New frontiers in affordable housing

SHANGHAI—Providing decent, affordable housing is a growing challenge in developing and developed economies alike. With demand far exceeding supply, the adverse effects—on mobility, productivity and growth—are (or will be) increasingly apparent.

Worldwide, 330 million low- and moderate-income urban households either live in substandard housing or are so financially stretched by housing payments that they must forgo spending on essentials like healthcare and education. By 2025, that figure could reach 440 million households, or about 1.6 billion people (one-third of the world’s urban population)—and that does not even cover some of the world’s poorest who often live outside of cities, on urban streets, or as squatters, leaving them unaccounted for in census estimates.

Replacing today’s substandard housing and building the additional units needed by 2025 would require an estimated $16-trillion investment—a daunting figure, to say the least.

But there are four key “levers” that can reduce the cost of housing delivery by 20-50 percent, thereby making housing affordable (amounting to no more than 30 percent of total income) for households earning 50-80 percent of the median income in most cities.

The first lever is more efficient land use.

Acquisition of land for development in the right location at a reasonable price has the greatest potential for reducing housing costs. Location is especially important in developing countries, where many areas lack adequate transport,

water, electricity and sanitation infrastructure. Investment in these areas would improve and expand land use—whether by unlocking unused land or equipping areas to support more inhabitants—thereby helping to reduce housing costs.

Similarly, cities can loosen land-use restrictions, such as unit size requirements, to allow for higher-density, and thus more valuable, projects. In exchange for providing the increased value to real estate developers, municipal authorities could require that a portion of the land or a certain number of units be set aside for affordable housing. Such a cross-subsidy would increase the housing supply across income bands, at no direct cost to the public.

The final step toward improving land use is the implementation of measures to discourage land hoarding. China, for example, imposes an idle-land tax on formerly public land if its owners fail to initiate the development process within a year.

This brings us to the second key lever: a more cohesive and efficient construction industry. As it stands, the housing-construction industry is highly fragmented, impeding its ability to take advantage of economies of scale; and builders rely largely on the same methods used 50 years ago.

By standardizing design elements like ceiling heights, fixtures and flooring, construction companies can cut costs and raise productivity, as workers gain experience with repetitive tasks. Further savings are possible through industrial approaches, such as the use of components—e.g., walls and flooring slabs—built offsite. And most builders lag behind other industries in terms of efficiency in purchasing and other processes. Together, these improvements could cut housing-construction costs by up to 30 percent and delivery time by 40-50 percent.

The third key lever relates to operations and maintenance—everything from heating the building to repairing cracked tiles—which account for 20-30 percent of total housing costs. Here, the biggest opportunity lies in efforts to improve energy efficiency, with insulation, windows and other retrofits generating energy savings of 20-30 percent.

Additional savings would be possible if maintenance and repair companies were more transparent and competitive, and operated on a larger scale. To this end, public institutions could certify and list suppliers that meet quality standards, or bring owners together in buying consortia—an approach that has helped the United Kingdom’s social-housing agencies cut costs on some items by more than 20 percent.

The final affordable-housing lever is expanded access to finance, especially for low-income households, which often face the highest borrowing costs—if they can gain access to finance at all. For the world’s many “unbanked,” who cannot accumulate savings or establish a credit record, the only option is to pay steep risk premiums for high loan-to-value mortgages.

To expand access to finance, countries can improve underwriting by establishing credit bureaus, which are uncommon in developing economies, and training and certifying property appraisers. In some countries, collective-savings programs—that is, provident funds and building societies—have helped low-income households to accumulate down payments, with the pooled savings also providing capital for low-interest mortgages.

At the same time, to reduce financing costs for developers, municipal bodies can “de-risk” projects by committing to purchase affordable units or guaranteeing qualified tenants. Cities can also streamline approval processes to accelerate completion.

Indeed, while municipal and national governments will have to take additional measures to address the needs of their poorest citizens, cities have powerful tools at their disposal for closing their affordable-housing gaps.

Though no single solution will work everywhere, initiatives that integrate land policy and more accessible finance with efforts to modernize housing construction and management can lead to progress everywhere. Project Syndicate

Charles S. Laven is president of Forsyth Street, an impact investment company, and an adjunct professor of real estate development at the Columbia University Graduate School of Architecture,

Planning, and Preservation. Jonathan Woetzel is a director of the McKinsey Global Institute.