Addressing India's Affordable Housing Challenge

The Ministry of Housing and Poverty Alleviation have estimated a deficit of 18.78 million housing units in 2011, with 95% among the lower income group (LIG) and below. To put this in perspective, the total number of housing units sanctioned in seven years under the flagship JNNURM is 1.44 million, of which less than 0.6 million have been completed and occupied. It is now proposed to bridge this deficit by 2022.

Public housing projects cannot make a dent on such a huge demand. Demand on such scale can be met only through the private markets. Unfortunately, the private market for affordable housing, especially for those at the lower part of the income ladder, is still-born. One of the perverse features of India’s urban housing market is that while 90% of the demand comes from those with annual incomes below Rs 500,000, whereas units for them make up just 10% of the supply.

Two factors contribute to this market failure. One, at prevailing costs, housing is simply unaffordable for the overwhelming majority of people, especially in the Tier I and Tier II cities, leave aside the metropolises. Two, the high costs of doing business in the LIG/EWS segment of the market exacerbate the problems, leaving this market commercially unviable for developers.

Alleviating this market failure requires public policy actions. The first step in bridging the affordability gap and catalyzing a vibrant private market in affordable housing is to enable access to housing mortgages. Public financing of housing in such large scale is simply impossible, leaving house-owner financing as the only alternative. Public support should come in the form of making ownership affordable.

Currently, lower income groups contribute a meagre share of mortgage origination. It is fairly reasonable to argue that this is not going to happen through market forces. Across the world, from Singapore to Mexico’s Infonavit, public policy has had a critical, often direct, role in enabling this access. The design of this arrangement has to be carefully structured as to maintain its credibility. It is fair to argue that access to mortgage market is a sine-qua-non for the achievement of the “housing for all” objective.

Once this access is enabled, the affordability gap can be bridged through a mix of subsidies and lower construction costs. Global experience shows that public subsidy in affordable housing has to come mainly in the form of interest subvention. The design of such interventions have to be carefully structured, so as to not create moral hazard and run the risk of such loans becoming non-performing assets, a reality across the country now, one which is an important factor in banks staying away from such borrowers.

A recent report on affordable housing by the McKinsey Global Institute estimated that construction costs will have to fall by 51% to support such housing demand. It advocates the lowering of construction costs through pre-cast materials, which does so both by directly reducing costs as well as lowering construction times (it is estimated that they reduce construction time by nearly a third, with resultant effects on cost of capital), use of modular construction technologies, and smart procurement approaches. But developers can leverage these benefits optimally if they are large enough.  

Another important contributor to construction costs are the transaction costs associated with dealing with public agencies and the uncertainties arising from time over-runs. It is estimated that developers require 60-100 permits of varying kinds, of which the problems faced in registration of land, its conversion, obtaining building approvals, utility connections, and occupation permits are debilitating. Taxation costs are prohibitive, as state governments have come to see the property market as primarily a revenue generation source. A 2010 McKinsey report estimated that 27% of the end-user cost of housing in Maharashtra came from taxes and levies.  

Finally, all these transactions introduce considerable uncertainty into the process, most often resulting in inordinate time delays in completing the project. It is commonplace for developers to have projects delayed by 24-36 months. The cost of capital almost doubles if a project with a two year construction timeline gets delayed by two years. While some share of the delays are also due to the vagaries of the market, delays in clearances and permits are arguably the dominant causes.

In a business where the developers leverage up heavily, cost of capital is the primary driver of profitability. Since the margins are very narrow in affordable housing, developers have limited cushion for uncertainties. The risks associated with time over-runs, with its cascading effect on cost of capital, are simply too large for developers to bear. 

The combined effect of limited reach of the mortgage market, large affordability gap, and commercially unviable construction costs has left the EWS/LIG housing market still-born. Since these constraints bind together, piecemeal approaches to addressing the problem are unlikely to be effective.

It is therefore no surprise that the current interventions that provide subsidies to developers and purchasers have had minimal impact. The Rajiv Awas Yojana (RAY) and the Affordable Housing Partnership (AHP) provide infrastructure capital grants to developers while the Rajiv Rin Yojana (RRY) and the Credit Risk Guarantee Fund Scheme (CRGFS) provide interest subvention subsidy to EWS/LIG house purchasers and credit guarantee to financiers of such units respectively. The limited uptake of these programs shows that response has not been encouraging.

Mortgage interest subsidy ought to take the largest share of public spending on affordable housing. But this requires the enablement of a mortgage market. Even with generous subsidies, catalyzing the mortgage market will require a host of enabling policies that mitigate the risk for lenders – a national credit registry (aadhaar-enabled) and/or psychometric tests to assess credit history, simplified mortgage foreclosure regulations, credit guarantees to banks on EWS/LIG mortgages etc. There may even be the need for a dedicated platform for channeling mortgage credit or an institution for mortgage re-finance.

Needless to say, any meaningful effort to create a vibrant mortgage market has to address the fundamental issue of lack of transparent market valuation of properties, distorted by the differential between the notified registration value and the actual market price. A bouquet of policies to lower stamp and registration duties, dispense with formal notification of registration values, limit circulation of black money in real estate transactions, create a database of property transactions and prices, stricter monitoring of housing finance transactions, and so on, would be necessary to address this problem.

All this has to be complemented with policies to lower construction costs through newer building technologies and processes, lower taxes, and considerably simplified approvals process. The entire process from land procurement to construction and occupation, for all housing projects, can be work-flow automated and its progress monitored on-line so as to minimize the harassment and delays in obtaining these permits. Since the vast majority of these projects are in municipal or urban development authority areas, the Urban Development Ministry in each state can be the nodal agency entrusted with the responsibility of monitoring and ensuring timely clearances. Developers can be encouraged to register into this by making such registration mandatory for loans, availing various benefits under government housing programs and so on. 

Policies like higher FSI for affordable housing schemes, transit-oriented development, and inclusive zoning, by increasing the depth and breadth of supply, too would contribute towards lowering housing costs.  Calibrated releases of the large hoardings of vacant lands in city centers with various public agencies and their densified development too can help put a downward pressure on property prices.

A mix of all of these coupled with the standard recipes - public housing projects, slum re-development, affordable housing mandates – may be necessary to make a significant dent on arguably our biggest urban development challenge.