Affordable Housing Innovation 05: Help wanted: Global affordable housing developers

By David A. Smith

February 1, 2013

When trying to change the world one housing ecosystem at a time, you migrate your activity to the ecosystem's pinch point – because whatever is most scarce is likely what is controlling the ecosystem's growth. In country after country, including recent work on Haiti, Iraq, and Nigeria, what we find is something precious yet surprisingly overlooked – namely, capable affordable housing developers.

In terms of growing successful housing, you may have the hungry townsfolk (effective demand); you may have the land; you may have the seeds (design concept); and you may have the fertilizer (subsidy) and sunshine (financing). But all of these come to nothing unless you have the farmer (developer), with his plow and his ox to pull it (development company) – and the farmer and the ox need to be paid for their labors.

Those homes don't develop themselves

New or renovated homes are the output of an eight-step supply-side value chain: land entitlement and zoning; trunk infrastructure; site infrastructure; site layout and homes configuration; development resource assembly; construction; sales and offtake; and post-offtake operations afterwards.

These value chains are challenging to link even in developed nations with robust and efficient ecosystems of law, finance, and building codes and their large populations of accredited delivery professionals). In emerging markets, ecosystem components may be inconsistent, ambiguous, or entropic, and reliable delivery professionals (real estate agents or brokers, mortgage originators, appraisers, title insurance entities, notaries, lawyers, and accountants) are scarce. Where the value chains function, it is typically only for high-end customers. As one moves down-pyramid, what is black and white becomes progressively grayer – and that means more uncertainty, and hence higher risk.

Those apartments aren't going to renovate themselves

A business riskier than you realize

Real estate development is inherently a high-risk business; developers working in emerging countries or targeting affordable housing face risks both greater and harder to quantify, including these:

  • Entitlement/ zoning risk. Urban land becomes economically valuable only if it can be formally owned and legally built upon. In many countries, both land title and development entitlement are complicated because of: registries of deeds (haq's in Egypt) rather than of title; land registries in paper form, not electronic, making search and verification difficult; long-term leasehold interests (affermage in Haiti); tribal land or communally owned land (ejido in Mexico); or zoning limitations (agricultural land that cannot be practically rezoned for residential).
  • Construction cost/ building materials risk. While homes are built mainly out of the prevalent indigenous material (cement, brick, wood), they also need rebar, framing, joins (e.g. flashing, soffits, fixtures) and finishing, some of which are usually imported. Supply chains can be disrupted or prices can spike.
  • Infrastructure delivery risk. Urban infrastructure delivery usually crosses multiple government ministries, agencies, or levels: roads, electricity, water, sewage, may all be under different entities, budgets, priorities, and queuing procedures – and the developer may be unable to control or rely on any of them.
  • Contractor performance risk. Payment and performance bonds are virtually unknown, and if construction stops, money drains away speedily.
  • Offtake risk. Real estate development requires something of the mentality of a commando raid: plan scenarios endlessly, then when the time comes to act, move quickly, be decisive, adapt, and most importantly, have a reliable and complete exit. We know there is desire for housing, but is it 'effective demand' – enough people with the ability to pay the full purchase price to take up all the homes promptly when they are delivered?
  • Demand-side risk. Because urban housing is expensive relative to people's annual income, the homeowners' ability to pay for the housing depends on the output of the eight-step demand-side value chain that begins with eligibility and ends with enforcement – and in many of these countries, that value chain too has some weak links.
  • Government counterparty risk. To address offtake risk, many developers quite understandably start by negotiating a bulk agreement with a benefactor entity such as major employer or civil service (e.g. army, police, or government workers). But what happens if the government simply refuses to honor its offtake agreement? In many countries, government is a virtually uncollectible counterparty because litigating against the government is a fool's errand, and there may be no outside party (e.g. a bank) willing to guarantee government's performance.

People sometimes conflate development with construction; if you can build, goes the theory, why isn't that all you need to be a developer? As the above list shows, developers take and manage massive risks that construction contractors do not.

Debt, equity, and money you can't have

Just as the buyers need demand-side financing, developers need supply-side financing: land acquisition or construction loans. In many countries development finance is economically infeasible to arrange, so the sponsors wind up using equity, which is even more expensive and harder to find. The result is a country with an oligopoly of a few mega-developers regarded as “safe” by the big banks, while smaller and intermediate entities cannot get the project financing to scale their pipelines.

The pricing updraft and the talent updraft

Remarkably, some developers do surmount all these challenges and become expert at creating homes. As they do, they encounter two enemies of affordability:

  • The pricing updraft. Between land costs, costs of development capital, inflexible engineer-written standards of infrastructure or site layout requirements, and minimum sustainable profit margins, housing developers may find their cheapest homes are still affordable only to the top 5% or 10% of the population – and high-end properties are often easier to do.
  • The talent updraft. Development is knowledge-specific, risk-specific, and place-specific. The people who do it are talented and work hard, and as they gain experience, they attract interest from high-end large developers. Then there a personal moment – a marriage, a new baby, or when the old computer or car dies – when the no-longer-young executive can be seduced away by high-end developers offering nicer offices, better computers, more financial resources, and faster development execution.

The pricing updraft means that true affordable housing development always requires some element of concessionary capital or resources (e.g. land). The talent updraft means countries need Mission Entrepreneurial Entities with equal emphasis on both economic and social outcomes.

Pity the poor developer?

As it says in the Bible, do not bind the mouths of the kine that tread the grain.

If a nation wants to grow its affordable housing, that nation needs to incubate and motivate affordable housing developers.