Pitfalls in the affordable housing model

Wed, 20 Jul Pre-Open

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The Indian housing market had witnessed unprecedented boom in recent times. Property prices kept on moving higher as demand remained buoyant. Considering the huge demand for housing many builders also launched low cost housing projects in order to cater to less affluent people. Their strategy was straightforward. An increase in disposable income/standard of living of an urban Indian meant that there was larger opportunity at the bottom of the pyramid. The builders were ready to risk their margins (affordable housing has low margins) in anticipation of higher volumes (lower price point meant better volumes). However, it seems that their strategy did not materialize as anticipated.

Majority of the builders have started pulling out of affordable housing. Some of them have even procrastinated their plans. And there are quite a few reasons for it. It may be noted that prices of steel, brick and cement have increased substantially in the recent past. Since the last two years the overall construction costs have gone up by approximately 25%. Now, considering that the increase in raw material prices is difficult to pass on as price elasticity is high in the affordable housing segment builders had to absorb the raw material price inflation. This meant a further squeeze on their margins.

Secondly, as the overall sentiment in the real estate industry was muted buyers started delaying their purchase plans. Hence, even the volume game went for a toss. The low margin-dry volume combination turned out to be a double whammy for the real estate builders. Hence, quite a few of them have re-engineered their plans and have started high end projects which yield better returns.

While the current fiasco is a temporary industry phenomenon, we believe that the success of such projects depends upon the speed of execution and approval process. Land is an important component of the overall construction cost. If awarding land title takes longer than expected (with land prices appreciating in the meanwhile) it can impact the profitability dynamics of the project. It could mean that the project has turned unviable from the developer's perspective.

Secondly, marketing these projects remains a key challenge. Remember, the population being targeted in low cost housing is probably illiterate and perhaps does not even have a bank account. Hence, the advertisement aspect needs to be carefully managed. Having dedicated personnel for this job may help to a certain extent. Arranging for home financing is another issue. Considering the target populace does not have a stable income (daily wage earners) there has to be some form of micro-finance lending facility in place. Bank lending would certainly be difficult here.

We believe that majority of the builders were not able to understand the marketing aspect of the low cost housing model. Neither were they equipped with the requisite execution skill sets which resulted in cost escalation and impacted margins.

As a result affordable housing turned out to be unaffordable for the developers!