James Hokans January 2010 A Builders Warranty Scheme: Would it help Unleash Finance into the Lower-end of the Mortgage Market?

Some keys to a functional affordable housing finance market Term Rate structure Amortization Security Refinancing facilities Securitization Credit guarantee Appraisal Credit bureau Insurance: property & life Enabling land environment Quality developers Builders warranty Developer finance Primary mortgage market infrastructure Retail products Liquidity & portfolio risk mitigation

Builders warranty scheme (BWS) can facilitate developer (debt) finance Developer (debt) finance Enabling environment Quality developers Builders warranty

Vexing problems in urban low-income housing markets Land security and affordability due to the limited supply of regulated land Limited number of financial institutions delivering small mortgages at scale within acceptable risk parameters How to attract reputable developers/builders? Difficulty of developers accessing construction finance Lack of standardization of acceptable building standards and processes Lack of consumer education and protection against rectifying building defects Others… Source: Monitor 2007

5 Housing finance segmentation (typical) Informal income; no legal title Urban; Middle/upper National poverty line Primarily rural; very poor Formal employment Title to land

Sources of developer finance I.Developer equity II.Pre-sales and/or buyer pre-payments III.Equity investors IV.Conventional debt finance (banks/NBFCs)

Limits and other problems with these first two sources: I.Developer equity is limited in quantity Fewer projects get developed II.When homeowners finance construction via deposit payments to developers, results include: Homebuyer bears construction (unmitigated) risk Risk of developer fraud Many creditworthy buyers dont have ample savings decreases effective demand

BWS helps develop affordable housing finance markets by facilitating developer access to conventional debt financing,* as in South Africa (discussed later) * The prospect of raising equity investment (from passive or institutional investors) is not discussed here. Such investment is unlikely to precede the leverage provided by conventional debt finance.

Virtuous circle of BWS: Drive out unsavory developers Attract reputable developers Minimize borrower boycott risk Boycott removal attracts lenders Steady availability of debt finance

What is a builders warranty scheme? Two models: Netherlands: Insure homeowners pre-payments in case developer defaults prior to completion South Africa: Coverage for building defects for a certain period after owner occupancy The latter is the focus of this presentation.

South African Context Post-Apartheid: President Mandela wanted to get the private sector involved Capital subsidies available Other institutional start-ups National Housing Builders Registration Council

Details of South African example Administered by NHBRC, which: sets national building standards manages registration & rating of all developers Independent inspection prior to occupancy Covers major building defects for 5 yrs. Covers minor building defects for 90 days Threat of license revocation if developer fails to correct defect Homeowner fee:1.3% of construction cost, and can be capitalized in loan or paid Developer fee: $100 in Year 1; then $25/yr.

Desirable outcomes of BWS in SA: Standardized housing design reduced cost Better quality housing stock Contributed to rapid development of 1 million new affordable houses (bank-financed)

Analysis of BWS Fees (all in USD) GradeSale priceFee calculationMaximum fee AUp to $64,5001.3% of sale price$813 B$64,500 - $129,000 Level A max, plus 1% * (Sale price – Level A max) $1,485 C$129,000 - $238,000 Level B max, plus.75% * (Sale price – Level B max) $2,454 D$238,000 - $645,000 Level C max, plus.75% * (Sale price – Level C max) $4,391 E$645,000+$4,391

Business Case for BWS can be positive: No Fiscal Contribution Big Assumptions: 1.0% warranty fee 1.1 m units under warranty yr 5 Inspector salary $30k/yr., completes 12 per day 1.5% make claims $2,250 (50%) cost per claim, with half ($1,125) covered by developer and half by BWS ($1,125) Other operating costs at 35% of revenues Fiscal contribution $.5m 1 st yr

Concerns and potential downsides to be carefully managed Developer resistance (costs, admin.) Insurer over-zealous resistance to pay claims Does not address developer default pre-occupancy Inadequate number of inspectors Added development costs (~ 1%) Insurer liability if unexpected claim rate

Key elements of BWS: Competent, well-positioned and politically supported institution to administer it Setting appropriate building code standards Low entry barriers & training for developers Availability of inspectors Efficient dispute & claim resolution process

Contact:James Hokans 48 Grove Street, Suite 303 Somerville, MA USA USA Tel: – 0711 India Cell: Thank you!