Evaluate investment opportunities in fast-growing tier-II and III cities

The key for real estate investors is to evaluate whether employment opportunities will grow, and infrastructure projects will be implemented

If you live in a metro city and plan to invest in residential real estate, you should consider widening the ambit of your search to some of the nearby tier-II and III cities as well. In a recent all-India consumer sentiment survey involving 2,797 participants conducted by real estate consultancy ANAROCK, 26 per cent of respondents preferred to invest in a tier-II or III city. With the real estate markets of many metros getting saturated due to high prices and limited availability of space, these upcoming destinations could well emerge as the future growth hubs.

Some of the tier II and III destinations that are now figuring on investors’ radar include Ahmedabad, Jaipur, Chandigarh, Nashik and Kochi. Lucknow is another city that offers good prospects. Says Anuj Puri, chairman–ANAROCK Property Consultants: “While metros like Bangalore, Hyderabad, Mumbai Metropolitan Region (MMR), Pune and Chennai will continue to attract both end-users and investors, tier-II and III cities will be the new growth engines where the bulk of real estate activity is likely to take place in the coming years.”

One piece of data from the Reserve Bank of India that attests to rapid real estate growth in many of these smaller centres is outstanding home loan. “Between 2013 and 2018, many of these smaller centres have shown faster growth,” says Samantak Das, chief economist and head of research & REIS, JLL India. While Mumbai has shown a compounded annual growth rate of 9 per cent, Thane has grown by 22 per cent. While Hyderabad has grown by 10 per cent, neighbouring Raigarh has shown 24 per cent growth. The figures for Delhi and Sonepat are 9 per cent and 20 per cent respectively.  

Growing attractiveness: A variety of factors have made select tier-II and III cities attractive to investors. The first is that price points are more affordable there. If you wish to invest in a metro like Mumbai, you would need at least Rs 1.5 crore for a 2-BHK within the city. In tier-II and III locations, on the other hand, many options become available within the Rs 20-40 lakh range, which is what the larger number of investors can afford.  

Most metro cities are bursting at the seams. Infrastructure development usually tries up to keep up with growing population pressure and needs, and it is usually a case of ‘too little, too late’. In tier-II and III cities, on the other hand, it is possible to carry out greenfield, forward-looking infrastructure development that can drive employment, and hence both capital and rental value appreciation. For instance, Lucknow’s realty market is riding high on the development of infrastructure projects such as the internal metro network and the Delhi-Agra-Lucknow Expressway. The inauguration of small stretches of the metro in cities like Nagpur and Kochi too has given a fillip to real estate along those corridors.

Moreover, according to ANAROCK, government initiatives like the Smart Cities Mission and AMRUT (Atal Mission for Rejuvenation and Urban Transformation) have seen better uptake in these smaller cities. The Smart City tag given to cities like Ahmedabad, Chandigarh and Kochi, among others, has provided a shot in the arm to their real estate profile.

IT-enabled services i another driver of real estate growth in tier-II and III cities. “Many tier-II cities have quality professional institutions, which means availability of qualified manpower. Lower land prices allow for setting up of larger campuses. And in recent years these cities have become technologically ready,” says Das.   

Do the due diligence: Not all tier-II and tier-III cities are equally attractive. How well a city’s real estate market performs will depend on the growth in its employment prospects, which will in turn be determined by its ability to attract companies, including multinationals, to set up their offices there. How fast infrastructure projects get implemented will also have a bearing on the capital appreciation and rental returns investors enjoy. Bigger investors, especially, may consider employing a credible property consultancy to do this evaluation on their behalf. A lot of private-equity investment has gone into smaller cities like Bhubaneshwar, Chandigarh, Ahmedabad, Mohali, Indore and Amritsar—$1.37 billion between 2015-18, according to ANAROCK. Riding on the coat tail of these big boys, who do a lot of due diligence, could be a good strategy.     

The pace of construction of commercial properties and their leasing activity can also provide a sense of whether there is demand for housing in a micro-market. “Companies go for new offices when they hire more people. More jobs in those cities mean there will be greater demand for housing in the catchment areas,” says Gagan Randev, national director-capital markets and investment services, Colliers International. He also suggests evaluating the supply of housing in the city. “Once the existing supply starts getting depleted, developers start new projects. It Indicates that the city is growing and property prices could rise,” he adds. 

Guard against risks: Land litigation is a major issue in these smaller cities. Another issue to check is whether the developer has got all the approvals from the authorities. “Hire a local lawyer to do the due diligence on your behalf, even if it means spending extra on their fee,” says Das.   

Many of the developers operating in these cities may have limited or non-existent ability to develop real estate. Check the developer’s financial soundness as well. Many pan-India level developers with a long track record of development are now expanding their footprints into these smaller cities. Going with them will help minimise development risk.

As India’s real estate market matures, those days when you could double your investments within three years are over. Have an investment horizon of at least five to seven years. Investors should also moderate their return expectations to an annualised rate of around 8-10 per cent.