Memorandum from The Nordic Enterprise Trust (NET) (CRED 03)
1/ Introduction
The Nordic Enterprise Trust (NET) is a Scottish social enterprise whose aim is to strengthen economic and cultural links between Scotland and the Nordic countries.
However, in view of the symbiotic relationship between Scotland and England, we believe that our work must necessarily be as relevant to Westminster as it is to Holyrood. We are therefore making this Submission to the Communities and Local Government Committee in that context.
In doing so our focus has been upon the legal and financial foundations or Enterprise Models which underpin our society. The conventional Enterprise Model consists of a combination of Equity (shares in a Company) and secured Debt, now in increasingly short supply due to the Credit Crunch.
NET has developed, with part funding from the Norwegian government agency Innovation Norway, a new legal framework for investment both in productive assets generally, and investment in land and buildings in particular.
In this Submission we outline a new form of financing and tenure framework we term the "Community Land Partnership" (CLP) and we will compare and contrast this enterprise model with the current suite of more or less conventional forms of tenure and finance currently available and under development.
We believe the potential policy outcomes of the CLP are compelling, and include the following: · Financing at a fraction of the cost of conventional finance. · A new asset class ideal for long term investment · A "Right to Invest" · A sustainable development framework, or enterprise model, within which it is more profitable to develop to high standards of quality and energy efficiency than to do otherwise · A policy which requires minimal, and probably no, legislation to implement
In addition, we believe that the CLP opens up consideration of potential breakthroughs in many areas of social policy.In summary, conventional funding of housing with secured debt has been choked off by the Credit Crunch. Our proposal is simply to replace this "deficit-based" funding with a new form of asset-based financing or Co-ownership, which comprises a new form of quasi equity within a partnership-based legal and financial framework.
In this way NET aims to mobilise Norwegian/Nordic financial and intellectual capital and resources to work in partnership with the UK to provide the sustainable and affordable housing which is so urgently needed.
2/ Conventional Enterprise Model
Tenure The subject of tenure relates to the rights of occupation of land, and essentially distinguishes between: l permanent rights of ownership, eg freeholds; and l temporary rights of more or less exclusive use for a defined term, eg leaseholds and tenancies.
Other - contractual - mechanisms allow the exclusive use of property, such as Housing Co-operatives. Here, a Corporate body (essentially a collective) owns the property, and the individual rights of occupation are conferred by the contractual arrangements set out in the Co-operative's governing agreement.
In recent years there have been new hybrid mechanisms such as the Co-ownership leasing arrangements in common use in Northern Ireland since 1978, and many schemes to share equity, "rent to buy" and so on.
More radically, there is the "Community Land Trust" ("CLT") which originated in the US, is currently being adopted in England, and has recently been defined in UK legislation. In this model - which is very close to the rural "Community Right to Buy" legislation in Scotland - the land is held in trust for the Community and leases granted to occupiers.
Financing and Development In all cases, financing comprises either grants (which may be repayable) or lending from a credit institution, such as a bank or building society, secured by a charge or mortgage over the freehold.
Developers operate on a transactional basis as intermediaries: · acquiring land; · building houses on the land -typically financing the development with a mixture of share capital (Equity) and secured debt; and · selling on the developed property to buyers who again use mortgage loans for the purpose.
Issues The issues arising from the conventional enterprise model are widely recognised, and have over the years been the subject of many and varied reports, policy initiatives and legislation.
The uplift in land values conferred by the granting of planning permission constitutes a major part of developers' profits. The capture of some or all of this uplift is the subject of ongoing guerrilla warfare between the housing industry and government, not just in Westminster and Holyrood but in most countries with conventional property rights.
The availability of land, which is often "banked" by developers and then fed into the market at an optimally profitable rate, is a major issue, and the subject of much recent consultation and discussion.
The sustainability of development has emerged in recent years as perhaps the most contentious issue in this conventional transaction-based model, where land is bought and sold on by a developer.
Since the developer wishes to maximise his profit on sale, he has an incentive to minimise costs and the standards of quality and energy efficiency - and therefore cost of ownership over time - will always be secondary to the primary purpose of profit generation.
3/ The Community Land Partnership
On 6 April 2001 a new legal entity, the Limited Liability Partnership (LLP), came into effect in order to protect professional partnerships from the consequences of their own negligence.
Confusingly, an LLP is not legally a partnership. It is, however - like a company - a corporate body with a continuing legal existence independent of its members. Also, as with a limited liability company, you cannot lose more than you invest in an LLP.
Unlike a company there is no requirement for a Memorandum of Incorporation or Articles of Association. It is also not subject to the body of legislation governing the relationship between investors and other stakeholders, and particularly the directors who act as their agents in managing the company.
The LLP agreement between members is totally flexible. It need not even be in writing, since simple provisions based upon partnership law apply by way of default. This new legal tool may be applied to create a framework for investment in, and ownership and occupation of, land and property.
A Community Land Partnership has four Members:
· Custodian Member - which holds the freehold of the Land in perpetuity on behalf of the Community
· Occupier Member - which consists of the community of individuals and/or enterprises which occupy the land and the property on it
· Investor Member - which consists of the consortium of individuals and enterprises who invest money and/or money's worth (such as the value of the land) in the CLP
· Developer/Operator Member, which provides development expertise and manages the CLP once the development is complete.
Structure
When the development is complete, the Occupier pays an agreed rental for the use of the Capital which has been invested in the property.
This rental is set at an affordable level initially, and comprises both a provision for maintenance/ depreciation and related management/ quality control (and possibly heating) of the building and a "Capital Rental" paid for the use of the Capital.
This Capital Rental then rises with an agreed indexed measure of inflation.
The Alchemy in this model arises from the fact that the land - which has constituted an increasingly disproportionate part of a property's value - does not depreciate in value and that no debt in respect of it need be repaid: ie this is Equity investment, not Debt
If an Occupier pays more than the affordable rental he invests automatically in proportional Equity Shares and thereby acquires a stake in the property in which he lives. Once he has acquired 100%, the income which he derives from the investment cancels out the rental he is due to pay, although he still must pay to maintain the property.
For an investor the income from the Capital Rental is a reasonable - maybe 3 or 4% - return where the capital - unlike in a bank or building society deposit - is protected from inflation.
For the Occupier, it is affordable housing, because there is no capital repayment cost.
Most radical, in this model, Occupiers may change, Investors may change, and the Developer/Operator may change, but the property need never be sold again. Occupiers moving elsewhere may sell their proportional Equity Shares to fund a purchase, or leave them in place and rent/buy somewhere else.
Example A land-owner in Brodick has land which he is prepared to invest in the Brodick Land Partnership.
He agrees with the other Brodick Land Partnership members that he will receive a 20% proportional Equity Share in the rentals from the developed property.
A Norwegian provider of eco-friendly and energy efficient wooden buildings is prepared to sell 5 units at a cost of £200,000 plus a 10% Equity Share (so he is investing part of his profit margin).
The Occupiers between them dig foundations, and provide other non-skilled labour and in return receive a 10% equity share.
Another £100,000 is necessary to cover other costs, perhaps including heat pumps, a wood chip boiler and other investment in energy efficiency.
It will be seen that 60% of the proposed Capital Rental must be available to pay for: (a) (say) 10% for ongoing Maintenance and Management; and (b) (say) 50% in respect of the £300,000 money investment.
At a 4% initial return on investment this requires a Capital Rental of £24,000 in the first year divided as follows.
· Management and Maintenance charge is 10% or £2400 · Land owner receives 20% ie £4,800 · Norwegian manufacturer receives £2,400 · Investors receive £12,000.
The Occupiers pay £4,800 per house initially, reduced by £480 (their Equity Share), ie an affordable £360/month each.
Any Investors owning proportional Equity Shares in future revenues may sell them at any time, or keep them for their retirement.
4/ Outcomes The CLP structure opens up new possibilities for developing the policy proposals set out in the Enquiry, and we propose to address these within two themes: Affordability, and Sustainability.
Affordability
Supply The problem is not one of affordability of housing, but rather the affordability of land, since construction costs are relatively uniform. In essence the issue relates to land rental values - since a land purchase price is simply the capitalised net present value of future land rentals.
The issue of supply primarily relates to planning, land use, and an absence of incentives to bring land into use.
While the subject of taxation of land rental values is not addressed in the Enquiry, we note that where such taxation has been introduced the result is invariably to bring land into productive use.
The use of the CLP allows land owners to invest the value of their land and to receive an agreed share of the rental value of the developed land. Similarly, the use of the CLP by Councils, allows them to invest the value of planning consents, and to use the resulting share of the rental value of developed land to cross-subsidise affordable property rentals.
We suggest that if Councils were to specify - possibly mandated by Central Government, which would require legislation - that development could only take place within a CLP framework, the result could be a major increase in development of affordable housing. In fact, the structure renders s106 of the Town & Country Planning act 1990 redundant because the issue of land value capture is addressed consensually within the CLP framework, rather than adversarially within a statutory framework.
In relation to the Right to Buy, the CLP gives Occupiers the Right to Invest in the Co-owned property in which they live, and not only through buying Equity Shares conventionally, but also potentially through Sweat Equity: (a) in self build or partial self build; (b) carrying out maintenance to agreed standards, to be monitored by the CLP Operator Member.
The outcome is that any investment made by Occupiers will buy Equity Shares, which will have the effect of reducing their rental obligation.
So when investment reaches a level at which Capital Rental income to an Investor equals his Capital Rental obligation as an Occupier the result is essentially de facto ownership, but in a way in which the Investor/Occupier may flexibly release Equity at any time simply by selling units.
Demand Addressing affordability through subsidising property purchases or rentals, merely serves to increase the price of land and the level of rentals, respectively.
The CLP model addresses affordability firstly by taking land ownership out of the equation by putting the land into the ownership of a Custodian, which is the approach used in the Scottish Community Right to Buy.
However, where land owners, either public sector, or private individuals, are reluctant to give up ownership, it is possible for them to retain ownership as the Custodian member. In that case, the CLP agreement essentially operates as an evergreen lease of indefinite duration. Where that is so, the measure of control retained by the owner would affect the amount and nature of the return they could expect through the CLP in their other stakeholder role as an Investor of the value of the land.
Secondly, and crucially, the CLP addresses affordability by drastically cutting long term financing costs.
The financing costs are reduced, because: (a) there is no return of capital, as with debt, since the capital is unitised into tradable Equity Shares in the CLP analogous to units in a Unit Trust; (b) the return on capital bears no relationship to interest rates, since it will be an index-linked return reflecting the risk of property-based investment largely backed by government supported rental revenues.
The requirement for development financing will be minimised through participation by stakeholders, eg land would typically not be bought with loan finance, but invested. Where land is in public ownership, this will allow the public sector to participate further in the increase in land rental value arising from development in addition to the gain accruing from the granting of planning permission.
In this model, Prudential Borrowing may be used to create a Pool of development credits continually recycled from sales of rental units.
Sustainability In the CLP model the Developer/Operator is a service provider, not an intermediary, and need neither risk conventional Equity investment nor put his business at risk by obtaining secured loan finance.
The Developer/Operator's interest lies in minimising the total cost of occupation over time, because this will maximise the rental revenues and therefore the value of the Units which are received in return for the provision of services, expertise and time committed.
Similarly, any contractors responsible for design and construction will be given the option of receiving these Units or money in respect of the costs they incur, but will be expected to operate on the basis that an agreed profit margin is received in Units rather than money. In this way, their interests are aligned with other stakeholders.
The outcome is that it is in the interests of all stakeholders that any buildings are constructed to high standards of quality and energy efficiency, since to do so minimises the total cost of ownership over time.
5/ Issues - and further Possibilities This response merely scratches the surface of what may be possible using partnership-based frameworks to develop policy options.
There are practical issues of implementation to be addressed, particularly in the areas of taxation and regulation, but NET is confident that the tax transparency of LLPs simplifies the former, and that in the work we have carried out in developing the CLP we have also addressed the latter, and have developed practical regulatory solutions.
In relation to further policy development, there are interesting possibilities in terms of private and public investment, and the deployment of public sector entitlements to land rental revenues.
Units or Equity Shares in the resulting pools of property and land rentals, are to all intents and purposes identical to units in Real Estate Investment Trusts (REITs). The streams of index-linked property-based revenues match perfectly the aspirations of long term savers, particularly those saving for retirement. However, UK tax treatment in respect of Property Investment LLPs currently inhibits participation by UK pension investors, and this would require legislation to amend.
NET developed the model from the point of view of encouraging simple and effective cross-border Scottish/Nordic investment (NET's core purpose) and there is considerable interest in Norway not only in relation to financial investment in UK productive assets, but also in relation to participation by Norwegian suppliers of materials, expertise and services.
In passing, it is an interesting aspect of the CLP model that the absence of debt and interest opens up the vast pool of Petrodollars in the Persian Gulf looking for Sharia'h compliant investment opportunities.
In relation to Key Worker housing, the deployment of professional pension schemes investing in Co-owned properties is the obvious solution, but currently precluded for tax reasons, as above.
And so on: the applications of the model are wide ranging.
6/ Summary The Community Land Partnership opens up a range of new policy options in respect of affordable housing which require to be developed and NET's approach is to do so through the implementation of demonstration pilot schemes.
The principal benefits of the CLP model are:
· Financial - unitisation of property rentals effectively replaces the need for secured debt at a time when credit creation is constrained by the Credit Crunch addressed by this Inquiry;
· Environmental - resulting from the sustainable development outcome of an enterprise model wherein developers operate as service providers rather than as transaction-focused intermediaries.
The CLP is also attractive in terms of policy formation, since it is:
· Consensual - requiring no further legislation;
· Flexible - offering a simple new tool for policy formation;
· Devolved - with potential benefits for Scottish and Welsh housing policy in particular.
The Nordic Enterprise Trust would welcome the opportunity to brief the Committee in respect of the CLP and to work with the Government to explore and develop the proposed model and the policy options it enables to resolve the effect of the Credit Crunch crisis on housing.
November 2008 |