Affordable Housing – a win-win opportunity for low-income Indian families

India has been growing at an average of 8% the past decade. Since economic reforms began in 1991, a couple of hundred million people have been lifted out of absolute poverty. However, as prosperity increases, aspirations increase alongside and one of the key aspirations of the working poor[1] is affordable and high quality housing. The economic forces that are rapidly urbanizing the planet (100 million people have moved to cities in India alone in the last 10 years) intensify this demand for affordable housing.

In India, the government estimates the shortfall of housing to be between 25 and 30 million units. About 95 per cent of the shortfall is the sub-$20,000 category. A cursory look however reveals that most of the supply targets high-income segments. We have looked at 40+ housing projects here that use the “affordable housing” tag. Only 3 of them actually target low-income groups, the rest target middle and high-income groups. Little wonder then that 50% of Mumbai lives in slums. Clearly, ‘low-income housing’ is a term that causes less confusion than ‘affordable housing’. Nonetheless, multiple research reports estimate the size of the low-income housing market to be approximately $200-$300 billion.

If the opportunity is large as it is, why hasn’t the market provided the housing? As it turns, it’s a fairly complex problem that took months of research to untangle. Our primary findings were:

1. Most people make a fundamental mistake by segmenting the market by income, when in fact a slum dweller in Mumbai most likely makes more money than a middle class person in a Tier 3 town. We discovered that segmentation is best done geographically, with each geography requiring a different housing solution. What works for slum redevelopment will not work in industrial housing or rural housing.
2. Most Indian cities have large SME clusters on their periphery, which employ large numbers of people. These clusters have a shortfall of over 6 million houses, despite formal sector jobs and the potential for payroll deductions, i.e. low hanging fruit for a developer. The payroll deductions make mortgages easier to administer.
3. Outside of the big cities, low-income homeowners prefer to live in ground-only, brick-and-mortar structures. They have no patience with fancy materials, which are in vogue in the west. They have made the single biggest investment of their lives and they tend to equate quality with what they see their better-off peers living in, namely brick and mortar homes. What’s more, ground only structures enable the possibility of home improvement or building an additional floor, doubling square footage in the process.
4. Moving to a working capital model with quick exits, rather than the traditional real estate model of land banking,^[2] there is a potential for generating significant profits.

Based on these intriguing research findings, our research team raised investment capital and built 220 ground-only homes in an industrial cluster, priced between $6000 and $11,000. 75% of the homes were sold out in 24 hours on pre-sales [indicating huge unmet demand], and the final IRR on the project turned out to be in excess of 100%. Coupled with low construction costs and a 20% down payment, the project was debt-free (no need for project finance) and cash flow positive from day one. Our second phase, funded by private equity, has just gone live in a chemicals cluster, with 100% of the houses selling out in 36 hours on pre sales. Clearly, the demand is for real, and execution and ability to hand over houses in time is really the key.

All of that said, these are still small projects, and there is no way to predict what the returns on investment will look like at genuine scale. Nonetheless, this is yet more proof that base of the pyramid markets, despite their complexity, can be profitable for providers of high quality products and services.

-Reuben Abraham is the Executive Director at the Centre for Emerging Markets Solutions, Indian School of Business and a Young Global Leader from the class of 2009.