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STATE OF THE LOW-INCOME HOUSING FINANCE MARKET 2018 Chandrima d as , a shish KaramChandani , Johan Thuard m ay 2018About FSG Mumbai FSG is a mission-driven nonprofit supporting leaders in creating large-scale, lasting social change. Through strategy, evaluation, research, and field work, we help many types of actorsindividually and collectivelymake progress against the worlds toughest problems. As part of our nonprofit mission, FSG directly supports learning communities and initiatives. The Inclusive Markets team based in Mumbai works on market-based solutions that address development challenges central to the lives of low-income families. The team runs programs, provides thought leadership, and supports action across sectors including affordable housing, education, healthcare, energy, and sanitation. To learn more, please visit: fsg. Our Work in Urban Low-Income Housing In 2006, as part of the Monitor Group, Ashish Karamchandani and the Inclusive Markets team began to build a new low-income housing industry that would enable thousands of low-income households to own homes in urban India. They were supported by the National Housing Bank (NHB), the World Bank Group, the Michael & Susan Dell Foundation, the Rockefeller Foundation, and the United Kingdoms Department for International Development (DFID). The genesis of this effort lay in the fact that low-income households, who often lived in rented accommodation, could afford to buy small houses at market prices, but no one was building these houses or financing such customers. The team started with creating supply. Developers intrinsically knew this demand existed, and the inclusive markets team showed them the profitability of serving this market. A few banks and housing finance companies agreed to fund customers in pilot projects, but it was still difficult to convince developers to create supply. After reaching out to more than 600 developers in three cities, the team finally convinced a smaller developer in Ahmedabad. They helped him select a site, refine layouts and pricing, and even sign up customers in local factories. The 450-unit project was sold out on the day of launch, with a waiting list of 9,000 customers! This led to other developers in Ahmedabad starting low-income projects. The Monitor Inclusive Mar- kets (MIM) team leveraged this success to get similar projects started in other markets and to get a broader range of players involved - from new participants like Jerry Rao, who founded VBHC, to established corporations like the Mahindra Group. Many urban low-income customers work in the informal sector and have no docu- mentation of income. Hence banks and traditional housing finance companies, which rely on such documentation to assess creditworthiness, were reluctant to serve them. In 2009, the team began promoting a new housing finance model that assessed applicants creditworthiness through field-based credit assessment. They incubated Micro Housing Finance Company (MHFC), led by former senior banking executives, to pioneer this model. They also helped an established player, the Muthoot Pappachan Group, start a housing finance company using this model. Soon there were a number of new “ Affordable Housing Finance” companies (AHFCs) using this model to serve informal sector low-income customers. The NHB actively supported the model by providing refinancing to these AHFCs and giving licenses to new AHFCs. The government also recognized the value of leveraging the private sector in its goal of providing “housing for all. ” The team worked with the Ministry of Housing and Urban Poverty Alleviation to provide feedback on the recommendations of the “ Affordable Housing Task Force” (much of the feedback was subsequently included in government programs like Pradhan Mantri Awas Y ojana (PMAY) and the Credit Linked Subsidy). Recognizing the key role of the state, the team also worked with the Department of Housing and Urban Development, Odisha, to develop a conducive state affordable housing policy (which could also serve as an example for other states). In 2013, the team carried out a “State of the Low Income Housing Market” study and found that more than 80,000 units had been sold and eight new AHFCs had a loan portfolio of close to 1,000 crores ($200 million). The team also found that in the preceding 19 months, 30,500 homes costing less than 10 lakhs ($20,000) had been launched in 132 projects across 22 cities. In other words, a vibrant market was on its way to scale. The Inclusive Markets team joined FSG in 2015 to set up its Mumbai office, and this study is our endeavor to circle back to the housing finance model we helped create for low-income informal customers. Our objective is to document the opportunities and challenges facing the low-income housing finance market and recommend steps to enable more urban working poor to purchase homes. We would like to acknowledge and thank the following for their leadership in the urban low-income housing program as part of the Inclusive Markets team: Bala Ven- katachalam, Madhavi Soman, Naina Batra, Smarinita Shetty and Vikram Jain. We would like to acknowledge and thank the following team members for their contributions to the urban low-income housing program: Abhishek Agarwal, Aditya Agarwal, Alexandria Wise, Anamitra Deb, Anand Raj, Ashutosh Parande, Darsh Maheshwari, Faheem Bhimani, Girish Karira, Indrani Handa, Kushagra Merchant, Mayank Jain, Nabomita Dutta, Namrata Kapoor, Nidhi Hegde, Nishant Lalwani, Nitin Jain, Parendim Bamji, Pradeep Prabhala, Pranay Mehrotra, Ramesh Krishnamurthy, Raina Singh, Raoul Uberoi, Riti Karnad, Rukesh Reddy, Rohini Ramanathan, S. K. Lakshmisha , Sandeep Nair, Sangeetha Ramachander, Srivatsa Anchan, Subhash Chennuri, Suchitra Shenoy, Swati Chaudhary, Tanushree Kumar, Vivek Hurry, and Zenobia Driver.| FSG d CONTENTS EXECUTIVE SUMMARY 2 THE LOW-INCOME HOUSING CUSTOMER 7 THE NEED FOR AFFORDABLE HOUSING 8 THE GROWTH OF AFFORDABLE HOUSING FINANCE 12 Households are Constructing their Own Homes 14 Developers Supply a Section of the Market 16 Monitoring the Health of Affordable Housing Finance 21 OPPORTUNITIES TO INCREASE AFFORDABILITY AND DEEPEN THE MARKET 23 Credit-Linked Subsidies 23 Home Improvement in Slums 24 Beneficiary-Led Construction by EWS Households 26 Home Extension and Improvement Loans 28 RECOMMENDATIONS FOR SHAPING A MORE INCLUSIVE AND ROBUST MARKET 29 Increasing Affordability for Customers 30 Expanding the Market to Reach New Customer Segments 31 Fostering a Healthy Affordable Housing Finance Market 32 GLOSSARY 34 ACKNOWLEDGEMENTS 35 STATE OF THE LOW-INCOME HOUSING FINANCE MARKET 2018 | 1 The Need for Low-Income Housing and Housing Finance Rapid urbanization and the lack of planned affordable housing in India have led to a shortage of 1012 million urban homes and 2637 million urban households residing in informal hous- ing, often in poor living conditions. The bulk of these households are low-incomeEconomically Weaker Section (EWS) households, with annual incomes below 3 lakhs ($4,600), and Low Income Group (LIG) households with annual incomes of 3 lakhs to 6 lakhs ($4,600$9,200). The government recognizes the need for new low-income housing and has set up the Pradhan Mantri Awas Yojana (PMAY), a scheme that aims to facilitate the provision of 20 million houses in urban India with financial assistance from the central government. 1While a section of low-income households (e.g., the lower end of EWS) cannot afford to buy a privately constructed home or improve their homes without significant help from the government, a large number of the upper end of EWS and LIG households can afford a home/home improve- ment without subsidies or with small subsidies (as provided by PMAY). However, most of these households need a housing loan to do so. The Growth of Affordable Housing Finance The bulk of low-income households work in the informal sector and do not possess reliable documentation of income. These households therefore cannot obtain housing loans from banks and traditional housing finance companies, which focus on middle- and high-income formal sector customers and provide loans on the basis of reliable income documentation. A new group of “Affordable Housing Finance Companies” (AHFCs) is now addressing this gap and serving low-income, urban informal customers using an innovation pioneered in Indiafield-based credit assessment. These companies have grown from a combined loan book of close to 1,000 1 PMAY (Housing for all) Scheme Guidelines, Ministry of Housing & Urban Poverty Alleviation, 2016. EXECUTIVE SUMMARY | FSG 2 crores ($200 million) in March 2013 to over 27,000 crores 2($4.1+ billion) in December 2017, at an average loan ticket size of 9.3 lakhs ($14,350), and have facilitated the ownership of more than 230,000 affordable homes. 3 This rapid growth is likely to continue because there is significant equity and reasonably priced debt available, and AHFCs are moving into new states as well as deepening their coverage in states where they already work by reaching smaller urban locations. Supply of Affordable Housing Sixty-two percent of the new housing being financed is “self-constructed,” standalone houses. Self-constructed homes are typically located on the outskirts of large cities and tier 2 and 3 towns. This type of standalone housing has always been popular in India as customers prefer a house where they have the option of expanding the structure. But instead of saving for years to buy land and then again saving for years to construct the house, households now save to buy the land and then use a loan to construct the house. However, since it requires significant equity to purchase land (which AHFCs typically do not finance) this type of housing is more accessible to the higher end of low-income households. Thirty-eight percent of financing from AHFCs is helping low-income customers purchase apart- ments, often in areas with higher land costs, where self-construction is less affordable. Such apartments are typically supplied by small “informal” developers that construct small projects in localities with high demand, typically in Gram Panchayat areas, just outside cities. They are able to supply this housing at lower prices because they follow Gram Panchayat norms that allow greater use of space. Large and mid-sized formal developers have largely been unsuccessful in supplying affordable housing to low-income customers as they tend to be more expensive and construct large projects that are further away from the city in less desirable locations. These distant locations also may lack infrastructure and require large investments, which further shrink the already low margins of such projects. The uptick in new housing activity is also addressing two key issues in the country: availability of rental housing and employment. Most households buying homes are moving out of rented accommodation and thereby freeing up rental stock. The type of housing being financedself- construction and small apartment buildingsrequires significant unskilled/low-skilled labor, and hence provides much needed employment. 2 Based on data from 26 AHFCs, excluding HFCs that do not fit the AHFC definition in the glossary (REPCO Home Finance, Gruh Finance, DHFL, PNB Housing Finance) and part of loan book acquired through the merger of Vysya into Aadhar Housing Finance in Dec 2017. 3 Estimate based on current portfolio of AHFCs, excluding non-housing loans (e.g., LAP , project finance), home-improvement/extension loans, and loans taken over by banks and other PLIs through balance transfer. STATE OF THE LOW-INCOME HOUSING FINANCE MARKET 2018 | 3 The Health of Affordable Housing Finance Gross Non-Performing Assets (NPAs) are likely to be higher for informal customers (e.g., 2 percent against the Indian norm of 1 percent for the formal sector) due to the higher variability in income. While most AHFCs have relatively low gross NPAs, a couple of players have NPAs of 4 percent and 5 percent. However, actual losses are minor because loan-to-value ratios (LTVs) are low and the AHFCs are able to repossess and sell the houses of chronic defaulters. One of the challenges for AHFCs is the loss of good customers. Once customers have a track record of regular payments, banks and larger HFCs are taking them over by providing loans at bet- ter rates and with “top-ups.” For some AHFCs, the annual outflow of such customers is as much as 1824 percent. Regulations do not allow pre-payment charges in India, so these “balance trans- fers” affect both the profitability of the AHFCs and the quality of the loan books (because they are losing some of their best customers), which in turn hurts their ability to improve their credit ratings and get lower-cost debt. This may lead to some AHFCs deprioritizing smaller customers since the cost of acquiring these customers is the same as the cost of acquiring larger customers, and in a short loan tenure regime, a larger customer is economically much more attractive. Increasing Affordability and Expanding the Market to Unserved and Underserved Households The credit-linked subsidy (CLS) under the PMAY scheme can be very helpful in increasing afford- ability as it provides an upfront reduction of up to 2.67 lakhs for a loan of 6 lakhs. It has reached tens of thousands of borrowers, but it has had little impact on affordability because customers only know whether they are getting the CLS after receiving a loan, and hence cannot factor it into their home purchase decision. Also, the bulk of new housing being financed by AHFCs is constructed on the peripheries of the approximately 4,500 urban areas notified for CLS, and therefore is often not eligible for the subsidy. In addition, there are disincentives for AHFCs to offer CLS, especially for smaller ticket sizes. AHFCs get a flat 3,000 and out-of-pocket expenses instead of their normal processing fees (typically 1.5 percent of the loan amount) for CLS loans less than 6 lakhs. Their outstanding portfolio also gets reduced as the CLS reduces the size of the loan. The Beneficiary Led Construction (BLC) vertical of PMAY provides financial support for families who own land but do not have pucca houses 4or have small houses (below 21 sq. meters). While the subsidy is significant (e.g., in Odisha, 1.5 lakhs from the central government and 0.5 lakh from the state government), most households still require a loan to construct a house. Urban local bodies (ULBs) that manage this scheme look to public sector banks to finance these customers, but 4 Dwellings that are designed to be solid and permanent. | FSG 4 these banks are usually not interested in lending to EWS households for whom they cannot readily assess repayment capacity. Some AHFCs and
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