,786 54,906,431 25,068,598 26,231,826 26,231,826 27,453,216 27,453,216 28,735,675 28,735,675 24,524,338 21,977,588 21,977,588 21,977,588 100,172,521 98,899,145 150,411,586 104,927,304 104,927,304 109,812,863 164,719,294 114,942,699 114,942,699 112,835,586 115,382,336 115,382,336 115,382,336 517,947,138 519,220,514 476,303,356 550,868,345 550,868,345 576,517,529 521,611,097 603,449,172 603,449,172 67,767,906 67,267,950 66,755,390 66,229,910 SCENARIO A LEVERED CASH FLOWS Earnings Before Interest, Depreciation & Tax Interest Depreciation VAT Corporate Tax 17,563,796 - 17,563,796 - 17,563,796 - 17,563,796 - Principal Repayment 19,832,523 Earnings After Tax 7,671,361 10,218,111 10,218,111 10,218,111 112,835,586 115,382,336 115,382,336 115,382,336 20,332,479 20,845,039 21,370,519 259,394,835 249,865,225 - - 79,037,084 79,037,084 - - 91,006,881 239,337,741 80,222,640 - 100,536,490 111,063,974 88,508,339 89,781,714 45,679,000 517,947,138 519,220,514 476,303,356 227,707,892 84,233,772 122,693,824 116,232,857 214,860,245 84,233,772 135,541,471 116,232,857 200,667,282 88,445,461 149,734,434 137,670,352 184,988,130 88,445,461 165,413,586 82,763,921 167,667,166 92,867,734 182,734,550 160,179,722 148,532,471 92,867,734 201,869,245 160,179,722 SCENARIO B UNLEVERED CASH FLOWS Earnings Before Interest, Depreciation & Tax Depreciation VAT Corporate Tax Earnings After Tax 17,563,796 95,271,789 17,563,796 97,818,540 17,563,796 97,818,540 17,563,796 97,818,540 - - 79,037,084 79,037,084 - - 438,910,054 440,183,430 The project has positive cash flows under both financing scenarios as can be shown above. 19 80,222,640 396,080,716 550,868,345 84,233,772 466,634,573 550,868,345 84,233,772 466,634,573 576,517,529 88,445,461 488,072,068 521,611,097 88,445,461 433,165,637 603,449,172 92,867,734 510,581,438 603,449,172 92,867,734 510,581,438 6.4 Returns From the above table we can be able to deduce the project returns as shown below; Figure 14: Return Summary SCENARIO A Unlevered IRR (10 YR ) 14.2% Payback period 9 yrs SCENARIO B 6.5 Levered IRR (10YR) 17.8% Payback period 8 yrs Interpretation Scenario A Under this scenario, the project provides an internal rate of return of 14.2% based on a ten year investment horizon which represents the investment yield to the fund on their investment. The payback period is at 9 years demonstrating the period to be taken by the fund to recover the investment in the project which stands at below the recommended maximum 10 year threshold for commercial real estate. Scenario B Using financial leverage within the financing mix, the project is able to achieve an internal rate of return of 17.8% to the pension fund representing quite a handsome return over the investment holding period. Current market returns in the office market range between 16% and 20%. The payback period reduces to 8 years owing to the larger cash flow stream arising thus providing for a feasible project as per industry norms. 20 6.6 Summary of Returns Option C Option D Option E Scenario A(Levered ) 15.2% 14.0% 17.8% Scenario B (Unlevered) 13.8% 12.4% 14.2% Scenario A (Levered ) 11 yrs 13 yrs 8 yrs Scenario B (Unlevered) 10 yrs 10 yrs 9 yrs Internal Rate of Return Payback period Conclusion The financial viability study has analyzed the three development options to generate the most feasible alternative for the fund. Option C has the lowest investment requirement which stands at Kshs 1.5 billion including land and the existing buildings. Requisite cash investment amounts to kshs 589 million. Based on a pure equity model the project yields a return of 13.8% while using leverage the project returns increase to 15.2%. Comparing this to Option D which yields a return of 14.0% and 12.4% on an levered and unlevered basis respectively, the initial option (Option C) yields a higher return comparatively thus the additional cost of development of the new block with basement and additional upper office and parking floors up to the seventh level yields no benefit and lowers returns to the fund. Option D further provides the longest payback period at 13 years on the levered option without adding significant space to the developer to boost revenues thus can be considered uneconomical. Option E provides the preferred development strategy as it provides the highest return and the shortest payback period. It has a return of 17.8% and 14.2% respectively based on a levered and unlevered basis. The payback period stands at 8 and 9 yrs respectively on the levered and unlevered options. It has a greater revenue stream and takes advantage of the site and degree of leverage fully though requires a higher level of cash investment. We thus recommend the adoption of Option E as the ideal option for the fund’s investment on the subject project site. 21 APPENDICES 22 Appendix 1: Market survey A. Central Business District PROPERTY 1 Contrust House Moi Avenue 2 Corner House Kimathi street 3 Hazina Towers Utalii Lane 4 Vedic Offices Mama Ngina Street 5 View Park Towers Utalii Lane 6 Alibahi Sharif House Kimathi Street 7 Pan African Life House Kenyatta Avenue 8 NSSF Building Milimani 9 Nairobi City County (monthly saloon parking rate) 10 Longonot place DESCRIPTION SPACE RENT/SF        Functional office space Standard office space High speed lifts 24hr security Close proximity with Stanley Hotel Secured metallic doors Common kitchen Office KSHS 65.00 SERVICE CHARGE/SF KSHS 20.00 Office 100.00 25.00 B          Strategically located within the central business district, Hazina towers provides standard office spaces. The building is well secured and has a reliable and safe elevator. Functional office space Standard office space Wide corridor Good light Sun screened windows Great view to Uhuru Park Office 100.00 25.00 B Office 60.00 20.00 C Retail 160.00 25.00 B        Standard office and retail space Recently renovated High speed lifts 24hr security Standard Retail Space High Speed Lifts 24hr Security Retail 110.00 20.00 B Office 80.00 Retail 160.00 30.00 B    Standard office and retail space Institutional Profile Good security Office 120.00 25.00 C LOCATION PARKING CLASS KSHS 7,000.00 C 5,000.00 Kijabe street     Standard office space Good security Adequate parking Well maintained Office 23 100.00 20.00 8,000.00 B B. New construction in Upper hill area COMPARABLE PROJECTS KCB PLAZA LOCATION Kenya Road, Upper Hill. FEATURES PRICE The new headquarters for the Kenya Commercial Bank will house a state of the art banking hall, personal banking facilities, administrative offices and conference facilities for meetings, conventions and workshops. The building will provide 800SQM of office space per level, and about 400 car parking on five parking levels.     PROJECT COST PROPERTY CLASSES Price: per sq ft KES130 – KES180 Type: Office Estimated Service Charge: KES 25 Per sq ft Let able areas from: 171792 sqft / 15960 SQM Kshs. 2.1Billion GRADE B Price: per sq ft KES130 KES180 per month Kshs 3.03 Billion. GRADE A The non frontal triangular shaped plan was intended to give all facades of the building prominence since a triangle has no front or back. This was to pose another great challenge; the building was, to a large extent, exposed to the glaring rays of the sun. The heat gain had to be contained at the minimum while allowing maximum daylight into the building. Use of mechanical ventilation systems was not an option. UAP TOWERS Corporate Business Park; Upper hill along Upper hill Road. Upper hill, Elgon Road The result was a fully sun-shaded office spaces achieved by the solar control envelope, which comprises vertical and horizontal Aluminum fins. An atrium and triple storey landscaped sky courts will allow for natural ventilation. The office complex offers high quality office accommodation, designed to International standards, offering the Tenant a secure, highly efficient and flexible working environment. The attractive amenities like; •Security and safety: Security has been prioritized, systems of international standards have been provided, integrating access control systems, CCTV surveillance, main entrance booms, parking management and 24 hour security services. Safety has been prioritized with provision of defined fire escape routes, modern firefighting equipment, emergency alarm system and sprinkler systems. •Cost efficiency Open plan office spaces that allow for business. Corporate Business Park consists of 5 blocks with over 118,000sqft of Lettable space with flexible internal layouts. Office space available is from 1,625sqft to 2971sqft a floor. Ready for viewing CIC Plaza; Mara Road, upper hill Kenya Mara Road, upper hill Amenities – Flexible floor units – High quality finishes and fittings – Ample parking for tenants and visitors – Standby generator – Borehole and underground water reservoirs – Provision for air conditioning – Fire alarm and detection system – Dedicated WCs provided for each unit – Access control, CCTV surveillance and 24hr security – Fiber optic ICT cable CIC Plaza comprises an office block with 12 levels with 2 basement parking levels totaling approximately 100,000 sqft The building is fitted with three high-speed passenger lifts. Generous floor heights allow for suspended ceilings, facilitating the installation of air conditioning if required.  1 standby generators500 KVA 24                Type A: Office Service charge KES25 Per sq ft Let able areas from: 3,000 309,700 sqft - 278.7 28,772.1 sqm Price: per sq ft KES110 KES200 Kshs 1.3Billion GRADE A Kshs. 600 Million GRADE B Type A: Mixed Use Rent: KES110 - KES200 Per sq ft Estimated Service Charge: KES20 Per sq ft. Let able areas from: 1,625 118,000 sqft - 151 10,962.6 sqm Sales Prices: Kshs. 16,000 17,000 per sqft, Parking Bays: Kshs. 1,000,000 Price: per sq ft KES100 KES150 per month Type A: Mixed Use Rent: KES100 - KES150 Per sq ft Estimated Service Charge: KES20 Per sq ft. Let able areas from: 4,400 44,000 sqft - 408.8 4,087.7 sqm Renaissance Corporate Park; Elgon Road, UPPERHILL, ELGON ROAD VICTORIA TOWERS Kilimanjaro Avenue, Upper Hill BRITAM TOWERS Upper hill, Mara Road, Near Blue shield. 3 high speed passenger lifts. Access control and CCTV surveillance. Ample underground water storage and borehole supply 24 hr security Fire alarm and detection system Generous onsite parking provision Direct link from main fiber optic Provision for installation of air conditioning. Renaissance Corporate Park is a 13 storey building totaling approximately 52,350 square feet with international appeal in design and finish. Renaissance Corporate park capitalizes on the need and caters to those very areas which determines the perfect corporate setting –offices which are space and amenities such as; Standby generators 3 high speed passenger lifts. Access control and CCTV surveillance. Ample underground water storage and borehole water supply 24 hr security Fire alarm and detection system Ample onsite parking provision Direct link from main fiber optic Sound security detail Roof Terrace for business cocktail The building is located on Kilimanjaro Avenue, Upper Hill area. It has standby generators, ample water supply, telephone and computer cabling as well as main fiber optic network. Each floor has lift stop, washrooms, kitchenette area among other amenities. 31-storey office tower and car park facility. The design for the proposed complex provides for a 31 grade A office building with a detached 10 storeyparkade with 970 parking bays. This unique complex will feature a collection of wind turbines hung off a central spire. The turbines will generate power for some parts of the building and will be the symbol of the iconic building, making it a city landmark. CTDLT Office building & Headquarters Vienna Court Valley Rd, Upper hill Located along State House Crescent      Price: per sq ft KES110  Type: Mixed Use  Rent: KES100 - KES150 Per sq ft  Estimated Service Charge: KES20 Per sq ft  Let able areas from: 60,000 sqft / 5574 sqm  Price: per sq ft KES 130 – KES200  Type: Office  Estimated Service Charge: KES25 Per sq ft  Let able areas from: 350,000 sqft / 27870 sqm for both commercial and office for rental. The tower has several green features to comply with international green regulations. The complex will comprise of an atrium with the tower housing office, accommodation on the top levels and retail facilities, including banking halls, restaurants and shops on the ground and mezzanine levels. 13 floors of state of the art office space located 1 KM from the city center. This office building provides exemplary access to the CBD and its environs. Amenities – Flexible floor units – High quality finishes and fittings – Ample parking for tenants and visitors – Standby generator – Borehole and underground water reservoirs – Provision for air conditioning – Fire alarm and detection system – Dedicated WCs provided for each unit – Access control, CCTV surveillance and 24hr security The building’s features include rainwater harvesting, balconies for solar shading, solar control glass, and bicycle storage facilities.          25 Price: per sq ft KES100 - KES150 Type: Mixed Use Rent: KES100 KES150 Per sq ft Estimated Service Charge: KES20 Per sq ft Let able areas from: 3,100 - 52,350 sqft / 288 - 4,863.5 sqm Rent Retail Kshs. 90.00 per sq feet. Rent Office Kshs. 70.00 Per sq feet Service charge. Kshs. 20.00 Per sq feet Parking Fee. Kshs 6,500.00 per bay per month Price: per sq ft KES110 KES200 Type A: Mixed Use Rent: KES110 - KES200 Per sq ft Estimated Service Charge: KES20 Per sq ft. Let able areas 129166 sqft/ Kshs 1.2Billion. GRADE A Ksh.1.2Billion GRADE B Kshs. 7 Billion. GRADE A Kshs 812 Million GRADE B KSh1.6 Billion. Grade B  Tajo Tower-Upper Hill Upper Hill Ideal office spaces on an entire floor of commercial block on Upper Hill in Nairobi. Features include:Modern surveillance systems, lifts,     Furniture and partitioned spaces, including a reception and common terrace   Modern finishes on walls floor ceilings and walls in all rooms 12000sqm Sales Prices: Kshs. 17,000 per sqft, Parking Bays: Kshs. 1,000,000 Price: per sq ft KES120 – KES150 Type A: Mixed Use Rent: KES110 – KES150 Per sq ft Estimated Service Charge: KES25 Per sq ft. Let able areas of 67,000sqft Sales Prices: Kshs. 85M per Floor, 190 Parking Bays: Kshs. 1,200,000 per parking Bay. Kshs. 800M GRADE B Price: per sq ft KES110 KES200 Type A: Mixed Use Rent: KES110 - KES200 Per sq ft Estimated Service Charge: KES25 Per sq ft. Sales Prices: Kshs. 18,000 per sqft, 235 Parking Bays: Kshs. 1,000,000 per Bay. Total build up / let able area 120,942 sqft. Ksh.1.2 Billion. GRADE B Price: per sq ft KES130 KES180 per month Kshs. 1.1B Grade B Office inclusive of 4 parking slots Flamingo Towers – Olympic PlazaUpper Hill Upper Hill, Mara Road in Upper hill next to the British High commission and the Embassy of Japan. Kenya road, opposite crown plaza The development consists of two wings, each with 10 levels of Grade ‘A’ offices for sale/let. Corporates, NGO’s, Professionals and business people now have the opportunity to own prime commercial real estate in Upper hill; an excellent choice for high quality grade ‘A’ offices. Flamingo Towers has been designed to offer the ideal working environment to ensure seamless business operations for the occupants. The key features include elegant design, ample parking space for 235 cars, CCTV surveillance, modern security features, stand-by generators and high speed elevators among others.  This building offers 16 Storey modern Executive office space measuring from- sqft designed under green Architecture principles. Amenities-Rotating floor with Museum & Hall of Fame of Olympic Heroes, Viewing deck &Terrace, Roof garden, Food court & Restaurants,3 speed lifts, backup generator, Borehole, IT ready offices & security enhanced with CCTV.  26         Type A: Office Service charge KES25 Per sq ft Sale able areas from: 1,000 - 10763 sqft – 1700 – 18298sqft. Appendix 2: Property classification 1. Building classification 1.1 Class A These buildings are said to make up 10% of the market. They have the highest quality infrastructure with unique and modern designs that can include glass, steel, and stone. Class A buildings attract the most prestigious tenants, such as financial institutions, law firms and energy firms. These buildings are newly constructed, usually within the last 10 years, or they are older but well renovated with modern finishes. They are commonly located in high demand areas with good accessibility via major freeways and public transportation. Class A buildings offer 24-hour access, state-of-the-art HVAC systems, covered parking with direct access to the building, swift elevators, and modern technology. Common building amenities include: dining facilities, valet parking, concierge services, on-site building administration, and a complete service staff with full-time maintenance, security, health clubs, and child care services. 1.2 Class B This class of buildings makes up the majority of the market. They attract a wide variety of tenants, such as accountants and foundations. Class B buildings are usually located near public transportation but they are located in less exclusive areas. These buildings typically offer 24-hour access, adequate heating/cooling systems, ample covered/uncovered parking, and updated technology, such as video security and adequate elevator service. Building amenities include: dining facilities, conference facilities, on-site building administration, maintenance staff, and customer service centers. 1.3 Class C Class C buildings are typically 20 or more years old and have not undergone recent renovations. They attract tenants who require no more than functional office space, such as staffing agencies, call centers, realtors, or first time office renters. Class C buildings are in less desirable locations that are usually located in transitional areas. They have older but functional heating/cooling systems, less robust technologies, and the aging finishes. Building amenities may or may not include: 24hour access, on-site building administration, maintenance staff and uncovered parking. 27 28