Opinion | Housing finance still remains an attractive business in years to come4 min read . Updated: 17 Feb 2019, 10:48 AM IST
- A housing finance platform will have to identify strategies that help drive robust quality demand
- Aggregating smaller HFC companies into a larger platform will help create better and low-cost funding sources
The recent NBFC (Non-Banking Financial Company) crisis in India has brought to the fore the funding and low equity capitalisation issues, especially of the housing finance company (HFC) sector. The problems are serious, and therefore the regulators and NBFCs have rightly themselves sprung into action to alleviate the situation.
However, even with the pessimistic views regarding the NBFC sector, one must remember that NBFCs and, especially, Housing Finance Companies (HFCs) still remain an attractive business opportunity in the years to come.
The one strategy institutional investors have utilised to participate in the Indian housing finance market is through taking equity stakes in housing finance institutions. The recent buyout of Aadhar Housing by global asset manager Blackstone is an example of this strategy.
Alternatively, institutional investors interested in the Indian housing finance sector can look to aggregate smaller housing finance institutions through a "platform structure" and grow this through bolt-on acquisitions. This strategy would allow for the creation of businesses that stand to benefit significantly from a country with rising income levels, high urbanisation and relatively low per capita home ownership.
The reasons a "platform structure" focused on housing finance holds value in India are twofold. Firstly, due to the fragmented nature of the market, and secondly, due to the sizeable future market size.
As per an ICRA estimate, India's housing finance market has more than 80-odd players, but the top five have 78% of the market share. More importantly, the average loan size for HFCs is at approximately ₹30 lakh ($35,000 as per ICRA at year-end 2018) in India, and coupled with a total housing demand that ranges from 12 to 20 million units give a market size that is comfortably more than ₹28 lakh crore ($400 billion), thereby providing an idea of the tremendous market potential that housing finance holds.
From an operational perspective, a housing finance platform will have to identify strategies that help drive robust quality demand. Aggregation will create scale and processes that help improve systems and utilise technology to increase efficiency.
Operationally, HFC platforms will also have to focus on the selection and financing of land banks.
To elaborate further, we need to understand the concept of "location rent", which helps to delineate the rental value. In common parlance, "location rent theory" tells us that the rent derived from land is the sum of non-urban use opportunity cost, the cost of building housing, and the rent one pays for the "location as a function of its distance from the city centre". Therefore operationally, the HFC platforms can add value by increasingly focusing on the correct "location" choice for the land banks.
It is essential to realise the importance of the HFC platform and its operational involvement with the land banks on the B2B side when working with real estate developers. The poor "location" choice and excessive land bank values paid have significantly contributed to asset quality issues for the real estate industry in general and non-performing assets (NPAs) for the HFCs. In the past, HFCs have had a mixed result working with real estate developers. Going forward more attention to the careful selection of the land banks will be essential for a robust HFC balance sheet, and this is where a significant operator in the HFC platform space can add value.
From a financial perspective, aggregating smaller HFC companies into a larger platform will help create better and low-cost funding sources. Operational scale, capacity to select better land banks for the housing projects and locational diversity through a larger platform will help create a balance sheet that is more robust. But over and above these conditions, a large institution with both operational and financial capacity will also be able to bring down the cost of funding through a diversified liability structure.
The operational and financial advantages of an HFC platform are symbiotic. For instance, the land bank sourcing mentioned above also translates into a financial advantage should the HFC platform be able to procure large quantities of land at incrementally better rates. Given just how vital a component land prices are to the value of urban housing, incremental improvements can be significant drivers of value creation.
A large institutionally-backed HFC platform will also have the capacity to use a more sophisticated capital structure than would small fragmented players. The ability to issue bonds backed by a strong balance sheet, utilise capital markets to securitise assets and source relatively low-cost foreign currency funding when required are all factors that will help an HFC platform deliver value. For smaller HFCs with limited funding sources, chasing high-risk borrowers has led to a vicious cycle of higher NPAs, poorer credit profile and consequently a higher cost of funding.
The ability to utilise the operational advantages of a large platform to generate structural balance sheet advantages can indeed help HFC platforms deliver value. With a growing market, the opportunity lies in accessing new customers as opposed to just competing for market share with incumbents.
This story has been published from a wire agency feed without modifications to the text. Only the headline has been changed.