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Affordable Housing:The Next Big
Opportunity for Private Equity Firms

February, 2018

CFO Insights on Financial Services

Kalpesh Ojha, Executive Director and CFO at Aspire Home Finance Corporation Limited writes about the rise in demand for affordable housing in India and related investment opportunities for Private Equity Firms.

Affordable housing schemes for the middle and lower income groups are finally on a serious growth curve, thanks to tailwinds like the government’s ‘Housing for All by 2022’ initiative, enhanced tax incentives, lower interest rates and the Real Estate Regulation and Development Act (RERA). This segment, where units are sold in the ticket range of Indian Rupees 15 lakh to 50 lakh, promises humongous growth for all stakeholders.

Consequently, the private equity (PE) investment case in housing finance companies (HFCs) is strong. This over $1-trillion opportunity can be compared to banking in the early 1990s, and telecom in the early 2000s. From a 10-year perspective, PE investments in HFCs can provide superior and unmatched risk-adjusted returns.

Planned-Push

Political will, action plan, and sops have made affordable housing segment a standout, amid an overall sluggish reality space. Ready-to-move projects in cities like Mumbai priced upwards of Indian Rupees 1 crore are struggling to find takers, when affordable housing is going strong as ever.

The Government's determined policy directive to provide ‘Housing for All by 2022’ is now beginning to result in some serious action on the ground. Collaborations with private builders and developers under a public-private partnership model is set to make ‘Housing for All by 2022’ a reality. Many developers have responded positively.

While previously the problem was wafer-size profit margins in this segment and lack of good incentive rationale, today the situation is vastly different. Along with 39% higher allocation for affordable housing development vis-a-vis FY17 under the Pradhan Mantri Awas Yojana (PMAY), a Credit Linked Subsidy scheme to loans of value up to Rs 1.2 million has been given.

Also, affordable housing has now been granted infrastructure status, which translates into easy financial credit for builders and makes it a profitable segment for them to invest in.

Flavour of the Season

A large percentage of the population is migrating to the tier-1 and tier-2 cities, attracted by the new job opportunities. This is boosting demand for affordable housing exponentially. Simultaneously, policy initiatives like RERA have helped buyer confidence, making even fence-sitters interested in pocket-friendly homes.

Indian real estate today is becoming a more credible and logic-driven market. Return-hungry property investors are focusing on affordable housing aimed at middle and lower income groups. This supports the long-term investment proposition of affordable housing.

The rising trend of nuclear families, driven by young professionals, is increasing. This can be felt most in metros where IT and other corporate sectors hold sway, such as Bengaluru, Pune, Hyderabad, Chennai, Thiruvananthapuram, Navi Mumbai, Gurugram, Noida and New Delhi. For the very first time in several decades, the demand-supply gap is narrowing.

Over the next five years, we will see affordable housing action on the ground unfolding at a rapid pace. Premier rating agency ICRA in a recent report said that affordable housing segment in India is set to grow at 30% over the medium term, faster than the rest of the realty industry. This will act as key growth driver for the Indian mortgage finance market.

PE Investment in Housing Finance

The secular growth trend in affordable housing augurs well for the PE funds eyeing housing finance companies. Firstly, at the macro level per capita house ownership in India is still one of the lowest compared to West and South East Asia. The ‘Housing-for-All project by 2022’ is likely to create an explosive demand for housing, which can sustain rich valuations.

Rural and semi-urban housing is a major untapped opportunity, buoyed by rising incomes and government investment augmenting demand. This will consequently widen the appetite of housing finance from current levels.

Over the next few years, there could be proliferation in the number of HFCs in India. Many of these companies may be available at reasonable valuations compared to established peers. For investors, this situation will open up two key opportunities.

First, there will be good-quality new HFCs available at reasonable valuations. Secondly, there will be the established HFCs, which include marquee names available today, which will give intermittent opportunities when they correct during volatile times.

Quality & Quantity

When selecting HFCs as investments, private equity funds will look at key quantitative and qualitative metrics. Assets Under Management (AUM) is the loan portfolio book size, which will give early indications into the size of the market. With retail credit demand growing at 18%, chalking up a growth rate of the HFC AUM in the 15-20% range is not difficult. Geographical diversification of AUM is key.

Non-Performing Assets (NPAs) show the understanding of the company of the target customer segment and the extent of robust risk management capabilities. A lower NPA provides the platform to grow exponentially through slightly riskier bets. The NPA for all HFCs with PE investment across asset classes is less than 1%.

Return on Assets (RoA) and Return on Equity (RoE) show the overall efficiency of the HFC. They can tell the PE fund the ability of the HFC to make profit from current loan portfolio. From past deals, HFCs with consumer and housing loan focus have had 1-2% ROA, whereas HFCs with more SME focus boasted of higher 3-4% RoA. Separately, an RoE of 10% is expected from any HFC to attract a PE investment. Past PE deals have been successfully done in HFCs with RoE as high as 29%.

Good HFCs are expected to have at least 15% capital adequacy across asset classes. Past deals indicate that PE investors look for capital adequacy of around 17-18%.

The Net Interest Margin (NIM) helps in gauging the average interest income generated from the outstanding assets. Historically, HFCs with PE investment had a NIM of 10% across retail and corporate assets.

In terms of qualitative factors, management plays an important role in adapting the HFC to dynamic market environment. Successful execution, irrespective of the situation, is hallmark of a good management.

Next, the HFC’s ownership structure has a bearing on how governance is implemented. Transparent governance with adequate safeguards is essential.

Lastly, an assessment of the future prospects will indicate the growth potential of the operating market for the HFC, since higher growth prospects tend to get higher preference.

Winners’ Trends

HFCs with a differentiated view and a clear value-creation plan are key levers for successful investments.

At the pre-deal stage, both HFCs and PE funds need to take part in rigorous due diligence, and should thrash out structures that protect against dilution of equity value. Also, important is the alignment of incentives of the promoter and management with value creation.

During holding period, PE funds must sweat the network to open new business opportunities for the HFC. Their contribution and participation in injecting talent and helping incorporate boards will be a key assistance. They also must strike a balance in activism to accelerate select decisions.

In the pre-exit stage, PE and HFCs will need to de¿ne the exit strategy early and conduct regular portfolio valuation to identify the right exit points.

That being said, opportunities for value-creation for PE in housing finance companies have historically seen certain stumbling blocks. As HFCs enter a high-growth phase thanks to affordable housing boost, they will have to work with PE investors to avoid dealbreakers like majority ownership, valuation discord, discomfort around accounting standards, disagreement over strategic focus, and evaporation of specific capital requirement.

In conclusion, the next 4-5 years will herald a new growth phase for affordable housing, which is a theme that can be played efficiently through good-quality housing finance companies. As a result, private equity funds will play an active role in determining the trajectory of this new era of value creation anchored to one of the oldest basic needs: a home. 

Opinions expressed in the article are the author’s own.

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