Small Cities Big Business

In the last five years or so, the demand fundamentals in India have seen a distinct shift towards tier-II and tier-III cities where consumers have the same aspirations as their counterparts in large metros. Consider this: Chandigarh has the highest number of cars per person, Lucknow has the second highest proportion of graduates after Kolkata and Ludhiana ranks extremely high in terms of consumerism.

India’s younger and English-speaking middle class population, which mostly resides in tier-II cities such as Chandigarh, Lucknow, Ludhiana, Baddi, Surat, Pune, Nashik Coimbatore, Visakhapatnam as well as Kochi are driving demand like never before. Tier-II and tier-III cities have become attractive destinations for several businesses, be it retail, real estate, financial services or IT. Economic growth has trickled down from metros to smaller cities thanks to investments by information technology (IT) and IT-Enabled Services (ITeS) industries, improvement in infrastructure as well as increasing urbanization.

Information Technology, in particular, has contributed a lot to the growth of tier-II and tier-III cities. Take the case of Bhubaneswar in Orissa, which has become a hot property destination after three IT companies – Tata Consultancy Services, Infosys and Wipro set up their campuses there. In Kerala, cities such as Thrissur, Trivandrum, Calicut and Kochi have seen a lot of activity in property markets in recent times because of the growing presence of IT companies in the cities and also because of the demand for real estate from non-residential Indians (NRIs). Other smaller cities such as Baddi in Himachal Pradesh and Pantnagar and Rudrapur in Uttaranchal have attracted a lot of residential developers thanks to the respective governments’ proactive policies.

Rudrapur, for instance, has seen prices appreciating by more than 80% in the past three years, which is higher than the price appreciation in India’s hottest property market, Mumbai. It is not just Rudrapur. There are many tier-II and tier-III cities like Coimbatore, Visakhapatnam and Kochi in the south and Pune, Nasik and Nagpur in the West, which are showing steady price appreciation. Real estate developers are developing a fancy for tier-II and tier-III cities because returns in such cities are stable and much better than metros over the long-term. There is not much speculative buying in smaller cities as has been the case in larger markets such as Mumbai and Delhi. Lack of speculative buying helps in keeping price and demand stable, which really works for developers exposed to volatile price and demand movements
in large cities.

A key demand driver for real estate development across cities is the retail sector. Experts believe that the demand for real estate development in tier-II and tier-III cities will expand exponentially after the government allows Foreign Direct Investment (FDI) in the retail sector. Foreign retailers such as Wal-mart and Metro are already operating in the cash-and-carry segment in smaller cities such as Raipur and Ludhiana. With FDI in retail, it is likely that foreign retailers will open stores in smaller cities. This is because unlike metros, tier-II cities have lower real estate costs attached to retail operations. Retailers would also be motivated by consumer demographics of tier-II cities, which are seeing an increase in income generating young population.

Once foreign retail chains open shop in smaller cities, infrastructure in tier-II and tier-III cities will improve because the retail chains will require warehousing, cold storage and logistics facilities. This will have a multiplier effect because as infrastructure improves, more national retailers will move towards tier-II cities. This will, in turn, stimulate the demand for commercial and residential real estate in these cities. It is not just retail and real estate sector, even automobile companies say that the demand for cars in smaller cities, especially luxury cars, has been rising in the last few years. Spending on luxury cars such as Bentley, Lamborghini, Aston Martin, Ferrari, Maserati and Bugatti has grown manifold.

This is quite a change from times when spending on luxury items was frowned upon in smaller cities. Cars such as BMW, Mercedes, Jaguar and Audi top the list of luxury cars bought by the rich in cities such as Indore, Lucknow and Coimbatore. Realizing the demand potential from tier-II and tier-III cities, auto companies such as Mercedes and BMW are increasing their dealership in these cities. While Mercedes has expanded to Surat, Jaipur and Goa, BMW plans to take the brand to Aurangabad, Surat, Ludhiana, Goa, Nagpur, Kolhapur, Jalandhar, Raipur and Noida. Luxury car makers are also tweaking their products to suit the demands of buyers in smaller cities. Brands such as Aston Martin, Porsche, Maserati and Ferrari have introduced four-door cars because buyers in tier-II cities prefer four-door luxury sedans compared to two-door sports cars.

Bike manufacturers are also targeting the rich in non-metros such as Guwahati, Jaipur, Bhubaneswar, Lucknow, Kochi, Bellary and Indore. For instance, Harley-Davidson plans to open dealership centres in Kolkata, Jaipur and Kochi. A study by ratings agency, Crisil makes it clear that rising income levels and a greater propensity to consume in India’s tier-II cities has created an attractive opportunity for retail finance players. The study covered markets including Bhopal, Coimbatore, Indore, Jaipur, Kanpur, Kozhikode, Lucknow, Ludhiana, Madurai, Mysore, Nagpur, Nashik, Rajkot, Thiruvananthapuram, and Visakhapatnam. These markets account for about 15% of the demand for retail loans in India, as per the report by Crisil. Crisil research believes that growth prospects in most of these markets are very strong. The report estimates that car loan disbursements in 10 of the 15 markets covered will clock a 20% compounded annual growth rate (CAGR) over the next two years compared to a CAGR of around 13% in larger cities.

Gold loans are expected to grow at a much faster pace (more than 50% annually) in five non-southern cities covered in the study. Strong growth prospects, less competition, high yields and profitability compared with larger cities make tier-II markets an extremely attractive proposition for financiers, as per industry experts at Crisil research. Reserve Bank of India’s mandate that one-fourth of new branches must be opened in rural and semi-urban unbanked regions indicates that the demand for retail loans will also come from consumers from smaller cities. “These cities would be the main drivers of retail loans in India,” the Crisil report said. Crisil says that despite the difference in volumes, higher profit margins can make smaller towns as attractive as metro cities. Banks, however, would have to be careful about the asset quality, which could be a concern for choosing the right cities. Yields in smaller cities, in products such as home and two-wheeler loans is higher while for asset quality again, in 8 out of 15 cities, bad loans were comparable to all-India standards. Crisil says that this means that if chosen carefully, the fear of more loans turning bad in smaller markets could be successfully combated. Credit card companies have been a step ahead of banks in offering their services in smaller cities, where there is a surge in borrowing for the purpose of consumption. Going by the success stories of several businesses in tier-II and tier-III cities, it is quite possible that in the coming years, we may see more and more companies targeting the burgeoning demand potential in smaller cities.