Fast-growing hotspots: Enter tier II cities while prices are attractive

Many of them could emerge as growth hubs in the near future offering sound price appreciation, but they also carry the risk of a supply glut

Tier II and tier III cities present a varied picture as far as price appreciation in the residential segment over the past year is 

concerned. Some micromarkets have witnessed good appreciation (See: Fast-growing hotspots), while in most others prices have been stagnant or risen in the single digit. Nonetheless, an investor exploring investment options should consider these cities. 

Affordable option: The primary reason why tier II and tier III cities should be on an investor's radar is affordability. They offer options even to those with a limited corpus. “Capital values are much lower in these cities than in the metros,” says Gagan Randev, national director, capital markets and investment services, Colliers International India. Capital values range largely from Rs 3,500-6,000 per sq ft.
 

Many of the metros have grown to the point of saturation. “Real estate demand is shifting from tier I cities because they face issues such as land scarcity, unaffordable property prices, and rising cost of living,” says Anuj Puri, chairman, Anarock Property Consultants. The government's policy initiatives are also providing a fillip to growth in non-metro destinations. Puri says that initiatives such as Housing for all, Smart Cities mission, Jawaharlal Nehru National Urban Renewal Mission (JNNURM), Atal Mission for Rejuvenation and Urban Transformation (AMRUT) are helping to transform living conditions in these smaller cities through constant infrastructure upgrades. As a result, many global corporates are looking to set up offices in them.  
 

Price appreciation is expected to be better in the cities that come under the Smart Cities mission. This project is expected to lead to better governance, improve ease of doing business through faster approvals, land records are expected to be digitised, and so on.  
 

Earlier, when top-rung developers went to tier II and III cities between 2007-2011, they catered to the upper middle class and the rich strata in these cities. But now, after the government's incentives, they are coming up with affordable housing projects. Thus, there is a better fit now between what the developers are offering and what the local population can absorb. 
 

Some tier II and tier III cities have witnessed real estate demand in recent times because of specific reasons. Vijaywada and Vizag in the south, for instance, have seen high demand after the new state was announced. In Vijaywada, prices rose rapidly because it is close to the new capital called Amaravati. In Vizag prices ran up because it gained prominence, as it is one of the largest cities of Andhra Pradesh. Dehradun in the north, meanwhile, is emerging as a hub for retirement homes, after the success of Antara. 

 

Beware of limited demand: The biggest risk of investing in these cities is that they have only a limited demand for housing, owing to their smaller population size. “The amount of demand that these markets can generate locally is limited. They don't have the kind of demand that exists in cities like Gurugram or Bengaluru, where it comes from both within the country and from non-residents. The moment a considerable amount of  supply comes into these markets, there is a glut, which hinders further price appreciation,” says Vamshi KK Nakirekanti, executive director and head, valuation and advisory services, CBRE South Asia. Demand for apartments is also limited in these cities, with standalone housing being the preferred option. Other risks that investors may encounter are lack of transparency in development regulations, encroachment of land parcels, and unclear ownership titles. 
 

Prices in tier II towns are increasing based on expectations of smart city development. “As these are long cycle projects, delays in their execution could also delay investors' returns,” warns Ankur Dhawan, chief investment officer, PropTiger.com.

Check for city’s growth drivers: Investors venturing into tier II and tier III cities must check whether the fundamental factors that drive real estate growth are in place. “See whether the level of economic activity and job growth is robust,” says Randev. 

The next factor you should check is infrastructure development. Tier II cities like Ahmedabad, Coimbatore, Jaipur, Chandigarh, etc, which are on investors' radar currently, have all witnessed considerable amount of highway development in the recent past. Besides core infrastructure, elements of social infrastructure — schools, colleges, malls, restaurants, movie halls, etc — must also be available. 

Get into the right project: For your investment to do well, you must choose the right project. The right location is critical. “Most projects that came up in tier II and III cities in 2007-2011 were on the outskirts, say, on the Ring Road. They did not do well. Projects should be situated close to existing settlements,” says Nakirekanti. Proximity or good connectivity to employment hubs is crucial. Also make sure that there is a good mix of end users and investors. If you only have investors, you could end up with a development that turns into a ghost town. Finally, the developer’s track record, and how aware he is of local regulations becomes important. “Many developers got stuck going into new markets earlier because they did not have an understanding of local regulations and processes,” says Nakirekanti.
 

Many people invest in a house in a tier II city because they hope to eventually retire there. In the meanwhile, they hope to earn a rent from it. While in many tier I cities the level of rental yield has shrunk to 1.5-2 per cent, in tier II cities you could earn a slightly higher yield of 2.5-3 per cent in a good project due to lower capital values. Invest now with a horizon of five years or more. 
 

Investors with a large corpus may look at commercial real estate options. However, they should be aware that maintenance costs tend to be higher, and managing and leasing the property remotely could be a challenge.