Leveraging REITs for Affordable Housing

Most of India’s housing deficit is in the affordable residential segment. Affordable housing in India ranges from 250-650 square feet (one or two bedroom set) and typically costs between USD 8,000-17,000 per unit. Considering an average housing size of 400 square feet, India requires about 15-18 billion square feet of development in this segment alone. As per the report of the Technical Group on Urban Housing Shortage (2012-17), Urban India is in need of 18.78 million dwelling units out of which nearly 96% belongs to the Economically Weaker Sections (EWS) and Lower Income Group (LIG) Households. These two income groups are expected to account for 85-90 per cent of the total residential development (number of housing units) i.e. about 40-45 million housing units by 2028.

Scarcity of affordable housing in Urban India and the existence of a wide gap between the demand and supply of housing, both in terms of quantity and quality, have created a plethora of problems, including the proliferation of slums. As per the National Sample Survey Organization, one-eighth of India’s urban population currently lives in slums. The deteriorating condition of the urban poor in major Indian cities is a disconcerting theme in the country’s urban revolution. More than 300 million persons are expected to be added to India’s working age population by the year 2050. According to UN estimates, India has the highest rate of change of urban population among the BRIC nations. An estimated 843 million people will live in Indian cities by the year 2050, which is about the same as the combined population of the US, Brazil, Russia, Japan and Germany.

Needless to say, the need for providing housing/accommodation facilities in our cities will become even more acute in the years ahead. It has therefore become a matter of great concern and urgency that our policymaking and government thrust is geared towards solving the country’s housing needs, especially in the affordable segment. Taking cognizance of this grave situation, the draft Model State Affordable Housing Policy for Urban Areas issued by the Ministry of Housing and Urban Poverty Alleviation calls upon state governments to establish linkages and bring convergence with the various fiscal initiatives provided by the Government of India for Affordable Housing projects such as Foreign Direct Investment, External Commercial Borrowings, Urban Housing Fund Refinance Scheme, Real Estate Mutual Funds, Real Estate Investment Trusts, etc.

Over the past few months, the new BJP government at the centre has moved ahead and set the ball rolling on quite a few of the above stated fronts. The government has announced that it is committed to providing “housing for all” by 2022. It has acted swiftly to further liberalize FDI in the construction sector and has granted greater leverage to Indian companies in tapping commercial borrowing from overseas. The recent notification of REITs – a vehicle that has played an important role in financing real estate industry in the US, Australia, Singapore, Hong Kong, and several other countries – by the Securities and Exchange Board of India, is expected to bring the country closer to finding the right solutions in providing affordable housing to large swathes of the Indian population.

However, for the time being, the REIT norms notified by SEBI don’t talk about its possible role in the affordable housing space. The focus of REITs for now would be on commercial and retail property. Leveraging REITs in affordable housing would require the creation of residential or housing REITs, which is not on the horizon currently. But one can expect many changes to the REITs regime going ahead, including those that could help address the issue of affordable housing in the country.

In mature markets such as the US and UK, where REITs have been operating for many years now, governments have shown a keen interest in exploring how this model could be used to attract investment into the residential sector, particularly for social and affordable housing. According to a report by Mazars, an advisory firm in UK, REITs have a vital role in funding the social housing schemes. Policymakers in the UK have been focusing on this model to facilitate an increase in the supply of social and affordable housing across the country.

Typically, housing REITs acquire, renovate, lease and manage residential properties located in markets to generate rental income. As REITs cannot invest in under-construction property but only in those with regular income, they hold properties over the long term and generate virtually all revenue by leasing the properties. This revenue is used to pay for operating costs and distribute dividends among shareholders. For instance, a type of housing REIT known as apartment REITs own a portfolio of rental apartment properties, which may be large residential properties such as mid-rise and high-rise buildings, student housing, senior housing or social housing.

On the other hand, REITs provide the sponsor (usually a developer or a private equity fund) avenues of exit thus providing liquidity and enable them to invest in other projects. The vehicle’s potential for generating liquidity is being harnessed across the world to securitize rental-housing units owned by government bodies and to help finance affordable housing by attracting private sector investment.

The potential of REITs to securitize government-owned rental housing and raise fund to finance new constructions of new affordable rental housing is something that the government in India can well make good use of. Government bodies and agencies in India hold a lot of public housing property worth billions of rupees. But the lack of liquidity has made these agencies stuck with holding properties, and reduced their ability to build more public housing for low and medium income groups employed in the government sector.

In fact, the government can move beyond public housing for its employees to leverage REITs for creating a public-private partnership for the development, funding and management of affordable housing for the public. Countries like the US and Hong Kong have made significant progress in affordable housing by creating appropriate REIT structures. In the US, REITs has had a long history of involvement in affordable housing. As far back as in the 1950s, a REIT called The Mutual Real Estate Investment Trust (M-REIT), started by Morris Milgram, began to build communities, which were both economically and racially integrated. The objective of M-REIT was to invest in income-producing real estate in good neighborhoods and offer housing to all.

Milgram realized in 1946 that there was an unwritten law in the US that all new housing and almost all decent housing was for whites only. He then decided to build integrated housing for all. The first integrated community, Concord Park Homes, was built in 1954 and buildings there were sold to both the white and the black. This project and the followings were successful and able to pay 7% a year to investors. Other than development, M-REIT also managed economically integrated buildings. Its first project had more than 300 apartments, with rents that range from $26 to $41 a room.

Like the countries that have successfully leveraged the REIT model to promote affordable housing, India too can tailor the REIT’s regime to unlock its potential and attract investment in the housing sector. However, due to the lower returns from social and intermediate housing, the country will need to develop a suitable model that is attractive enough to encourage investors. Lessons from other countries suggest that REIT models can be used to develop a strong rental market in affordable housing.

As land cost in India is inordinately high, buying a property becomes an unviable affair for many. Creating a strong rental market in affordable housing is therefore essential for not just making accommodation available to low and mid income groups but also for attracting REITs in this space. Affordable housing that guarantees a stable and steady cash flow to REITs not only makes it a low risk business but would also help to attract the interest of institutional investors in the sector. As demand of affordable housing in the country is huge, the vacancy rate is bound to be very low. That is to say affordable housing has a relatively lower risk than other property types, making it a low risk investment tool for pension funds and insurance companies.

But to attract participation of the private sector in affordable housing REITs, government should subsidize the development and holding of affordable housing. Experience from the US tells us of the key role that the policies of government played in attracting REITs into affordable housing. The active participation of REITs happened during the period when Section 8 Program and LIHTC Program were largely used. While Section 8 Program helps the holding of affordable housing through rent subsidy, LIHTC Program helps the development of affordable housing through subsidy of tax waiving.

It is therefore not too much to ask the government to step in with incentives and appropriate policies that would make affordable housing attractive to REITs. As in the US, India can look at providing rental subsidies by way of tax credits and incentives so that REITs are able to tap into affordable housing for providing stable income with little risk of losing tenants. To help REITs enter and build the market for affordable housing, government should also design long-term policies that encourage building affordable housing by the private sector. This is especially important because REITs are only a way to help liquefy properties, but have limited power in attracting private sector participation without the advantages of policies. Therefore, government should keep in mind that REITs still need policy supports to play a real active role in affordable housing.

About P. Sahel

As Vice Chairman of Lotus Greens, Sahel is responsible for giving directions on overall business strategy and key investments decisions of the firm. Being one of the founding members of Lotus Greens, Sahel has been instrumental in formulating various company policies, setting up systems and processes, and building a strong team of professionals. Prior to Lotus Greens, Sahel worked for more than 16 years in some of India’s largest and most respected real estate companies like Jones Lang LaSalle for 13 years as the Managing Director of the Markets & Solution Development and DLF prior to that. The views expressed are personal

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