In Jaithirth “Jerry” Rao’s favourite poem, “The Love Song of J. Alfred Prufrock” by T.S. Eliot, there is a line where the protagonist ponders, “Do I dare/Disturb the universe?” It might as well be a question Jerry saves for rumination post-retirement, because he goes ahead and does it anyway.
The 58-year-old part-time poet and former head of Citibank India, quit 20 years of finance to found the software firm Mphasis. Diminutive and thoughtful, yet fast-talking with pungent verve and energy, Rao thrives on being the contrarian. He acquired a technology-driven firm when the dotcom boom was in decline and a few years later sold a controlling stake in his company to EDS for $380 million. Since then, he has been a venture capitalist, invested in Grover Vineyards, picked up five percent stake in Osian’s — an art auction house and published poetry.
Most people would think nothing of calling it a day. But then, Jerry Rao is not most people. The serial entrepreneur has taken up a new passion: affordable housing. Putting a roof over the heads of those the last real estate boom missed. Houses that cost Rs. 7 lakh or less. Pipedream? Well, Rao is unfazed. Most successful businesses started as pipedreams anyway.
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 a management consultancy, 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? In late 2008, Rao’s attention was caught by this opportunity, thanks to some convincing by Monitor.A New Deal
Usually, builders acquire land and treat it as a capital asset. They build each project over several years. By the time the project is complete, the land appreciates in value and the prices they charge are pegged to the new rate.
Rao argues it isn’t possible to build low-cost housing from this perspective. Instead, look at land as working capital — or, as he puts it — inventory. Down payments from customers take care of land acquisition costs. Because he has tied up with banks to finance his customer base, construction finance isn’t a problem either. It is in the interest of his company, Value Budget Housing Development Corporation, to finish the project fast in 12 to 18 months and move to the next one. While this means his profit margins are significantly lower than if he were building for higher income groups (Rao is looking to make just 25 percent profits as compared to 300 percent profits) he claims his rate of return, or IRR, is comparable to industry standards. Instead of doing one project over four years, Rao will make the same by doing four such projects in four years.
But he’s got to make sure he achieves that target. He must manage his construction costs in that one year frame, else it will cut into his returns. For instance, if there is labour unrest and his workers don’t show up on time — for that matter, if he doesn’t get land approvals on time. Unlike other builders, he doesn’t have the flexibility to factor that additional cost into the price of the flat. “It’s all about the execution. If we get that right, the upside is enormous,” says Rao.
What happens if cost escalates? “We have the leeway to increase prices 20 percent,” he counters. “But our very attractive IRR will drop to attractive.” In much the same way, if the time taken on a project breaches the 12-18 month deadline, “we’ll get positive returns, but nothing interesting,” he offers.
On the building side, for Rao’s project to be successful he has to ensure a near-perfect combination of land availability, low construction costs and quick turnover. To ensure the first, Rao is restricting plot sizes to just three acres each.Building costs are kept low with the use of new technology that allows rapid construction of houses of a similar kind, perfect for standardised, mass housing. As a thumb rule, builders spend Rs. 600 to Rs. 1,100 per square foot on construction. Rao says he’s at the bottom quartile. “Our construction costs are in the region of Rs. 700 to Rs. 850 per square foot.”
Can It Be Done?
Rao believes that meticulous execution will keep the project profitable, even though the per square-foot price is low. But this argument doesn’t cut ice with Abhisheck Lodha of Lodha Group. “There is a certain cut-off point below which you can’t maintain quality standards or profitability,” he says. The cheapest segment that he is comfortable with is the Rs. 10 lakhs to Rs. 25 lakh segment. “Gives us more breathing room,” he says. His sentiments are echoed by Ashish Jindal, northern regional director, for realty research firm Knight Frank.
“The only way this market will be taken seriously is if the government gives permissions for a higher floor space index (FSI) or you build these homes as part of a public-private partnership.”
Ever since he started, these arguments have been buttressed by the fall in the real estate market. Unfazed, Rao looked for solutions. He allayed the developers’ concerns by fast-tracking the projects and that began to attract financiers. He found support from heavyweights like Parekh of HDFC. The housing finance giant has picked up a 10 percent stake for Rs. 8 crore in his project. “We are providing construction finance to Jerry and we’re also going to provide housing mortgages to his customers,” says Parekh.
“He is a real entrepreneur. Someone you can bet on,” he adds for good measure.
The Monitor Group has also helped other businessmen, most of them developers, to evolve similar business models.
Having been a banker, Jerry Rao understands money. Having run a software business, he also understands service and timely delivery. His angel investing will keep him focussed on returns. All he needs to do is some heavy lifting to make possible what is considered by real estate veterans to be impossible.
BOTTOM-UP LAST RUNG HOUSING OUT ON A LIMBTata Housing
The housing arm of the Tatas will build one-room-kitchen flats for just over Rs. 3 lakh in a township being developed at Boisar, 100 km from MumbaiGodrej Group
Is building a township outside Ahmedabad with homes from Rs. 5 lakh to Rs. 25 lakh
Is investing Rs. 500 crore in the next year to develop 10,000 homes for lower income groups, priced between Rs. 2.5 lakh and Rs. 9.5 lakh in the states of Uttar Pradesh and Rajasthan
is developing a pilot project of 1,000 houses in Ahmedabad
Is set to unveil 1,000 homes in Kahlol in Ahmedabad.
The Tanaji Malusare City in Karjat near Mumbai is a really big project. Plans are afoot for building 15,000 homes over 100 acres in the next three years.
is focussing on Thane district just outside Mumbai. The company is offering one bedroom-hall-kitchen flats of 315 sq. ft. for Rs. 4.75 lakh each
BACKING ‘EM UP
The country’s largest mortgage lender is at the forefront of funding low-cost houses. It is financing Jerry Rao’s project with Rs. 8 crore for construction. It also plans to lend against mortgages in the range of Rs. 5 lakh - Rs. 10 lakh once the project is completed.
Micro-Finance Housing Company
MHFC is the first housing finance company in the country dedicated to providing home loans to low-income individuals in the informal sector, thereby combining the advantages of a bank and an MFI in one entity.
MAS Financial Services
An Ahmedabad-based MFI which has tied up with TMC for the latter’s project. The company aggregrates customers and determines their credit-risk.State Bank of India and LIC Housing
SBI and LIC Housing have agreed to tie up with Foliage Developers via an employee payroll deduction scheme.(This story has been corrected. Monitor India is a management consultancy and not a research firm as mentioned earlier.)
(This story appears in the 05 June, 2009 issue of Forbes India. You can buy our tablet version from Magzter.com. To visit our Archives, click here.)