As first published in Social Housing on 6 December 2017.
Housing leaders and industry experts explore the HA ‘blueprint’ and merits of off-balance sheet vehicles, REITs and equity. David Blackman reports. Photography by Belinda Lawley
Housing association business models are under the spotlight amid increased ambition to address housing need and renewed political pressure to deliver more homes and services.
Recent debates over ways to increase financial and development capacity have tended to focus on efficiency, mergers and off-balance sheet vehicles, but have also reopened the long-running discussion about whether equity has a place in a non-profit sector. In the meantime, new-to-sector funding and delivery models have gained traction this year, namely in the form of real estate investment trusts (REITs).
To explore how associations are shaping up in a changing landscape, Social Housing and Devonshires Solicitors brought together housing leaders, funders, REITs and advisors for a round table discussion.
The event took place a week before last month’s Budget, with the outlook for housing associations brighter than it has been for many years.
Jonathan Walters, deputy director of strategy and performance at the Homes and Communities Agency (HCA), said: “The world has moved on a lot. Two years ago, it felt like [the sector] was being kicked from a number of different angles. Now it is seen as a key delivery partner – but if it doesn’t deliver there will be political consequences.”
Matthew Bailes, chief executive of Paradigm Housing Group and formerly of the HCA, said that the government’s more emollient approach to the sector is a pragmatic response to wider economic and political uncertainties.
“They see the need for a countercyclical buffer, mostly due to Brexit, but also due to the inevitable rise of interest rates.
“If market sentiment becomes very difficult, a lot of people are going to catch a cold in the South.”
Given the likelihood of another three to four years of economic uncertainty, he said the sector is “well placed to sustain its position round the table”.
Phil Jenkins, managing director of Centrus, questioned to what extent housing associations can still be described as countercyclical actors in the housing market.
He said: “If you look at where development is concentrated at the top end, a lot of models are based on outright and first tranche shared ownership sales to make schemes stack up.”
Mr Walters warned that associations are at risk of becoming too wedded to the vagaries of the wider housing market: “The more pro-cyclical the sector becomes, the more it destroys its key unique selling point with government and investors: the sector needs to think quite hard about how it balances its market against its core product.”
But others argued that systemic shifts in the housing market mean that the sector is obliged to respond to a wider spectrum of need than it has historically.
“The meta-economics of owner-occupation mean that almost nobody could afford it if you took it off them,” said Brian Cronin, chief executive of North West-based Your Housing Group (YHG).
He said the government wants to be presented with a solution for the increasing numbers of 25 to 40-year-olds who are renting privately with no security of tenure.
“There are some people who will never be owner-occupiers who would have been 20 years ago; therefore we need to plan for and manage that.
“There are a lot more people getting a bad deal in the housing market,” he said.
Allowing this trend to continue, which would effectively replace owner-occupation with private renting for an entire generation, would be “deeply difficult” without wider pension saving and housing reforms.
“The model of high rents and no pension saving is a time bomb for everyone, including the generation affected,” Mr Cronin said. He added that it is not a “tenable future” to force this cohort to keep working so they can keep a roof over their heads, or to make the state pick up the tab.
“These are big tax and cultural issues for government to tackle,” he said, adding that it is more likely to make an effort to get the next generation onto the housing ladder.
In order to cater for this growing group, he said YHG is trialling the introduction of lifetime tenancies in its private rented stock.
Mr Bailes said that while social landlords have traditionally focused on the relatively small proportion of people who rent social accommodation, they are now gearing up to cater for an entire generation.
Amid the renewed focus on the sector’s traditional core social housing demographic in the wake of the Grenfell Tower disaster, he said associations have to be careful not to lose sight of this wider population.
“We have obligations to a whole range of people in the market and a whole age group.”
Build on strengths
Andrew Cowan, a partner at law firm Devonshires, suggested that in this changing landscape social landlords could use their balance sheet strength to boost supply: “Associations have a capital base to intervene, create new markets and then exit like Waitrose did with Ocado,” he said.
But adopting this more entrepreneurial approach poses challenges to how housing association finances are structured.
Many associations’ financial covenants have not changed in line with the shifts in their underlying business, he pointed out. “To make that shift you would have to be prepared to refinance all your loans with bond debt where you would end up with different kinds of financial covenants.”
Centrus’ Mr Jenkins added a note of caution. “You still have to manage your business to a reasonable level of interest cover to satisfy a ratings agency or a regulator,” he said.
Housing associations’ traditional charitable status also came under the microscope at the round table.
Helen Collins, head of Savills Housing Consultancy, mooted the idea that associations reinvent themselves as what she termed “ethical property residential developers”. As long as they agreed that at least 50 per cent of their activity should cater for those excluded from the market, adopting this ethical developer model would give organisations more control over their futures.
The sector could more fully realise its hugely powerful asset base, without abandoning its social purpose, Ms Collins said.
Mr Cowan, meanwhile, was not convinced the public really understood what is meant by housing associations’ not-for-profit status. “It’s not a sacred cow beyond being a regulatory requirement to keep enough cash in the business,” he said.
For Mr Cronin the red line was maintaining associations’ status as not-for-profit bodies.
The introduction of new equity financing will also pose challenges to associations’ traditional business models. “This sector has been built on high grant rates and low cost of debt, but that’s changing,” said Mr Cowan.
Alex Gipson, lending manager at Legal & General, said the sector remains attractive to investors: “There is plenty of money out there.”
However, several participants at the round table expressed concern that it is becoming too dependent on institutional investment.
Mr Gipson said associations have a “dangerous history of being reliant on a single source of capital”, recalling how the sector used to be wedded to bank lending.
He pointed to HCA figures showing that the sector’s debt is projected to rise from £66bn to £77bn by 2021/22.
“We have a problem now. Unless we have different types of capital we will be reliant on the investment grade institutional market, which won’t be able to cope.”
Mr Jenkins noted what he described as a “slightly destructive tendency in the housing sector to carry on borrowing until we can’t”.
“If you started with a blank sheet of paper, you wouldn’t start with the capital structure we have. The traditional reliance on debt was fine when you had 50 per cent grant in there because you could manage a sustainable growth position, but without grant you are borrowing more and more against the same asset base.”
There needs to be a more sustainable way for the sector to deliver, he added.
Ken Youngman, chief ﬁnancial officer of the recently launched Residential Secure Income REIT, said the social housing sector is becoming much more akin to the corporate world, where a mix of debt and equity is common. Historically, he said, the sector’s ability to draw down grant has enabled it to build up equity at no cost.
Mr Gipson said associations’ balance sheet strength provides a robust platform that could be leveraged. “The sector has been sheltered by nil-coupon government grant and has some ability to leverage further,” he said.
Mr Youngman said that equity could also help organisations to absorb losses during a downturn. “You still have to pay coupon on debt, whereas equity gives the ability to ride that period out.”
However, Paradigm’s Mr Bailes doubted that associations could use equity to finance their traditional mainstream provision. “Social housing without subsidy is not really an investable proposition. It’s difficult to see how that would work in affordable housing because without subsidy the returns would not service the debt or equity,” he said.
In addition, there are potential reputational risks for associations when tapping equity providers, said Mr Jenkins. He said: “You have to understand the capital you are getting into bed with.”
He noted that boards are more likely to be cautious when dealing with US hedge funds than long-established UK institutions like L&G.
“If you are getting a board to agree a transaction you will get a very different view of reputational risk if you are trying to do a deal with Blackstone as opposed to L&G. Those organisations have a very strong vested interest in their own reputation.”
Mr Cowan queried whether this should necessarily be the case. “L&G is much more susceptible to political interference than a non‑UK fund,” he said.
More broadly, Mr Jenkins said there is plenty of scope for misalignments of interest between associations and investors.
“As a housing association you have a very long-term mind set: you can take a 100-year view.”
By contrast, he said, for many City of London funders, taking a long-term view means seven or eight years. “If you put those into a structure together it causes real problems down the track.”
Andrew Dawber, director at Civitas Housing Advisors, said much depends on the nature of the investor. He said: “There will be some very short-term money that is quite aggressive and is not suitable for this sector at all. Equally there will be money that is very passive, has a 20 to 30-year time horizon and is matching liabilities which would be very suitable.”
He added that the increasingly sophisticated nature of associations means they no longer need just patient capital. “Most housing associations now have a core bit that needs [long-term capital] and other bits that need something different.
“This sector needs some impatient capital as well because some stuff is short-term development.”
However, Mr Gipson said that the increasingly opaque nature of housing association balance sheets means that broad-brush ratings no longer provide a clear picture.“Lots of organisations are taking capital out of their business and investing it somewhere else to make a greater return.
“A large London housing association that is rated A+ probably has an AA-rated housing association with a sub-investment grade-rated developer in there,” he said.
This lack of clarity means some investors are uncomfortable about where the business as a whole is heading, Mr Gipson said, giving the example of a large London developing association that could shed more light on its private rented sector (PRS) returns. He added: “It needs to bring those investors with it on the journey.”
Centrus’ Mr Jenkins agreed: “The problem for lenders has been lack of clarity on what value at risk is in which parts of the group.”
He added that the way Thames Valley has structured its Fizzy Living PRS subsidiary is “a very good template” for other housing associations.
“If the sector is a bit more honest about where it is going you can get the right capital in the right part of the business,” he said.
The HCA’s Mr Walters raised concerns over associations’ use of off-balance sheet vehicles.
“The concern we have with off-balance sheet is that when you go through a few distressed situations, you find that things not on balance sheet have a way of coming back on.”
Sharing the load
Joint ventures offer another way for associations to boost their capacity.
Fenella Edge, treasurer at The Housing Finance Corporation, said that some housing associations have been “naive” about entering into JVs.
Ray Tierney, relationship director for social housing at Lloyds Bank, said the key is to avoid getting into a JV with an organisation that has very different aims.
Working together, as L&Q is doing with Trafford Housing Trust, could be a better value-for-money option than merger, he said. As an example of the downsides of tie-ups, he pointed to the “staggering” sums associations have spent on rebuilding IT systems after merging.
But Mr Cronin said that housing associations remain handicapped by their relatively low output levels compared to house builders, which can secure better procurement deals.
“If you want to set up an entity that was going to get significant value chain savings, you are talking about 20,000 units per annum so you would probably need 40 to 50 associations to come together in one entity.”
On a more modest scale, Savills’ Ms Collins told the event that she was working with Devonshires on a bid by Greater Manchester’s housing associations to set up a development vehicle that aims to deliver 500 homes per annum on land released by the conurbation’s local authorities.
“Politicians are incredibly positive because it’s Greater Manchester which is so much more mature as a combined authority than any other. On the other hand, it’s horribly complicated: I hope that it comes to fruition because it’s very positive.”
The changing nature of the sector’s business models also raised questions over how it is regulated. Mr Cronin suggested that the housing regulator should adopt a new model, like The Pensions Regulator.
“Rather than spending loads of time and effort making sure everyone stays afloat, they have the ability to step in when somebody doesn’t. We manage to make some people stay afloat who shouldn’t.”
He argued that this different way of regulating the sector should provide lenders with sufficient reassurance.