India: Affordable housing finance: India’s next big opportunity

Everyone agrees that housing is a key multiplier to a nation’s economic growth agenda, given its linkages with numerous ancillary industries. Affordable housing is crucial for a robust property market.

But the experience of countries, especially developing ones like India, shows housing development so far has largely targeted high/mid-income population.

A glaring gap remains in housing for the mid/low-income population – the affordable housing segment. This is the bracket in which most of the population resides.

Home finance disbursements have also largely been targeted to the high/mid-income groups due to easier availability of credit assessment proofs. Ability to raise finance has been tough for the mid/low-income segment and population employed in informal sectors.

However, affordable housing finance is fast becoming a focus area for the governments now, given the objective of financial inclusion.

Taking India’s example, initiatives in recent Budgets include External Commercial Borrowings for affordable housing projects, special refinancing schemes of the National Housing Bank, interest deduction of Rs 0.1mn on loans up to Rs 2.5mn, credit risk guarantee fund scheme and Rajiv Awas Yojna subsidies.

Affordable housing roughly refers to dwellings below a price level of around Rs 2.5mn. This includes the mid/low-income population who are salaried, the self-employed and those employed in the informal sector, whose earnings frequency is uneven. Most are first-time buyers with numerous queries related to the financing process.

There are perceived risks. Nevertheless, most are genuine buyers committed to repaying loans, since they would gladly exit their current housing options – usually consisting of poorly constructed dwellings, with poor sanitation/support-infrastructure and poor social environment for children.

There is already an available buyer base and housing finance companies (HFCs) do not really need to create demand. Characterising the opportunity of affordable housing finance as ‘huge’ would be an understatement. India estimates its national housing shortage at a sheer 19mn.

Monitor Inclusive Markets estimates the shortage for budget homes priced between Rs 0.3-1mn at approximately 22mn and for homes priced between Rs 1-2.5mn at around 5mn. This spells a potential home loan opportunity of between Rs 8tn and 22tn, assuming a lower loan-to-value ratio of 65%-70% since HFCs in this segment might want higher proportional commitment from borrowers given the perceived risks.

While this might be a long term estimate, even if an inventory of 1mn out of this hits the market, it means a potential loan opportunity of between Rs 300bn-800bn. Given that disbursements for smaller ticket sized loans have lagged, the sizable inventory expected to come up indicates potential headroom for growth.

Conditions

While the thrust towards the affordable home/housing finance is picking up, the success of this sector depends on certain critical aspects.

Efficiency of field-based credit assessment is crucial, more than business development. Affordable housing finance is a sector where the market already exists due to large-scale supply shortage. Hence, creating demand is not the first worry.

The bigger worry is building an efficient field-based credit assessment method, since that holds key to repayment, asset quality and long-term sustainability for the HFC’s loan book.

Risk assessment for salaried clients is quite straightforward. However, the process is complicated for self employed and informal categories. Self employed borrowers do not have consistent monthly income as their earnings are prone to business cycles.

Most in the informal sector may not have proper documents for income/taxation. These people work in diverse areas and the income generation capability of each work is different. Hence, credit assessment processes need to be dynamic.

HFCs here use field-based credit assessment by visiting the client’s place personally to understand the nature of his work, income patterns, monthly commitments, savings flows, his attitude/lifestyle/habits, and to understand the loan’s objective in terms of plot/apartment shortlisted.

The credit officer needs to do cross-reference checks by personally meeting that self-employed applicant’s business customers, suppliers and competitors to gauge the reasonable profit generated by his business. This includes meeting the applicant’s existing creditors to estimate his speed in honouring payments due.

It may also involve using more than one credit evaluator, either for second opinion or for faster turnaround. In short, these field officers should be able to gauge the client’s repayment capabilities and his genuine willingness to repay.

Skills

In a business where the field-based credit evaluation holds the key to estimating the viability of lending to low-income/self-employed borrowers, retaining of quality credit appraisal staff and training of fresh recruits is a major operational criticality.

The experienced credit officers with good strike-rates (in terms of bringing in genuine borrowers who repaid in time) might claim a premium for their quality work, hence salary costs as a percentage of topline needs to be monitored closely for HFCs to maintain profitability.

HFCs might need to benchmark/document the best-practices processes of experienced officers, which can help training the newer, fresh recruits who will typically come at a lower price.

But while the quality credit officers might claim a premium, HFCs also need to build accountability from them. During cases of delays or defaults, the credit officer who had checked that client is typically involved in the follow-up process by way of personal visits to that client.

Often, his annual incentives might be linked to this metric in order to ensure the push remains. After credit appraisal, collection and default monitoring is a key area and it is imperative to build early-warning systems.

For borrowers in low-income/informal sector, repayment frequency can be weekly/fortnightly or more than monthly, instead of the standard monthly. HFCs’ MIS systems need to identify cases of slippages and alert the recovery team through early-warning systems. This can ensure better monitoring of the cash flows and faster turnaround for recovery initiation in case of possible default.

Marketing methods need to get closer to the ‘horse’s mouth’. Affordable housing companies base home-loan counselors at the actual project site, so that prospective buyers can enquire about documentation and home loan products at the same time.

Other methods include advertising on radio and in newspapers, as well as banners on buses and autorikshaws. These are the platforms where HFCs can best grab the eyeballs of the target clients in this specific segment. Many HFCs are also tying up with developers directly to get enlisted for a particular project.

The ‘hub-and-spoke’ operating structure might be preferable to ensure a balance between centralized accountability and decentralized fast turnaround.

The corporate office divides its target geography into regional units, and each unit is responsible for certain branches. Regional offices will typically house collection staff, and an operational team to process paperwork from branches. The branches interact with the client and house appraisal and customer service staff. Smaller HFCs operating in a limited area might not need regional unit levels.

Apart from field credit officers, these HFCs also need to house legal/technical officers to do checks on the property to ensure it is free of litigation, encumbrance etc. This help the HFCs to identify clean projects for their own viability, and also helps potential buyers by giving them a comfort factor.

The target clients in this segment may not have easy access to legal resources to undertake these checks themselves, and any legal wrangle can have major implications on client trust and future business flow. Smaller HFCs might outsource this function to specialist providers.

Region

Developing countries are large and the potential might vary from area to area, especially in terms of profitability. Using India’s case, most players are region-focused with operations centered in few states bordering each other.

These are typically states with a large population base to scale up business from fewer outlets, like Tamil Nadu, Gujarat, Maharashtra, Bihar, Rajasthan, Andhra, West Bengal and Uttar Pradesh. Opportunity to scale up exists in large cities like Mumbai, Bangalore, Delhi, Kolkata given their large population.

Next-tier cities like Ahmedabad, Indore, Chennai, Jaipur, Nagpur, Baroda are evincing interest as urban-migration increases. Industrial-corridors like Delhi-Jaipur and Kalyan-Karjat also hold key. Smaller format apartments like 1 RK (one room kitchen flat) are in demand in larger cities like Mumbai and Ahmedabad, while 1/2 BHK (bedroom, hall, kitchen) formats are more popular in towns like Indore, Jaipur.

Developers see opportunity in mixed-income projects with units priced across the spectrum as they get sold faster. Given the space constraints, customers prefer the format of more rooms vs. larger rooms. Initial buyer response to the projects is encouraging. Some developers are now in their second or third round of projects, a positive sign since it means the commercial viability exists.

A ‘game of scale’ – given the involvement required in credit processes in this segment – can lead to higher operational cost as a percent of revenues. Higher operational expenses would impact margins, hence this is largely a business of scale –higher volumes making up for lower margins.

However, the chase for volume cannot be at the cost of asset quality, which is where the credit officers’ skills are crucial. Affordable housing finance is a long-duration relationship, during which it can sell more products to that captive base, provided the client’s experience during the home loan process was positive.

Major challenges include access to low-cost funding to grow the loan book at reasonable spreads, retaining and affording quality credit staff, investing into systems for default warning, building profitable scale in a low margin environment, delays in completion/delivery of projects, lower asset appreciation/liquidity in smaller towns leading to difficulties during sale for recovery, garnering a guarantor for this target group and the ability to build an enabling environment via faster approvals, support-infrastructure, tax incentives etc.

The bulk of the real estate market in most developing countries is the residential segment, and the criticality of affordable homes/housing finance for societal well-being cannot be overemphasized.

While the supply of affordable housing and housing finance has increased, the gap between supply and demand is still huge, spelling a significant opportunity.

The ultimate success of the business for the service providers, however, depends on certain operational particularities specific to this segment.

By Sourajit Aiyer

Image Courtesy: Thinkstock & Financial Express

Originally published here – http://www.marketmoving.info/affordable-housing-finance-indias-next-big-opportunity/

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