[Continued from yesterday’s Part 1.]
Back in late May, at the World Bank’s Fifth Global Housing Finance Conference in Washington DC, I had fifteen minutes to describe AHI’s theory of impact in housing finance and slum upgrading, and somehow I managed to distill my full presentation (link in pdf) into six words. Yesterday, in Part 1, I covered two of them – underwrite informality. Next up are two more:
Is that housing formal or informal?
Underwrite durability
Real estate is unique among asset classes because, as I’ve written dozens of times, it is immovable. Because of this, investment into real estate is different collateral, one that cannot be pilfered away. Of course, an empty house can be looted – toilets and even plumbing ripped out, cabinets taken – but the essential building structure must remain where it is. As such, once someone has invested in housing, that asset has value to the investor only if the person remains there to live in it.
So you can collect on it, even if you can’t resell it.
Thus, when you’re looking at a housing asset as potential collateral for a loan, ask yourself, Is it durable?
What is its durable value?
When looking to underwrite, look at the physical structure more than the paper
The house above may be formal or informal (to find out, tune in tomorrow for Part 3), but it is unquestionably durable. Lots of person-hours went into building it. The door and window frames are properly set. It’s connected to the electrical grids, and to the telephone. The house is here to stay.
And it’s normally a house’s exterior that is least appealing:
Jadibanagar, inner street, Ahmedabad, October, 2007
The scene above is from Jadibanagar, a wholly informal neighborhood in Ahmedabad. (The neighborhood is informal ultimately because the land is zoned agricultural, the owners are grandchildren and great-grandchildren of the original landowner, and to rezone it as residential-urban would take many steps and cost a fortune.) The houses don’t look like much outside, but step inside and things change.
Same street, inside a typical house
All the surfaces (except the ceiling) are finished; the kitchen wall is tiled. There’s a television (protected from dust in plastic), a DVD player, a fluorescent light. Somebody’s gone to trouble to make the inner space livable. All this is durability.
Remarkably, the difference between what you and I would consider a hovel, and what we’d consider a home, can be as simple as improving the interior surfaces.
Kitchens and bathrooms, visible surfaces
The kitchen above is an informal house, from Bogota, Colombia, that qualified for the Colombian government’s Vivienda Saludable (healthy living) program: grants to pay for visible surface and fixture upgrades in kitchens and bathrooms: faucets, ceramic sinks, ceramic tile over cement block and on stove and countertops. Do these simple things and the room is transformed into something that feels fully formal inside, and when it feels like home, you protect it like a home.
When deciding how to treat informal neighborhoods, then, look at durability:
- Durability of homes. Will they stand up to the elements?
- Durability of neighborhood. How long has this community been here? Do people who move here stay here?
- Durability of inhabitation. How long has the occupant lived in the home?
- Durability of commitment? Do the homes show evidence of periodic investment?
Such reasoning, among other factors, motivated the City of Sao Paulo to finance upgrading of informal settlements scattered all up and down the hillsides of Guarapiranga Reservoir.
Financing slum upgrading as health and sanitation
In the upgrading, open ravines were scraped and cleared of debris, then reinforced with concrete walkways and runoff channels. The resulting flat spaces became walkways and even narrow streets. Informal houses had their facades redone, pointed, and then painted in bright colors. The result, while still legally informal, is vastly improved – and equally important, the residents now feel that they are citizens too, people to whom the city provides services.
The cost of improvements brings us to the critical tool used in underwriting durability – Home Asset Loan Finance (HALF), as we call it, halfway between microfinance and mortgage finance.
The idea is straightforward: a loan product aimed particularly at purchasing or improving informal homes, in an amount large enough to do a whole room or a whole very inexpensive house at one spend.
The people we are targeting are informally employed, and their income may be somewhat variable. As a result, for them – and indeed, for almost every other income group – what they will pay in the future is determined by what they have paid in the past.
In reality, a loan is simply a pledge by you to make a fixed payment every period (say, a month) for a long time, and the longer you will pledge to make those payments, the more I will give you for making the pledge. If you want to borrow a larger amount, therefore, you cannot realistically increase your payments; rather, you have to stretch out the loan tenor – the repayment interval. And this works logarithmically, not linearly – to borrow six times as much, say, you have to encumber yourself for ten times as long a period.
Requires creating new financial products
In other words, a microfinance loan (see diagram above) for a small amount like $500 can be repaid in six monthly payments (tenor of one half a year). But $500 won’t do a whole room, and trying to do a room in six sequential microfinance loans means you have to start and stop construction/ renovation sequentially. That’s complicated operationally and complicated financially, and few people can accomplish it.
[Cemex, the Mexican cement company, has solved this problem with its wonderful Patrimonio Hoy program, about which I’ll post sometime – by vertically integrating every component of the delivery system. Patrimonio Hoy’s fantastic, and I’d love to see it replicated elsewhere, though it takes a big cement company to launch and sustain. – Ed.]
So we need the $3,000 loan, and that means a five-year tenor.
Now turn that same reasoning around and look at it from the lender’s perspective. If I’m lending you money for six months, the only credit decisions to concern me are personal to you. Will you still be here? Will you be able to make money? These are very visible, immediate questions.
When we shift to a five-year loan and home improvements, however, more risks appear on the horizon. Will you stay healthy for the five years? Is your work one that’s steady, not seasonal? Will the local economy decline? Is the neighborhood safe?
All these differences mean that the loan’s risk characteristics change.
HALF in the spectrum: product and risk characteristics
A microfinance loan has no collateral – if there is a default, the loan is almost certainly a total loss (as we’ve seen in Andhra Pradesh, there is no practical means of collecting and defaults can become epidemic). Hence it’s essential to keep probability of default minuscule.
Approaching this asset type from the other direction, we can look at the mortgage loan as the longest pledge of payments – decades’ worth, in some cases. To make such a loan, the lender has to believe there’s a high recovery after default, because there are so many uncertainties when looking decades into the future. To make loan recovery high, you need the most durable asset, one that will keep its physical integrity, hold its use value (people always wanting to live in it), and can be repossessed (via foreclosure) and then resold. All that makes mortgage finance a complex construction – an airplane, if you will – that depends on a great deal of legal and financial technology.
It’s not mortgage finance (too informal)
It’s not microfinance (too big, too long)
Conversely, microfinance was and is a tremendous invention of the 1990’s (and a rediscovery of the home improvement lending invented in America over 120 years ago) – but microfinance can only grow so large. If mortgage finance is an airplane, microfinance is an insect – any given one can be squashed, but they swarm effectively.
Banks love mortgage financing – it scales naturally, it relishes formality, and it can be encompassed by clear and definitive paper trails. Yet in emerging countries, the actual demand for traditional mortgages is tiny, because most citizens have informal incomes and most housing is informal (a legacy of rapid urbanization and the economic rationality of informal settlements and slums).
Home Asset Loan Finance: the ‘missing middle’ of lending
Meanwhile, microfinance has a huge effective demand, which led to its rapid proliferation across the global south. Yet even with its compact business model, microfinance is a difficult business, one that is extremely hard to scale, and hard to make enduringly profitable.
That leaves a large group of households who have a permanent asset (their home) that is nevertheless fully informal. They’re above the reach of microfinance, and below that of mortgage finance. That’s the gap to be filled by HALF financing.
HALF addresses a gap in housing finance
At the same time, not every property can be a HALF candidate: we need durability, and that word has multiple meanings here.
What makes an informal home a HALF candidate?
- Physical durability, as evidenced by structures that stand up. In doubtful cases, engineering reports are needed, but more often, it’s simply a physical inspection, documented by time-stamped digital photographs. These also establish a baseline for future condition reports, and that helps demonstrate the owner’s commitment to improving the property.
- Occupancy and use durability. When you see For Sale signs, that’s proof the occupancy is so durable the right to it can be sold from one person to another. I love this photo, because even though the complex (a Cingapura mid-rise in Sao Paulo) won’t necessarily have clear title, someone believes their apartment can be sold. And someone else will buy on that belief.
- Tenure durability. While this is not always verifiable through documentation, a savings history can help, as can membership in a church or mosque, or children who’ve been enrolled in the same school several years running.
Children from informal neighborhood, Durban, leaving school
- Municipal durability. Street numbers and mailboxes matter. Homes that are connected to the city’s networks – mail, water, sanitation, electricity, roads, and public transport – will benefit from improvements in their neighborhood that are brought on by the increase of city services and the co-investment of other home owners.
That leaves only two more words in AHI’s comprehensive theory of impact.
In two words, what?
[Continued tomorrow in Part 3.]