Challenges in the successful delivery of affordable housing: An on-ground perspective

Introduction

The real-estate sector is a critical component of the Indian GDP. It is expected to contribute 13% to the GDP by 2025 and reach a total market size of US$1 trillion by 2030. It is also a source of mass employment, directly employing over 60 million people and contributing significantly more indirectly owing to its linkages to various other ancillary industries. Due to its sheer size and importance, it is no surprise that it continues to garner a lot of attention from industry participants.

Affordable Housing

More recently, that attention has shifted towards affordable housing. The concept of affordable housing in itself is not new: there has always been a felt need to provide high-quality, for-sale housing to the underserved. According to a report, urban cities are likely to house 40% of the Indian population by 2030 with an estimated 590 million people living in those cities. For a country of our scale and size, the demand for housing will perpetually sustain. The reason it has only now come into the forefront is two-fold: firstly, the central government has made it lucrative for the private sector to participate through various demand-side interventions and policy support; and secondly, softness in demand in luxury residential real-estate has forced developers to look for newer growth avenues.

Impact

Looking beyond just the commercial lens – providing housing that is safe, affordable, and accessible creates vibrant communities around it and a more secure and just world for all. Studies have shown that providing affordable quality homes boosts school attendance, lowers dropout rates, and provides a safe space for children to grow. It also contributes to building resilient cities strong enough to withstand adverse environmental conditions and disasters. A decent place to live improves the family’s social standing in society and eliminates the various barriers to opportunity that are often associated with homelessness. The COVID-19 induced pandemic, if anything, has only put a premium on the concept of homeownership and the importance of putting a roof above one’s head. People living in informal settlements are the most vulnerable to disease outbreaks, and a pandemic only exacerbates the situation by exploiting the pre-existing inequalities. It is in the best interest of all market participants to find a long-term economically viable solution to alleviate such impacts in the future.

Doing It Right

It is very clear that the opportunity set in front of us is big and has only grown over the past few years. Despite that, we have not seen developers been able to successfully make a sustainable business case out of it. This is not as much about the lack of a market opportunity inasmuch it is about executing it correctly within a certain framework. According to our on-ground research, developments usually go off-track due to the following reasons:

1. Location: As with any other real-estate development, location is the key and the most important starting point. Developers often chose land parcels situated very far away from the city-center without an adequate social and trunk infrastructure in a bid to lower their land acquisition costs. It is critical to place these developments in peri-urban areas with established transportation linkages and built-in infrastructure. Low-income residents invariably provide a higher weightage in their decision-making process to direct commuter access via public transportation to the city and the availability of nearby amenities like schools and hospitals .
2. Land: It is important to pursue a value-accretive land acquisition strategy while ensuring a disciplined capital structure to achieve appropriate risk-adjusted returns. Developers should focus on acquiring land parcels of certain select sizes – between 4-6 acres – which can be completed in 1-2 phases and have a typical completion timeline of 4-5 years. Local developers have often faced challenges in developing township-like projects as it necessitates a build-out of the entire internal/external hard infrastructure like approach roads, electricity lines, drainage, etc. which adds significantly to the project timeline/costs. It also requires a certain level of project management and execution experience to successfully deliver them in a budgeted manner. Further, special emphasis must be made to reduce the lead-time between the acquisition of land parcels and the project launch. This ensures that the developer can focus on its core competency of constructing and delivering the project instead of getting stuck in a smorgasbord of regulatory approvals.
3. Project Inventory: Affordable housing projects are often low-rise G+4/6 structures that are simpler and faster to construct. A developer can extract added value out of the project by having a maniacal focus on running a manufacturing-like operation with standardized structures, units with little/no personalized modifications, and streamlined processes/control functions to accelerate the project timelines.
4. Capital Stack: Residential real estate development has gradually, over time, become much more capital intensive due to an evolving regulatory environment with the launch of the Real Estate (Regulation and Development) Act (RERA) in 2016 and a shift in customer preference towards ready-to-move-in properties. The conflux of these has expedited consolidation in the market, thereby crowding-out weaker developers and ensuring that only those who have the financial wherewithal to support a project through to its completion can survive.

Traditionally, the sector has seen a debt-fueled expansion over the past decade due to the availability of abundant liquidity in the system. However, affordable housing projects typically entail a higher equity requirement due to the unique nature of the target segment i.e. customers having a monthly household income of INR 15,000 – INR 30,000. These customers do not have the bandwidth to service two cashflows of rent and EMI concurrently. Therefore the developer must have the flexibility to part-fund up to a third of the total development expenses to get the project to a steady state before it can achieve financial closure, by way of accumulation of a critical mass of customers from pre-sales and obtaining  construction financing at appropriate pricing.

Knowing Your Customer

Today, much of the conversation around affordable housing revolves around cost control and execution with an understanding that if the developer can keep a lid on its expenses – it can ultimately turn a profit out of the venture. While that may be true, it is not the whole story.

It is equally important, if not more, to understand the unique needs and aspirations of your customer i.e. identifying who your customer is and then subsequently acquiring and servicing them. Traditionally, affordable housing has attracted two categories of customers 1) End-users from the EWS/LIG category themselves and 2) MIG/HIG category who have bought it for investment/speculative purposes. While it is easy to attract and service the latter, it is the former which is the most challenging. The reasons for that are multiple:

1. Mortgage Financing: Lending institutions such as Banks/NBFCs/Housing Finance Companies (HFCs) prefer to lend to customers who are salaried and employed in the formal sector. This is due to the relative easiness in underwriting the credit risk and a better sight of the repayment capability of the borrower. Since much of the EWS/LIG category of customers are either employed in the informal sector or are self-employed with an unpredictable and highly variable income source – financial institutions have largely shied away from lending to them. However, over the past 5-7 years that situation has improved due to the advent of specialized HFCs such as Svatantra MHFC which aims to plug that gap in the market. A second challenge that usually comes up given that the customer can avail of mortgage financing is in its ability to service them continually. EWS/LIG customers need to be made aware of the monthly financial burden that would fall on them for the coming 15-20 years (assuming a standard loan tenure). The rule of thumb in mortgage financing is that about a third of the monthly household income could go towards servicing EMI. However, when on speaking to the customers in this segment we realized that for someone earning INR 15,000 – INR 20,000 a month – they do not have INR 5,000 – 6,000 to spare whilst they are already meeting their monthly rental obligations.
2. Source of livelihood: Affordable housing dwelling units are similar-sized to the existing slums/informal settlements where the EWS/LIG customers currently reside. However, it is a formal property with all the necessary utilities and amenities built to a certain standard of construction and safety. Since most of these customers often either have their workplace attached to their homes or work in nearby urban centers – they find little incentive to move away from the city due to a lack of suitable employment opportunities and necessary infrastructure.
3. On-going recurring costs: EWS/LIG customers also need to take into account the ongoing operational costs i.e. water, power, maintenance, security, etc. that are associated with living in a formal gated community. These are costs that are usually side-stepped and overlooked when residing in an informal house in the city.

Roadblocks

As outlined above, it is now well understood that the core competencies of an affordable housing developer lie not only in land acquisition/aggregation, construction, and project management, but equally in customer acquisition and service delivery as well. In addition to solving these, most developers also face significant headwinds with regards to the following:

1. Access to and sources of financing: In general, real-estate developments are capital guzzlers. They require not only significant up-front deployment but also access to a continual and stable source of funding to support the various stages of the development life-cycle. Traditionally, developers have relied on loans from banks and NBFCs as the primary source of debt capital. Attempts to deepen and broaden the capital markets base have been mixed with access limited to PSUs and corporates with a good credit rating. With banks retreating from lending to the sector due to limited focus and regulatory restrictions – developers have had to rely on NBFCs as the only available source of funding. However, since the onset of liquidity crisis perpetuated by the IL&FS default, that channel has significantly slowed with a general risk-aversion amongst the lenders. Structurally, loans are not a very good fit for project finance due to their characteristics of following a linear and a prescriptive waterfall model. Any project funding requires some sort of flexibility that takes into account the nuances of the real-estate developments around permissions, construction delays, and slow sales off-take. An Alternative Investment Fund structure modeled on the lines of the recently launched INR 25,000 crores Special Window for Completion of Construction of Affordable and Mid-Income Housing Projects (SWAMIH) fund provides a good precedent on how best we could tackle the problems plaguing greenfield developments. For instance, a zero-coupon non-convertible debenture structure with a reimbursement mechanism in-place that prioritizes the cashflows towards construction and operational creditors ensures that the monies are channeled for project completion before financial creditors and developers are paid out.
2. Single-window clearances: Introduction of RERA in 2016 ushered in a new era of transparency in the real-estate sector. Customers are now empowered with the complete set of project information and developers are finally being held accountable for their misdeeds. While progressive regulatory interventions like RERA benefit all stakeholders, that support has unfortunately not been further extended in the form of a single-window clearance. Navigating through the byzantine regulatory process requires significant local know-how, time, and resources which only adds to the project timeline. A streamlined approval process would eliminate the need for cooperation from multiple and silo-ed government departments.

Conclusion

As an industry, real-estate is a heavily localized industry which requires boots-on-the-ground.  Thus, it is no surprise that we have seen the emergence of very few national pan-India real-estate developers in the past decade. Housing demand is often met by local developers who have extensive experience in dealing with (1) landowners by tapping into their relationships; (2) local regulatory body in procuring approvals promptly; (3) labour contractors and procurement vendors/suppliers who are often city-specific; and (4) customer segments in micro-markets that have different specificity and characteristics. This has created a market that is heavily fragmented with a total of 10 developers in India accounting for only 11% of the overall supply.

To remedy the problem, the focus must be on creating a handful of local champions in each of cities. Various stakeholders need to work in tandem to create a conducive ecosystem for the sector to thrive. We need a coordinated policy effort from the central/state government through a more targeted supply-side intervention that will encourage greater private sector participation. The real estate developers need to prove their mettle by demonstrating they can achieve best-in-class corporate governance and built-in controls. Financial intermediaries must channel the flow of institutional capital into the sector at appropriate terms. The confluence of the above is likely to ensure that the sector can achieve its true potential.