India’s Housing Developers Need to Focus on the Consumer

Published: Saturday, January 14th, 2017 by Lenora

Hiranandani Thane in Mumbai, India

Hiranandani Thane. Credit: Premshree Pillai

Recent years were tough on India’s residential real estate industry – slow growth, stalled demand and a mismatch between the pricing of inventory and the price point that Indian households find affordable. Thousands of vacant units of inventory remain unsold. While the slump was lifting last year, demonetization has again presented a challenge for the real estate industry. The advice of Bain & Company, the premier consulting firm, is even more relevant that next wave of successful housing developers in India will be more focused on the customer, quality, transparency and service. Their report “Residential Real Estate in India: A New Paradigm for Success” points to a new day for residential real estate development in India for those who can adapt to a new regulatory framework, an era of tighter margins and cash management and a more activist homebuyer.

Given that low and moderate income buyers represent most of India’s housing deficit, I was interested to know how the report specifically relates to doing business in the affordable housing market. Parijat Jain, one of Bain India’s principals, spoke with about how these new rules apply to housing the majority in India.

DSC: The report refers to a range of forces acting on the residential real estate market, but it doesn’t dissect India’s housing markets by socioeconomic segment. Do your recommendations apply to affordable housing for lower and moderate income segments as well?

Parijat Jain, Bain & Company: True, the report doesn’t focus specifically on affordable, which can mean a lot of different things now. We didn’t collect data by segment. Still, a lot of the housing we considered in this report sells in the range of less than $100/sq ft. With the slowdown in India’s residential real estate markets, the hangover in luxury segments has been much higher. In the major Tier 1 metros, the average development is in the middle to luxury segment. In Tier 2 cities and the neighboring areas, there tends to be more affordable housing development.

DSC: I keep hearing anecdotally that affordable segments have been more resilient, a good way for developers to cushion against the slowdown. Did the homebuilding slowdown affect affordable segments the same as others?

PJ: In fact, I would say demand in affordable segments is more robust because the buyers are the end users, and there are fewer investors. In India, people invest in a house or an apartment before it’s built and continue to pay during construction. With delayed handovers by developers and a price drop across most segments, investors have generally disappeared because the cost of financing is high for investors. It’s the lower churn and lack of liquidity that’s causing the supply glut now.

DSC: In the report, you refer to developers being forced to put forward new paradigms for financing and new payment schemes?

PJ: You have to recall that the emergence of multifamily housing is relatively new. Traditionally, it was only Mumbai that had more dense multifamily housing. Everyone used to buy land and build themselves. Small construction companies grew from late 90s to early 2000s. Big developers with large land banks benefited from the growth of cities. Some companies, for instance, has been aggregating land for decades. Whether through luck or genius, they started developing this land so most of the value in the real estate company in that era came from holding land assets not the value created by the product.

Land prices have gone up so much that profits are tighter and cash management has become an important core competency. So now real estate has to run like a business.

In the past, construction-linked payment plans involved buyers paying along with the construction process – often with 70-80% paid in while building may still be a year away from delivery. Markets went up dramatically from 2003 to 2008, so people got used to paying up front.

When developers started losing business, they adapted their pricing to keep buyers engaged. Now, in some situations, new homebuyers are required to only pay 20-25% of the home value upfront, and the remaining on possession.  So this was just a reaction by developers to the drop in sales. This also brought investors back.

But we think new payment schemes are only selectively applied. It depends very much on demand and supply rather than being a broader trend.

DSC: What about your mention of developers now having to cater to an increasingly activist consumer?

PJ: Consumer expectations have increased across segments. Developers have to look ahead because it’s 5 years from concept to delivery. Most houses in the affordable segment are not big tickets, so you might expect a very basic unit. But things are now changing very quickly. Access to information has reduced the asymmetry of information. Buyers now have smart phones and at least access to computers. What was big in 2010 is the baseline for 2016. Four years ago in Gurgaon, a smart house with high speed internet and automation was high end. Now, it’s baseline.

DSC: Are your conclusions about new regulatory hoops, tighter profits because of land costs and the need for disciplined cash management even harder for developers in the affordable segment? How about the effect of the Real Estate (Regulation and Development) Law.

PJ: There’s no question that the list of approvals from government agencies is the hardest part of developing housing in India. A residential project in Mumbai requires 100-200 approvals before you can build. Managing the regulatory hurdles creates ambiguity. They can be detrimental to any developer. Developers need to manage and they are, but it’s the consumer who pays for everything in the end.

Because of the high costs of development and financing, it’s much more difficult to own a house in India. That’s the main reason why the affordable segment hasn’t taken off in India. From a design and engineering perspective, it’s possible. When you consider overhead and other costs, plus sales, development, etc. plus 15% ROI plus a 10-12% cost of debt for developers, the underlying costs undermine the affordability.

The new Real Estate Law (RERA) will make it more difficult for developers to pull off their current juggling routine where they will get 80% of approvals and then launch the project to be able to bring in some money. Some developers do that now, but to safeguard the consumer, this will stop.

What needs to happen now is that the ease of doing business must be better. The government has to ensure that guidelines can be followed and that approvals are efficient. This is a key issue at all government levels – Central, state and city. At the end of the day, if as a business owner, I have to incur a high cost of production, then I’m not going to invest in that business. The intent of the law is absolutely right. It’s important to make sure the extra cost of approval is minimized to be able to deliver that additional security to consumers.

Finally, there are more stringent rules on when you can collect money. Also, plans for a development cannot change unless you have 70% consensus from buyers. In some ways, it will result in higher cost of business for developers. It needs to be done. We just hope that the government will increase the efficiency of its machinery so that the additional compliance cost will not get passed on to the customer. That would not be the best outcome for any homebuyer, but especially for those of more moderate incomes.