When practitioners talk about 'affordable housing', whether it is a government official, a banker, or a real estate developer, it is often unclear what this means - after all, it can easily be argued that affordability and supply are issues for over 90 per cent of the population. Often, slum redevelopment, small format housing, as well as large 2 and 3 BHK flats located outside of the city centre are all talked about under this moniker. The reality is that this definition varies, not only by location in terms of the cost of building a home, what buyers can afford, and whether mortgage financing is even available.

For the last several years, residential developers have been building homes for the wealthiest 15 per cent of the population. India's housing shortage spans the rest of the population - and as the country is diverse in culture and religion, it is also diverse in its income base and the challenges faced in meeting housing demand for each segment of the population.

How much home can one afford?

We will focus on the market of urban homes for sale, as rental housing has not been a viable industry for developers due to historical fear of squatting tenants and outdated rent control laws.

If one is not fortunate enough to be able to buy a home with one's savings, a home purchase usually involves getting a loan secured by a mortgage, with the loan size based on household income. In India, as a rule of thumb banks and housing finance companies (HFCs) make home loans that are typically up to 3.5 times the annual household income of the buyer, assuming the buyer contributes at least 20 per cent of the home price. As an example, to purchase a flat costing Rs 20 lakh, the buyer must contribute Rs 4 lakh as equity and must also demonstrate a monthly income of Rs 38,000 to obtain a bank loan of Rs 16 lakh.

Housing for the most affluent

Residential developers respond to market demand in a manner that realizes the largest profit, which has resulted in larger homes built to suit the larger spending and borrowing capacity of the most affluent in urban India. During the residential construction boom of the last 5 years, the majority of new housing supply has been largely concentrated on meeting the demand of perhaps two million households, who can afford homes priced above Rs 25 lakh.

Segmenting market demand: the highly affluent top 3 per cent

In recent years, as India's growth has accelerated, there has been a significant disconnect between new housing supply and the needs of the majority of the urban population. If we consider the purchase price of a home that is affordable based on household income (making simplifying assumptions as indicated in the chart), this highly affluent segment represents approxi-mately the top 3 per cent of the urban income pyramid.

To understand different segments of housing demand, consider the home prices Indians can afford based on household income. According to a study done by the Inclusive Markets practice at The Monitor Group (a global strategy consulting firm), monthly household income (MHI) in urban India is stratified as indicated in the chart .

The next 7 per cent: 'Upper Middle'

The economic downturn of 2008 significantly affected consumer spending, forcing developers to consider alternative segments of market demand. A number of developers, such as DLF, Unitech and Purvankara have begun exploiting the market for housing costing between Rs 10-25 lakh. Based on household purchasing power, this affluent segment of 5 million urban households represents just over 7 per cent of the urban income pyramid. These projects have made home ownership, within an hour of major city centres attractive and possible for many aspiring 'upper middle' income earning families.

The next 30 per cent: 'Lower Middle'

With fully 90 per cent of the total urban population unable to afford housing costing more than Rs 10 lakh, there remains a major imperfection between market demand and mainstream supply by residential developers.

Over the last couple of years, the UPA government has been promoting the idea of 'affordable housing for all.' Practically speaking, housing policy has typically been targeted at slums and a focus on economically weaker groups, with government ambitions for a slum-free India over the next five years. But given the range of needs for a diverse population, some believe that it is critical to start solving the problem by identifying market opportunities without the need for government subsidy.

Low income housing opportunity

Ashish Karamchandani, founding partner of Monitor Inclusive Markets based in Mumbai, believes that there is a ripe market for housing costing between Rs. 3 lakh and 10 lakh. Monitor refers to this as the 'low income housing opportunity.' According to the data, this price segment represents the pent up demand of 21 million households, or just over 30 per cent of urban dwelling households. Since 2007, Monitor has been working with urban developers throughout urban India to articulate the profit opportunity in a market segment worth Rs 1.3 million crore (the equivalent of over $280 billion).

The acute shortage of new housing supply in this segment has been articulated repeatedly in Mumbai, where there has been a disproportionate response to schemes offered by state-owned development agency MHADA and private sector projects like Matheran Realty's Tanjui Malusare City. Tata Housing and entrepreneur Jerry Rao's Value Budget Housing, among other new entrants, are also focusing on this space.

Efficient design, no compromise in quality...

Monitor's research has proven out the demand in this space as well as the viability of the economics. Costs are low as unit layouts are small at 300 - 400 square feet, with developer profitability dependent upon the ability of developers to build and sell units more rapidly. According to Bala Venkatachalam of Monitor, who has helped spur developers to enter this space: "we are talking about low income housing with efficient design but no compromise in quality. The basic difference 'from business as usual' is that this business model conceives of land as inventory, rather than an asset to be held for appreciation. For the capable, enterprising developer, the return on investment is similar to high end housing."

Who are the target buyers for this type of housing? They represent not only many government sector employees, but also many in the education sector, middle and junior management employees in the private sector, as well as millions in the self- employed sector. Many of these households are currently living in rented homes in slum-like conditions. But these same households are part of India's ambitious, consuming masses. A visit to their homes might well show a colour TV, refrigerator, several mobile phones - and perhaps even the occasional computer.

Credit risk of informal workers

Despite their propensity to spend, this group has not found an eager audience with mortgage lenders. The majority of large banks and housing finance companies (HFCs) have been reluctant to serve customers in the informal sector, because of the small loan sizes and a lack of documentation (such as pay slips for informal workers) and perception of higher credit risk. Karamchandani's team has done substantial work to articulate the profit opportunity for entrepreneurs interested in starting HFCs in this space, as Monitor works to bring savvy players into this as yet unexploited niche. In fact, Monitor has supported a start-up lending operation who has taken the early lead in underwriting the credit risk of informal workers.

Why supply for this segment would be a win-win for industry, citizens and society

Addressing the shortage of urban housing for over 30 per cent of Indian society is critical. First, it will prove out if private enterprise is up to the task of meeting market demand without subsidy, albeit with assistance from local governments in reducing regulatory bureaucracy. If financial institutions willing to underwrite the risks of the informal sector, they may unlock significant profit potential by increasing access to mortgages - and would need to look no further than the success of the microfinance industry. Fulfillment of the demand for tens of millions of homes will also result in significant job creation as well as demand for basic materials.

Second, housing provides an opportunity for those with lower incomes to break into a 'middle class' lifestyle with demonstrable benefits. A permanent home provides a family with stability, increased income and wealth building opportunities and with improved performance by children in schools, not to mention the physical and mental benefits of hygiene and dignity.

Finally, society at large will benefit tremendously if this housing challenge can be met. Healthier and happier home dwellers will have a higher propensity to spend on new amenities, become more productive workers, generate a larger tax base, and will create a voting block with leverage to demand government investment in additional infrastructure linkages as housing spreads further from city centres. All of which is critical to building a society where all citizens are more interdependent and invested in the success of the many, which will make India an even more attractive country to live in.

The bottom 60 per cent: urban poor

And what of the remaining population, making up perhaps 60 per cent of the urban masses? There is a need to segment this group further as this represents a massive population with differing demographics and needs. From the simplifying perspective of income, however, for most in this group, the idea of buying a home remains just a dream. From a builder's perspective, the economics of profit making on homes below Rs 3 lakh appears not to be economically viable without subsidy. Much of this population survives in slums or chawls, either squatting illegally on government land or paying exorbitant rents to land owners. While this number sounds outlandish, it is sobering to note that 54 per cent of Mumbai lives in slums. The most unfortunate 5 per cent at the bottom of the pyramid can't even afford a home in the slums and end up on the streets.

In our next two articles in this series, we will address government efforts to address India's housing crisis, and discuss the longstanding efforts of one NGO in particular that has played a critical role in forging innovative financing and empowering slum dwellers to participate in the process.

- (to be continued)