The economics of affordable housing

Affordable Housing is the new buzz in the real estate sector, companies are looking closely at this model to ensure higher margins, given the new emphasis by the Modi government to provide housing to all citizens.

The New Model in Town:

Affordable housing is the new buzz word, especially after the new government in Delhi has spelt out a vision of housing for every citizen. The word 'Affordable Housing' is loosely used by all and no one really understands what actually is affordable housing. It is also most commonly confused with Low Cost Housing. No, one in the industry is talking about low-cost housing, but all are talking of affordable housing. And affordability differs from city to city and town to town. People residing in Metros may find a Rs 50 lakh home affordable, but unfortunately, he may not find one in the Metro. 

HDFC Chairman, Deepak Parekh in his address to the shareholders raised the opportunity affordable housing will provide. He says, "developers must provide more affordable housing in the price range of Rs 15 to 40 lakh. They need to focus not on the high-end luxury segment, but on building more one and two-bedroom apartments, which is where the real need is. Even though margins may be lower, the turnaround time is much faster in the affordable housing segment. Affordable housing is a volume game, which is why the speed of obtaining approvals becomes more compelling."

For affordable housing to be successful, speed is the essence. And Deepak Parekh is right that it is a volumes game, and speed in providing approvals could reduce cost by 20 percent and improve margins – infact, many believe that ROEs could be as high as 25 percent.

And that is evident from the statement of Mahindra Group Chairman, Anand Mahindra who believes, "The fact is that it is a 150 billion dollar opportunity for private enterprise and the only point I want to make today is that what we call shared value projects such as these, which will enable the broad vision of this government to become a new reality. Shared value simply means that you can do well and do good at the same time. SO it's not CSR, this is not being driven only by purpose without profit.'

But even though it may be a shared value, the margins that could be earned will be much higher than traditional real estate activity.

Don't confuse it with Low Income Housing:

Low Income housing is often confused with Affordable housing.  Low Income Housing involves flats with less than 500 sq ft and cost between Rs 5 lakhs to Rs 15 lakhs. There are tier-2 and tier-3 cities where many are making low income housing projects. These projects may not have all the accessories but are bare skeleton flats. The Reserve Bank so far recognises housing loans of up to Rs 25 lakhs in metros and Rs 15 lakhs in other cities.  HFCs and banks hardly find any projects in metros that fit the Rs 25 lakhs bill. And with urbanisation expanding its geography, there is a call to enhance this limit to Rs 40 lakhs.

The Salary Income Maths:

Firstly, anyone earning less than Rs 30,000 per month cannot afford the so called affordable housing. That's because, a 500 sq ft of apartment would be sold for atleast Rs 3000 per square feet, making the cost of the apartment at a minimum of Rs 15 lakhs. For a salaried individual, earning a take home salary of Rs 30,000 - Rs 1 lakh per month. The available income to pay EMI for the home mortgage is between Rs 15000 to Rs 50000 per month. At this EMI the loan available to a person is between Rs 15 to 50 lakhs. It is important to note that the average free cash that one is assuming is 50 percent of the take-home. Which is not always the case? Given Savings rate has fallen in the last 5 years, and inflation has forced individuals to tap into their free-cash and savings to meet the cost of living. So an affordable housing project has to be in the region of Rs 15 lakhs to Rs 40 lakhs and should satisfy the return economics.

The Infrastructure Link:

For the affordable housing model to be successful, it has to have a credible infrastructure linkage. Affordable Housing projects can only be successful if satellite towns are constructed around Metros & tier 1 cities. These cities should have excellent connectivity to these satellite towns, thereby allowing expansion of the city and migration of urbanites from core of the city to suburbs. Infrastructure will also play a important role in ensuring that distance is not a deterrent for affordable housing.

Affordable Economics:

The affordable model is likely to work only if the sales price of the apartment is between Rs 3000 – Rs 7000 per square feet. Now, one might not be able to find any houses in cities like Mumbai, but there is enough potential for this price range across other cities. The land cost for these projects vary from Rs 500 to Rs 2000 per square feet.  The model will work when land cost is financed via equity and development cost is financed using pre-sales and debt. This is another place where a huge opportunity exists for Private Equity to step in, which will finance land cost via equity and development via mezzanine debt. In fact, many PEs are already following this model. HDFC Chairman, Deepak Parekh wants RBI to allow banks and HFCs to fund land transactions. Since the returns expected from these projects are much higher than traditional infrastructure projects and gestation period is at maximum of 3 years. Land cost as percentage of total cost may be between 70-80 percent in metro cities like Mumbai, but in smaller cities & towns in varies between 25-40 percent.

Sales Price/ sq ft	3000	7000
Cost of Land or Equity per sq ft	500	2000
Approval Cost per sq ft	100	200
Cost of Construction per sq ft	1500	2500
Construction Finance per sq ft	750	1250
Interest Cost for 3 yrs per sq ft	550	1450
Total Cost per sq ft	1900	4900
Return per sq ft	1100	2100
* Rough figures

 

These projects currently also face approval cost which ranges from Rs 100 to rs 200 per square feet. These approval cost currently are with respect to municipality or municipal corporation approvals or speed money to expedite the approvals. Construction cost varies from Rs 1500 per square feet for a Ground + 3 storied building to Rs 2500 per square feet for a Ground + 15 storied building.

Typically, developer fund development cost of the project using 50 percent debt and 50 percent pre-sales fund flows.  The volumes and price is factor that will play an important role in how fast the developer is able to sell the project to the investors. The project will require debt in the range of Rs 750 to Rs 1250 per sq ft.

The cost of financing the debt typically ranges between 12-15 percent for real estate developers. And hence the interest cost of Rs 550 to Rs 1450 per square feet over a 3 year period. The total cost of the project so far including the cost of equity and debt comes to Rs 1900 to Rs 4900 per square feet. In the end the developer ends up with a return of Rs 1100 square feet on a sales price of Rs 3000 and Rs 2100 on a sales price of Rs 7000 per square feet.

Obviously, the success of the model depends extensively on cost of land. Developers who get the land at significantly lower rates will be able to make handsome returns in the model. A land cost of Rs 1 crore per acre translates in to Rs 230 per square feet. Thereby, any land cost above 5-8 crores will reduce the return one can make from the affordable housing model. As the cost of land escalates the returns of the affordable model declines and developers will need to migrate to a luxury housing project model to maintain same margins. 

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