Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Economy

Low Cost Housing – Not quite "Altruistic"

Forbes India on Jerry Rao’s New New Thing:

His hypothesis is a simple one. India’s real estate boom was built around its emerging middle class. Nobody gave low income housing too much thought. As Deepak Parekh, executive chairman of Housing Development Finance Corp. explains, “it was way too profitable to be doing something else.” Why sell low-cost houses as long as you get chumps to buy them at several times that price?

But when Ashish Karamchandani, CEO of research firm Monitor India, did the math for a study for public sector National Housing Bank in 2007, he was astounded. He found there are 23 million Indians earning at least Rs. 5,000 a month who do not own a house but aspire to do so. Doubtless, lenders know this potential but have stayed clear of pumping money into low-cost housing because of small ticket sizes of such loans. Also, they weren’t ready to take the credit risk with this segment.

A large addressable, but ignored market with a crying need for a winning business model. Could a fired-up entrepreneur ask for anything more?

I must agree here – lower cost housing is very important and has been ignored. I think there’s money here, tons of it.

To those who want the math: An acre close to a city is available for about Rs. 50 lakh to 5 crores. That’s between 100 and 1000 rupees a square foot. Let’s just say 400 is what a low cost builder will get. Typically you could build a 1:1.5 to 1:2 FSI for lower income housing, so you can build around 80,000 sq. ft. in an acre (which is about 44K sq. ft). This is “built up” area, or what can be sold to a buyer (includes common area, lifts etc.). If you were to construct 700 sq. ft. houses it would be enough for those earning about 5-10K a month (and in Mumbai, even 10 lakhs a month, it seems). That’s about 100 low cost houses per acre. Each house takes about Rs. 800 per sq. ft. to construct, so the construction cost of a house is about 5.6 lakhs. The land cost, at about 2 FSI, is about 1.4 lakhs (700 sq. ft at 2 FSI is 350 real sq. ft. x 400 per sq. foot cost). A total of 7 lakhs.

In an acre, if you can build a 100 flats, it will cost you about 7 crores. You could sell these flats at 10 lakhs each – a cost of 1400 per sq. ft. is cheap, especially where the other options are 300 sq. ft+. Economy of scale will make 1 acre plots difficult but you could do well with 3-5 acres at one spot.

If the demand is here, then getting the cost of the project financed by customers should be very easy – they can pay in 10 installments of 10L each. Assume then, that for construction and paperwork etc. you will need to only spend an upfront amount of Rs. 3 lakh per flat – the rest will come from the buyers’ installments. You get revenue of 10 lakh on a cost of 7 lakh per apt – a profit of 3 lakhs. For an investment of 3 lakhs, that’s a 100% return!

And I’m being conservative: Most builders will own land at substantially lower holding costs than the 2 crore an acre I expect someone to buy it at. Plus, construction costs will go lower as cement, steel, ceramics etc. drop off a cliff in terms of prices.

If it’s so good why don’t builders do this more often? Because the profit margins on premium apartments are substantially higher – 400-500%. It needs the thoughts of someone outside the industry to realise that even 100% is a great margin. Even if you account for the fact that not all flats will be sold early etc. it’s a great deal – and the demand will get addressed where there is literally no large scale supply.

I love this space. With the real estate crunch for the lower middle class, and a glut in the high income space, it is our only real growth opportunity. Many people have realized it – like the article mentions, companies like Godrej, Tata and Sintex are scaling up. But don’t believe for a minute that they are doing it from the goodness of their hearts. Oh no, they’re not. They are just doing what should have been done by everyone far earlier – addressing the lower-middle-class demand, and earning a pretty good margin out of it.

Heck, if I had the money, I’d be doing it too.

Like our content? Join Capitalmind Premium.

  • Equity, fixed income, macro and personal finance research
  • Model equity and fixed-income portfolios
  • Exclusive apps, tutorials, and member community
Subscribe Now Or start with a free-trial