5 major factors driving real estate growth in Tier II and Tier III cities

affordable housing

By Sandeep Batra

The majority of India’s real estate market is driven by metropolitan cities such as NCR, MMR, Bengaluru, Chennai, and Kolkata. The action in the real estate industry is now set for change towards smaller cities. The scarcity of land resources, high land and construction-related cost, unaffordable property prices, high inventory levels, declining demand, inadequate infrastructural facilities, and a high cost of living are forcing developers and investors to shift their focus towards Tier II and III cities.

The five major factors driving real estate growth in these cities are:

• India’s urban population is expected to surpass 850 million by 2050, of which 50 percent is expected to be in the age group of 19-58 years, which is the key demographic core to the consumer demand phenomenon. With increasing disposable incomes and nuclear families, this will lead to higher demand for housing and organized retail consequently.
• Well-established industries such as engineering, textile, pharmaceuticals and capital goods and growth drivers including the availability of skilled labour at cheaper rates, lower fixed costs/overheads in smaller towns are leading to higher disposable incomes. Also, cities such as Chandigarh, Coimbatore, Vadodara, Jamshedpur have become the hub of e-commerce while Ahmedabad, Surat, and Vadodara have made huge progress in the industrial sector. On the other hand, Coimbatore has more than 25,000 SMEs while Vizag has been suitable for industries such as mining, heavy manufacturing, etc. Jaipur has been leading in service sector investments.
• Availability of land and labour at reasonable rates compared to metro cities will lead to affordable prices of real estate in these locations. Land is one of the major components for a typical real estate project. Thus, lower land costs will lead to affordable rates of residential units and rentals in case of retail projects.
• Conducive government policies and thrust on physical infrastructures like airports, flyovers, metro corridors, and expressways are fuelling rapid growth in smaller towns. For instance, smart city project plans to build 100 smart cities. Besides this, National Urban Housing Fund has been approved by the union cabinet with an outlay of Rs 60,000 crore. Under the Credit Linked Subsidy Scheme (CLSS), housing for EWS/LIG/MIG beneficiaries is being sanctioned by the HFCs under the PMAY (Urban). The target is to cater to the demand of housing shortage of 1.2 crore (approx.) and fulfill government vision of ‘Housing for All’ by 2022.
• RERA has led to the realization that the industry will be driven by end-users and investors will have a limited role to play. Consumers in tier II and III cities are currently underserved by industry and these cities have a lot of latent demand for quality real estate at affordable rates. Going forward, as RERA becomes an integral part of planning, developers will turn towards end users and shift their focus to these cities.

From an investment standpoint, these cities offer better prospects. According to NHB – Residex, on year-to-date basis, Tier II and III cities have witnessed better price appreciation compared to metros. For instance, property prices in Ahmedabad grew by 8.1 percent, in New Town (Kolkata) by 6.5 percent, Chandigarh (5.3%), Nashik (5.8%) while prices declined by 5.8 percent in Gurugram, Chennai (1.5%), Mumbai (3.6%), and remained constant in Kolkata.

Smaller cities are currently under-served markets for quality retail and entertainment experiences while the population has a high propensity to spend. Therefore, many retailers are actively looking beyond the metros to explore opportunities offered by a large consumer base, which is hungry for experiential retail.

A Mumbai-based retail developer, Phoenix Mills, recently bought two under construction malls in Lucknow and Indore. Apart from this, retail giants like Future Retail, Reliance Digital, H&M, Trent's value fashion brand Zudio etc. are looking to expand their presence beyond metros. Besides retail, there are many opportunities to develop warehousing space in smaller cities owing to better transport networks and benign land prices. Many of these cities have strategic locations servicing growing hinterlands of India’s sub-regions. For instance, Walmart and Amazon are developing new fulfillment centers to cater to growing demand from these cities.

Indian real estate industry is evolving rapidly after the recent turmoil and regulatory developments. Focus on end-user driven demand and consequently shift towards smaller towns is at the focal point of this change. While it may not help everyone, those who will embrace changing market dynamics will emerge as winners.

The author is Associate Director, Capital Markets and Investment Services, Colliers International India. Views are personal.