What's Holding Back Affordable Housing in India?Published: October 18, 2012 in India Knowledge@Wharton
When real estate developer Xrbia recently launched a 170-acre housing project in Hinjwadi, a suburb on the outskirts of Pune in Maharashtra, all the 3,400 apartment units were sold within a week. The biggest unit in this apartment complex was 550 square feet and the smallest was close to 250 square feet. The units were priced at Rs. 22 lakh (around US$40,000) and Rs. 9 lakh (US$ 16,000) respectively.
Pointing to the quick sale of these homes, Rajesh Krishnan, managing director and CEO of Brick Eagle, a Mumbai-based land banking firm that acquires land and promotes affordable housing in partnership with developers, says: "In a way, this shows the demand-supply gap [in the affordable housing segment in India]. People physically queue up under the sun to apply for allotment of these houses." He considers affordable housing in India to be homes that cost less than US$40,000.
There are other definitions, too. The ministry of housing and urban poverty alleviation (MHUPA) defines affordable housing for the middle-income group and below as one where the equated monthly installment (EMI) or rent does not exceed 30%-40% of a resident's gross monthly household income. Government officials have also created guidelines for the minimum size of the units. According to the Bangalore-based Value and Budget Housing Corporation (VBHC), which is headed by ex-Citibank employees Jaithirth (Jerry) Rao and P.S. Jayakumar, affordable housing costs within three-and-a-half times a resident's annual household income. "We do have some homes in the Rs. 20 lakh price point, but by and large, most of our homes are within Rs. 6 lakh and Rs. 15 lakh," says Jayakumar. "But the way it is defined generally, even homes between Rs. 25 lakh to Rs. 40 lakh are termed 'affordable'."
Vikram Jain who heads the low-income housing practice at the Monitor Group, a global management consulting and merchant banking firm, notes that typically, when large builders talk of affordable housing in India, the homes are in the Rs. 10 lakh to Rs. 25 lakh price range. "Our definition of low-income houses is those priced between Rs. 5 lakh and Rs. 10 lakh. We think people with a monthly household income of Rs. 12,500 and Rs. 25,000 can afford homes at this price point," says Jain.
Whatever the definition of affordable housing, no one disputes that there is a huge shortage in this segment. A report by global property management firm Jones Lang LaSalle (JLL) points out that according to MHUPA, the shortage of urban housing in India at the end of the 10th Five-Year Plan [2002-2007] was around 27.1 million dwellings to serve 66.3 million households. Eighty-eight percent of this shortage was estimated to be in the economically weaker section -- households with monthly per capita expenditure of up to Rs. 3,300. The income group with monthly per capita expenditure of Rs. 3,301 to Rs. 7,300 accounted for 11% of the shortage. "During the 11th Five-Year Plan, [MHUPA] estimated that the total housing requirement in Indian cities (including backlog) by end-2012 will be to the tune of 26.53 million dwelling units [to serve] 75.01 million households," the report notes. "If the current increase in backlog of housing is maintained, a minimum of 30 million additional houses will be required by 2020."
However, a recent report by the technical group on urban housing shortage (2012-2017) by MHUPA estimates that the when the 12th Plan (2012-2017) began this year, the housing shortage was down to 18.78 million. Industry analysts find this drop surprising. They point out that as mentioned in the new report, some of the parameters used to measure the housing shortage for 2012-2017 are in fact different from those used for the earlier projections. For instance, more recent census data has been used for the new report.
"While I am glad that [MHUPA] has taken steps to revise the projections based on more recent data, I don't think there is a genuine drop," says Hariharan Ganesan, assistant vice president for research and real estate intelligence service (REIS) at JLL India. "The drop is only because of the methodology they have used. Just because MHUPA's number [with respect to the housing shortage] has fallen, it does not mean that a good amount of supply has come up in affordable housing. We still have a long way to go."
So why is this demand not being met? Amitabh Kundu, professor at the school of social sciences at the Jawaharlal Nehru University in New Delhi, suggests that one reason is that the "concept of affordable housing has become highly politicized." Kundu, who was a member of the High Level Task Force on Affordable Housing for All constituted by MHUPA, points out that, in the name of affordable housing, "everyone is being included, including the middle and the upper class. People are using the vehicle of affordable housing to open the housing market. But just by facilitating the housing market you are not going to help the poor. We need to have strong enabling policies and very clear targeting."
According to Kundu, the public-private partnership is a good model to cater to the housing needs at the bottom of the pyramid but "not the way it is happening at present." He notes that currently, any builder can approach the government for subsidies in the name of constructing homes for the poor, and while there are stipulations, these are only on paper. "The private sector has to be engaged in a manner that results in proper targeting of the housing stock. You can't have subsidies and then sell in a non-transparent manner."
A New Approach
Traditionally, the big developers in India have focused on the high-end and upper-middle segments of the housing market as these fetch high margins. During the slowdown of 2008-2009, the market for high-priced homes contracted, and many companies saw an opportunity in lower-income segments. That's when the interest around mass "affordable housing" started gaining traction. Leading developers like DLF, Unitech, Tata Housing, Purvankara, Omaxe and others announced new projects in the Rs. 20 lakh per unit category. New players like Rao and Jayakumar also entered the fray. A recent entrant is Mahindra Lifespace, the real estate and infrastructure arm of auto-to-IT conglomerate the Mahindra Group. In addition, there are a host of smaller and regional players, including Foliage in Surat, Kanchan Ganga in Nagpur and Janaadhar in Bangalore.
Ashutosh Limaye, head of research and real estate intelligence services at JLL India, says that this segment is too fragmented to arrive at a reasonable estimate of the total number of players. But he expects it to only grow. "There is huge unmet demand and I don't see that contracting for the next 20 years. This is a sunrise sector and I expect it to increase multiple times."
But is some of the sheen wearing off? Take DLF, the country's largest developer. In 2009, DLF announced that it would build 100,000 flats in the under Rs. 20 lakh per unit category across the major cities. However, in a recent interview with the business daily Economic Times, Rajeev Talwar, executive director at DLF, notes that "such projects are not viable anymore. In 2009 there was a downturn in the global economy ... but now prices have gone up and it does not make much business sense to launch such projects."
Monitor group's Jain does not agree. He feels that it is a mind-set issue, pointing out that under the traditional model, developers buy a huge piece of land in the city and begin constructing at the periphery of this property. They then wait for the price of rest of the land to appreciate before constructing further. "They treat land as an asset; construction is incidental. A developer buys land for say Rs. 100 a square foot, holds on to it for a few years and then sells it for as high as Rs, 10,000 a square foot. That's the kinds of margins possible in this game."
The business model for affordable homes needs to be very different, some experts suggest. Developers need to buy land on the outskirts of the cities because it is cheaper there. More importantly, they need to treat this land as inventory. Cycle times must be short and all the units must be sold and constructed at one go. Further, the units need to be small in size and well designed for efficient use of space.
In this model, the land cost is recovered through down payments and construction is financed by the construction-linked payments made by the customers. Jain says that this is a "risk-free" model. "One can get decent margins of around 20% while the IRR [internal rate of return] can be as high as 40%," he notes. Pointing out that a car company does not wait for the cost of steel to increase so that it can inflate the price of automobiles, Jain suggests that developers need to bring in a manufacturing mindset if they want to be successful in the affordable and low-income housing segment. "Essentially it's a volume game and not a margin game," adds JLL's Limaye. "Developers who don't understand the nuances of this market find the going tough."
But there are other issues, too. Take land itself, for instance. It is not easily available and the records are not properly maintained. This makes acquiring land a time consuming, cumbersome and expensive process. The JLL report points out that "With high population density, which is growing due to rapid urbanization, there is a huge demand for land in urban India. The real shortage has been further exacerbated artificially by poorly conceived central, state and municipal regulations. As a result, land prices in India are much higher than intrinsic levels that can support mass real estate developments."
Then there is the protracted process of obtaining a host of government approvals from multiple agencies before construction can begin. Sometimes this can take as long as 18 to 24 months. "This inordinate delay adds to the cost and can make the project unviable," says Jayakumar, VBHC's managing director. Speaking to the Times of India recently, VBHC chairman Rao pushed for a single-window clearance for the affordable housing segment. "The laws of the land are really drafted to encourage the construction of Rs. 1 crore villas or Rs. 80 lakh apartments," Rao said. "They positively discourage homes that cost Rs. 10 lakh to Rs. 15 lakh." Noting that the government already has a single window clearance process for township projects that are spread over 100-plus acres, Limaye adds: "They need to do it for smaller projects, too."
Inadequate infrastructure is another challenge. As mentioned earlier, to keep costs down, developers typically must buy land in peri-urban locations. But roads and the public transportation system in these areas are often not adequately developed, which make the developments unattractive to lower-income citizens who depend largely on public transportation to get around. In some cases, the developer also needs to provide the last mile connectivity for basic amenities like power and water, adding additional costs.
"Land should also come with physical infrastructure, such as access to public transport, sewage treatment lines, and water and power supplies. Without these, no project would be saleable," says Brotin Banerjee, managing director and CEO of Tata Housing. "Right now, we don't have enough serviced land around our cities for affordable housing to pick up," notes Limaye. The increase in cost of construction also impacts this segment the most. According to industry estimates, construction costs account for more than 50% of the total price of affordable units, while in the case of luxury projects it is only around 20%.
At the customer end, obtaining financing is a key constraint. One main reason for this is that this customer segment is employed largely in the unorganized sector and typically lacks documents that show proof of address, salary and other information that is mandatory to avail of loans from the frontline banks. "We find that 75% of our target consumers have regular income but don't have the required documents," notes Monitor's Jain. "Housing finance organizations need to take a fundamentally different approach. They need to assess the customers through field verifications ... and not the documents."
The Way Ahead
Industry analysts and developers believe that if the government takes the initiative to remove the roadblocks, the segment could move to the fast track. They say that if infrastructure is developed outside the city limits, then the market forces will ensure steady supply. And within the city limits, granting of additional floor space index (FSI – the ratio between the built-up area and the plot area) can spur the sector. "The principal issue is that government polices come in the way of affordable housing. If land is available easily and the approvals process is speeded up, the rest of the issues can be managed," says Jayakumar of VBHC.
VBHC currently has two ongoing projects, one each in Bangalore and Chennai. Between the two, it has sold 1,400 units that are 350 square feet to 720 square feet in size at the average price of Rs. 2,200 per square foot. Of these, 400 have been handed over to the buyers. Going forward, the vision is to create a million homes across the country in 10 years. "We believe that it is possible to have a profitable proposition in affordable housing," Jayakumar notes. "But the project and cost management needs to be very strong." He adds that VHBC has invested substantially in technology that helps speed up construction. The company's investors include housing finance company HDFC, Monitor Group and private equity firm Carlyle.
Tata Housing, which earlier focused only on premium homes, launched a subsidiary called Smart Value Homes (SVH) in 2009 to address the middle and low-income segments. SVH has two brands -- Shubh Griha, comprising apartments priced between Rs. 4 lakh and Rs. 10 lakh, and New Haven in the Rs. 12 lakh to Rs. 35 lakh price range. Currently, SVH is developing three townships in Gujarat. "We plan to take both the brands pan-India in the next two to three years," says Brotin.
According to Brotin, economies of scale and developing a standard product have helped his team to keep the costs low. "[We use] a lot of construction [related] technological innovations and specific design strategies, including adequate lighting and ventilation and optimal use of materials. [This has] helped us attain economies of scale [and] keep costs under control. We have also tied up with long-term supply contractors for steel, cement, tiles and other materials used in the business."
Affordable housing projects provide for low-risk, reasonable-return opportunities, notes Shailesh Ghorpade, CEO of Azure Capital Advisors. "Due to huge latent demand, saleability is not an issue for such projects. While margins are lower in affordable housing than in luxury projects, investment returns in terms of IRR are attractive due to faster sales velocity. This is a segment which balances the risk-return profile of any fund's portfolio." For Azure, affordability is based on income levels of the residents in the catchment area. The firm has invested in a residential development project in Dahej in Gujarat. The units in the project are priced at around Rs. 8 lakh.
But Ghorpade does not expect a rush of private equity players to enter this space in the near future. "Structurally speaking, there are normally three entities in any development -- the land owner, the developer and the PE fund. The project should be able to create value for all three players. With the present land costs, lack of government support and a limit on sales realization, there is not enough value created for the PE fund. The second issue is scale. Affordable projects are viable if the scale is large. For example, 800 to 1,000 units make a critical mass. However, scale also means increased complexity in execution, which can erode the already thin margins." Pointing out that affordable housing is more susceptible to cost overruns, which in turn can make the projects unviable, Ghorpade adds: "PE players need to proactively participate in monitoring the development of such projects ensuring cost control and project timelines. If done so, this segment provides attractive investment opportunities especially considering the risk return spectrum."
So what is the way ahead for affordable housing in India? "Affordable housing is a financially viable proposition," says Limaye of JLL. "There is so much demand that as long as the pricing is good, you are bound to sell at a healthy absorption rate. But for this to happen, all stakeholders need to have a common vision and work toward it."