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When one drive to Nashik, before entering city will see lots of construction work progressing on both sides of highway. It used to be a city to retire but it has changed its image in recent years. As per latest Housing market reports, Nashik outstanding home loan portfolio is at astounding 16,000 crores which is growing at more than 10% rate YoY. This city is not alone, cities like Coimbatore, Lucknow, Indore, Surat, Jaipur, Rajkot or Vijayawada all are witnessing tremendous growth in housing and Real Estate, which is higher than national average.
India Real Estate Finance market comprise of PSUs, Private Banks, NBFCs, HFCs, AIFs and select PE funds. These Institutions have traditionally limited Real estate exposure to top 7 cities in India but recent boom in housing market and focus on affordable housing by government and extra ordinary housing demand from these cities have started to change the perspective of Tier 2 cities on funding horizon.
As per recent RBI and CRIF reports, growth in housing market in Tier 2 cities have been happening at around 10.8% while Tier 1 cities are growing at around 7.9%. Similarly delinquencies in Housing market in both categories are similar in range of 2.3%. This data has brought Tier 2 cities on front of Real Estate financing and lots of RE funding partners have started looking at these cities favourably from risk and return perspective.
What are the factors which have favoured this shift? As per industry experts, Covid has changed the dynamics of rule, IT/ITES and BFSI sectors have triggered migration of talent pool from Metros to Tier 2 cities, triggering housing demand in these cities. Other important aspect is 24/7 Data availability, better IT Infrastructure, lower cost of living and improved work life balance, attracting young talent from bigger cities to smaller ones.
These cities are also emerging as hubs of warehousing and logistics, creating tremendous employment opportunities, also many Industrial corridors pass through these cities fuelling Real Estate prices and in turn bringing in new opportunities for real estate financing.
Fuelling housing demand and rapid urbanization of these cities have brought many Real estate funding institutions to tier 2 cities. LIC Housing, SBI, HDFC have traditionally been present in these markets but recently ICICI HFC, Tata Capital, IIFL Home Finance and few other players have started looking at Tier 2 cities aggressively and have started lending for real estate projects.
So what is the type of funding happening in these cities? Unlike in past, where pre-launch and investor money was easily available to commence the construction, post RERA these sources have dried up and need for working capital is growing with every passing year. In tier 2 cities also, Working capital for Real estate projects is the primary end use of capital inflows. While there is still dearth of ‘Growth Capital’ in these cities, but availability of working capital is ensuring timely completion and recycling of capital.
Similarly, as compared to big cities, size of real estate projects is much smaller and hence project demands lower quantum of working capital amount. Generally, Real Estate ticket size is under 40-50 crores for majority of funding opportunities in tier 2 cities. One more important parameter for RE lending is selection of borrowing partners in these cities, while not every real estate developer in Tier 2 cities get finance, but larger players in these geographies have definitely started getting visibility and timely financial closure for their projects from leading financial institutions.
Other advantage is better IRR on lending. Due to limited availability of capital in these cities, lenders are able to get better IRR on deployed capital. This perfectly fits in tick box wherein you select best player, fund working capital and get better IRR. This ‘Tick Box’ lending is making these cities attractive from entry and quick exit point of view for real estate lenders reducing lending risks significantly.
Overall, Tier 2 cities have started consuming a pie of Real Estate funding and have started emerging as an alternate option for many lenders. Will this trend continue? In my opinion- Yes. While, Tier 2 cities might not get growth capital in initial years but single project exposure, lower quantum of funding, end use driven funds deployment and better IRR are too good to ignore for any serious financial institution looking to expand to Tier 2 cities in India.
