The challenge of building affordable housing in developing countries … and how DFIs can help
By Debra Erb
Managing Director, OPIC Housing Programs
(This blog is adapted from a speech Debra Erb delivered in November 2014 at the general meeting of the African Union for Housing Finance.)
One of the fundamental steps to advancing development in emerging markets is giving low-income people a secure place to live.
As a banker who has successfully assembled financing to help builders construct low-income housing in some of the world’s most challenging regions from Honduras to South Africa, I know that it is possible to provide homes that are not only affordable and high quality but also financially sustainable to the builders and investors.
But I also know that this isn’t easy.
Most real estate developers in Africa are small groups with limited capital who are most comfortable building a few high-end houses at a time, using the buyers’ money and reaping high return over a relatively short period. Affordable housing, on the other hand, is only profitable in scale, and large scale development requires large investments of time and money and comes with a high level of complexity. Developers must not only assemble a plan for building the project quickly and efficiently, they also have to ensure there is financing for the buyers, who are usually first-time homeowners and may not even have a bank account.
There are also many other players that need to work together to successfully build an affordable housing development. Builders and property managers, land owners, local governments, investors, suppliers, mortgage lenders and surrounding communities form a sort of ecosystem in the housing sector. When they come together to work on a project, they often represent a set of conflicting agendas and incentives. I’d argue that the reason we don’t have more affordable housing around the world is that we haven’t fully addressed the gaps in this ecosystem.
This notion of an affordable housing ecosystem comes from Ron Adner, professor of strategy at Dartmouth’s Tuck School of Business, and author of The Wide Lens, which highlights some of the hidden challenges that can impede business plans and general innovation.
All of these interested parties leave the developer in the center of a group of competing interests. Rather than in a position to take the lead, the developer must navigate all of these competing interests. The best developers understand this and become adept at working with different parties.
Government, for example, is often one of the primary stakeholders, since mass housing construction addresses issues of economic development, land use, and public safety. But government is not a single entity. It includes national, regional and local governments as well as different ministries of public works, land and finance – each which has its own priorities.
Landowners represent another key party whose interests are often not aligned with an affordable housing mandate. Left to themselves, private landowners have no incentive to support affordable housing developments.
Even tangential groups like utility providers play an essential role in the successful completion of a project. I have seen projects where an entire community of completed houses awaits connection to power or water or sewage treatment systems that were promised but never delivered.
Then there are the investors. Housing developments require capital, of course, but since capital generally looks for highest return with lowest risk, investors often prefer to build a commercial property or high-end housing. With low-income housing, there is the added financing challenge of converting families in need into qualified buyers.
How governments and DFIs can help
Development finance institutions like OPIC play a key role in the developing low-income housing by providing debt capital and working to structure mortgages in a way that are affordable to poor families. A perfect example is Los Castanos de Choloma (pictured), a Honduran affordable housing project developed by Inter-Mac International, the U.S. investor, and HOLA Realty, the local builder. We were able to structure a loan that funded not only land development, home construction but also a 25-year lease-purchase plan putting nearly 2,500 low-income families on the path to home ownership.
The project was successful because it was built with significant investors’ equity capital and solid investor balance sheets.
OPIC has also supported successful low-income housing projects in Africa, where the need is great. But the universe of investors interested in housing projects in Africa is very small, and the number of African developers with strong balance sheets to support completion guaranties is smaller still.
The point here is that, even though the low-income housing is built for low-income families, it’s not the families that drive the construction process. Something as simple as construction and delivery of a 37-square-meter house involves a large number of players and sufficient capital to see a large housing project through to completion.
Even in the best scenarios, it takes a long time to identify and develop a project before a single shovel of earth is excavated, and timelines are unpredictable throughout the process. Execution risk is extremely high, not surprisingly!
If we are going develop more large-scale affordable housing projects, we need to understand the challenges and work to ensure that all key stakeholders have the right incentives. Government can and should play a major role, with tax incentives, policies, subsidies, land grants and other well-designed programs to encourage qualified companies to enter the market. Development finance institutions can support these projects with capital, and perhaps even by taking a lead in helping to encourage partnering of larger builders with smaller developers and contractors. This leads to greater local capacity and a deeper, more functional market for all participants.