Low-income housing: Creating social impact through a $240 billion business opportunity

Alexandria Wise, Guest Contributor
Senior Consultant, Monitor Inclusive Markets

The housing market in urban India has traditionally focused on the top end, with the lower-income segment virtually unserved. Urban households with monthly earnings of INR7,500-25,000 (US ~$135-455) aspire to live in, and can afford to buy, houses between 250-600 square feet in the suburbs at current market prices. However, supply is very limited. Families struggle, living in rented rooms in slums or low-income neighborhoods that are characterized by poor construction, cramped spaces, deplorable sanitary conditions, and a lack of basic neighborhood amenities. In Mumbai, the problem is particularly severe, as approximately 60 percent of the population lives in slums, according to initial estimates from the 2011 Census.

Using the accepted rule that a family can afford a house costing 40 times its monthly income, a house costing INR10 lakh (US~$18,200) implies a monthly household earning of at least INR25,000 (US~$455). According to research conducted by Monitor Inclusive Markets (MIM) [1], only 13 percent of India's urban population earns more than INR25,000 per month. The next 35 percent of the urban population — those earning INR 7,500-25,000 — can afford housing in the INR3-10 lakh segment and represent an estimated 21 million-household market size. Collectively, the market potential is INR1,300,000 crores (USD $235 billion) — as big as middle- and high-income housing combined.

However, despite the buzz around "affordable housing," few established developers have ventured into this space due to various misconceptions — these homes are low-quality, they won't sell, you can't make any money in this segment, etc. Monitor Inclusive Markets (MIM, a division of the Monitor Group) has spent the last six years working with developers, housing finance companies, governments, and other stakeholders to "make the market" in low-income urban housing. In doing so, MIM has found on-the-ground data that demonstrates that there is a profitable, scalable business with internal rates of return (IRRs) comparable to premium housing. Progressive developers and entrepreneurs have built a quality product profitably while creating social impact.

Building a sustainable and scalable low-income housing business requires a fundamentally different business model that entails the following three key elements:

First, land should be viewed as inventory, not as a capital asset. In the traditional housing model, builders acquire land and treat it as a capital asset. The construction is spread out over several years and value to developers accrues not only from the value of the home, but also from appreciated land value. Both of these comprise the bulk of the final price charged to the customer. In contrast, the low-income housing model is characterized by a less pliable market price that is capped by the affordability of the low-income segment. Land prices for low-income housing comprise approximately 15-20 percent of total project costs. While this implies a lower unit margin, the high volume potential of this segment offers an opportunity to build a commercially viable business model.

Second, site selection is critical to customer demand. Site selection needs to achieve a balance between limiting land cost as a percentage of total project costs, and providing access to economic and social infrastructure for low-income customers. Such customers are reliant on public transportation; therefore, ensuring nearby markets, schools, hospitals, and public transportation is essential to the success of the project. The cost of land is vital to the profitability of the project. As such, ideal low-income housing land parcels are generally located in suburbs of the city that have social infrastructure and are directly connected to public transportation (and thus to employment locations).

Third, quick turnover drives higher IRRs. Low-income housing projects are characterized by two elements:

• Most projects manage to sell their units almost as soon as they are launched due to high customer demand. This translates to increased access to construction financing for developers.

• Projects typically require shorter construction timelines (12-18 months), as opposed to three to four years for a traditional project. This allows developers to receive their return more quickly and thus increases IRRs.

Customers' down payments are typically 20 percent of the house price, and this covers developers' land acquisition costs. The money required to fund construction is supplied through banks and housing finance companies (that provide loans to low-income customers). Since developers recover their entire upfront investment in land early in the construction process, subsequent working capital needs are marginal and project IRRs become very attractive.

Together, these three elements provide a foundation for the feasibility of low-income housing. The successful development of this market has the potential to transform millions of lives — providing a better quality of life and greater financial security to those who greatly need it.

1.  Of approximately 28 million addressable households in the target segment, it is assumed that 75 percent live in rented housing or in multi-family units and would be interested in buying their own homes.
Source: NHB Trends in Housing; Monitor Research.

Alexandria Wise is a senior consultant at Monitor Inclusive Markets (MIM), where she supports initiatives that encourage the development of the low-income housing market in urban India.