Memorandum from Gentoo Group (CRED 26)

 

Summary

• The Government's targets for new housing provision are unlikely to be met without a significant shift in political and financial will to fund it

• Volume build has been achieved before but with much heavier public subsidy and lower build standards

• The market conditions for new build housing are extremely difficult with the result that many schemes have been put on hold

• Housing Associations are having to constantly monitor financial ratios and covenants but remain viable

• Innovation is required to unlock the affordability problem and new products are being proposed to address this

• The mechanisms by which effective demand and supply are brought together are currently frozen.

• The requirement to spend a high proportion of income to be able to afford owner occupation negatively impacts on the quality of life for many.

 

 

1.0 Introduction

 

1.1 Gentoo Group welcomes the opportunity to respond to the Communities and Local Government Committee inquiry into Housing and the Credit Crunch. The following response represents the views of Gentoo Group, which comprises the following companies:

 

Gentoo Group Limited

Gentoo Sunderland

Gentoo Construction

Gentoo Homes

Gentoo Ventures

 

 

 

 

 

2.0 General Comment

 

2.1 The so called credit crunch has had a range of effects on the housing industry. From the Group's point of view this has had particular effects on the following areas:

· Supply of housing for sale and a drop off in effective demand (i.e. able to purchase)

· The ability to cross subsidise from sale to rental properties

· Capital lock up in new developments

 

2.2 Across all tenures the market positions are now very different. The social rented sector continues to see high levels of demand and low turnover. There is evidence of increasing demand for market rental properties as an alternative to accessing owner occupation. There is a long term demand for owner occupation but this has been severely restricted by more stringent mortgage conditions and a lack of confidence that has resulted in a greatly reduced turnover of properties.

 

2.3 Within the Group there is a mixed tenure portfolio which is insulating the Group from any immediate financial pressure. The Group's development plans have had to be temporarily scaled back however until such time as sale prices and demand picks up.

 

3.0 Specific Comments

 

3.1 In relation to the specific discussion questions the Group will respond as follows:

 

3.2 Achievement of the Government's housebuilding targets, both for market and for social housing

 

3.2.1 The Government's housebuilding targets were always ambitious. The intention to increase supply stated in the Barker Review of Housing Supply and in the Housing Green Paper would see build rates achieving levels not seen since the 1970's. Of critical importance in this is an understanding of the supply side of new housebuilding. Since the 1950's the majority of housing supply in England has come from private building peaking in 1968 with 203,320 completions. In more recent times, i.e. since 1991, private housebuilding completions peaked in 2007 with just 152,090 completions. Unless something significant therefore happens to massively increase the housing association or local authority supply side, it is difficult to see how a 250,000 a year figure can be achieved.

 

3.2.2 This is not to say it could not be done however. England has seen public sector build rates in excess of 100,000 units per annum as the norm before. Between 1946 and 1979 England saw annual completion rates of public housing in excess of 100,000 units in 26 of the 34 years. It was only in the 1980's that public sector build rates began to fall rapidly such that we now regard completion rates in excess of 20,000 per annum as significant. High volume build rates were clearly a political and funding priority in historical times but would take a further significant political and funding shift in current times to re-create anything like build rates that this Country once regarded as the norm.

 

3.2.3 There are further issues to consider however, in discussions on volume build. The current build standards are much more stringent than when volume building previously took place with corresponding effects on unit costs. Without flexibility on the revenue side to accommodate the cost elements it is difficult to see how anything like the volumes previously seen could be achieved.

 

3.2.4 From the Group's point of view there is consistent high demand for an affordable housing product. The issue is simply that the build cost is not met by the revenue generated to finance it. On the affordable rented side the build costs are still in excess of revenue, given the combination of rising costs, restricted revenue through target rents and diminishing grant rates. The cost tower (fig 1) shows the average costs for Gentoo new build property. Even with a grant rate of £38,000 per unit there is a shortfall that has to be met from a combination of core business cross subsidy, land and property sales. This is not a sustainable position in the long term.

 

 

 

Figure 1 - Gentoo New Build Cost Tower

 

 

In addition, for the private sale market, there is a limit to what the market can command price wise and the current market down turn has made formerly viable sites unprofitable, resulting in them being mothballed.

 

3.2.5 A further illustration of difficulties facing developers when building new affordable housing is the shortfall in finance over a 30 year period when looking at rental income.

 

· The average build cost shown in the cost tower above is £121, 951

· The shortfall over a 30 year period when socially renting is £68,048 (using an assumed interest rate of 6% and a weekly rent of £80), inflating by 2.5% each year thereafter.

 

· To fund this new build unit over 30 years, with no profit would require a market rent of £148 per week - an increase of 85% over the social rent.

 

· This means that an affordable rent only funds 54% of the rent required to pay back the original build cost even with NO PROFIT for the housing provider.

 

3.2.6 In terms of the scale of the Group's new build activity there are plans to build out 3,600 new properties for a mix of rent and sale over the next ten years. However, the sale elements of this programme are under threat given the current market conditions. As a proportion of the whole programme relies on sale to cross subsidise the rental element, there is therefore also a knock on effect to the rental elements of the programme. In short, until the market stabilises and begins to pick up, the majority of schemes within the overall programme will have to be halted thereby delaying the overall delivery profile.

 

3.2.7 In summary there are now major difficulties facing the achievement of the Government targets for new build housing. Part of this is market based in that there is little current incentive to build in a declining market. Part of this is simply down to income and expenditure in that previous funding streams to enable new affordable housing provision are no longer viable or achievable.

 

3.3 The financial viability and ongoing business of housing associations

 

3.3.1 Having taken a view of the current economic climate it is also fair to say that the overall financial position of the Group has remained healthy. The Group is continually monitoring and revising its financial projections. Having taken a pessimistic view of the potential to sell new build homes, the Group has been able to continually meet its financial covenants. However, should the market deteriorate further then as with most Housing Associations we may look to renegotiate the loan covenants with lenders. That said, the RSL part of the Group continues to perform strongly in terms of its KPI's. The Group's wider business activities are all monitored as part of the Group's business planning, risk management and financial appraisal mechanisms. The key financial ratios of gearing and net interest cover are also monitored as a matter of course, as are the loan covenants with the Group's principal lenders. Where there have been concerns over particular commercial developments these have been appraised on a case by case basis and in some cases have been put on hold where there may be a risk to the viability of a particular scheme. The Group's monitoring has included sensitivity analysis to a range of sale and market scenarios such that the Group's exposure to risk at any time can be controlled.

 

3.3.2 There has been recent concern that an increasing number of RSL's are balancing their books through property sales with 6 of the top 20 providers of social housing reporting a combined total of £129 million through surplus on the sale of fixed assets in 2007/08. Steve Douglas, Chief Executive of the Housing Corporation has also gone on record to say that they are watching a number of housing associations very carefully. The reality facing housing associations is that they have to keep their business portfolios in balance, ring fencing and protecting the social housing assets whilst balancing the risk elements of their commercial dealings.

 

3.3.3 A particular issue the Group is facing in the current credit crunch is the capital lock up associated with new development schemes. The Group has mitigated against exposure to large, capital intensive schemes through limiting the number underway at any time. The Group underpins these schemes through gap funding, while maximising alternative funding through sales and market rental options. Sales to investors have also fallen off due to restrictive lending criteria, which have further exacerbated the lack of activity in the housing market. Indeed, lending rates need to improve to at least 2007 levels for private purchasers and investors as a step towards kickstarting some movement and activity in the housing market.

 

3.4 Measures to help existing and prospective homeowners affected by the credit crunch

 

3.4.1 The Group has had a particular concern over the issue of access to the housing market for some time. This has been articulated with the former housing minister - Caroline Flint and with senior civil servants within the CLG. There is a wealth of evidence that indicates there is a large section of the population who are finding it increasingly difficult to access the housing market through the three tenure options of affordable rent, market rent and owner occupation and have an acceptable standard of living. Even in the current market downturn, medium term house price inflation has dramatically outstripped earnings leading to increased mortgage to income ratios required to access owner occupation.

 

3.4.2 The Group has looked to model the impacts of this and in Sunderland this has led to the picture illustrated in fig. 2.1. On a simple traffic light system where green is equal to less than 30% of disposable income on housing costs, amber is between 30% and 50% of disposable income on housing costs and red is greater than 50% of disposable income on housing costs it becomes clear that large sections of the population are excluded on affordability grounds from certain tenures. Affordable rented housing is the most affordable tenure but the reality is that this is severely restricted due to a combination of low turnover and priority based on need rather than affordability. This situation is not specific to Sunderland and is replicated across England as seen in fig. 2.2. Put simply, people not currently in the housing market are finding it increasingly difficult to get a foot on the housing ladder. It is also essential to address the negative impact that the rising cost of housing has had on people's standard of living.

 

 

 

 

 

Figure 2.1: Housing Affordability analysis in Sunderland

ASHE percentiles	Gross earnings at each percentile point in Sunderland	Monthly Net Income	Total in each percentile grouping	Average Social Rent	Average Private Rent	Owner Occupation*
				£247	£485	£770
10%	£5,822	£485	9300	51%	100%	159%
20%	£9,616	£673	9300	37%	72%	114%
25%	£11,344	£784	4650	32%	62%	98%
30%	£12,965	£864	4650	29%	56%	89%
40%	£15,242	£1,003	9300	25%	48%	77%
60%	£20,162	£1,276	18600	19%	38%	60%
70%	£22,644	£1,415	9300	17%	34%	54%
75%	£24,502	£1,510	4650	16%	32%	51%
80%	£26,768	£1,650	4650	15%	29%	47%

 

Key: % of net income

0-30%

30-50%

50-100+%

Likely to be eligible for Government Support

* Average monthly repayment for a Flat/Maisonette in Sunderland at £112k on a 25 yr repayment at 6.5% interest, no deposit.

 

Figure 2.2: Housing Affordability in England

 

Ave House Price in Eng. (Land Reg. Data Sep 2008)	Deposit (15%)	Interest Rate	Monthly Payment	Income Required (Housing Costs at 30% of Net Income)
Monthly	Annual (Net)	Annual (Gross)
£168,814	£25,322	6.5%	£980.30	£3267	£39,189	£56,303

 

3.4.2 The situation is equally bleak in England as a whole. As the table above suggests a relatively high income is required to afford an average house price (even with a 15% deposit). Indeed, ASHE (Annual Survey of Hours and Earnings) data suggests that less than 10% of individuals could realistically afford a property without using more than 30% of their income on housing. The situation is similarly bleak if looking at household income (i.e. potential for two incomes), with ONS statistics suggesting only the top quintile group would be able to access housing at a reasonable proportion of income.

 

3.4.3 Given the affordability scenarios there is a need to think creatively around the models of access that can be generated to assist people into the housing market who otherwise cannot afford to do so. The Group is currently working on two models that have been discussed with civil servants with a view to feasibility and market testing in the coming months. These models are aimed at improving access to housing, whilst also allowing individuals to have a good quality of life. These are described as follows:

 

3.4.4 Homestart

 

Homestart is a scheme that produces Housing 'Graduates' - people who are ready and able to buy their first home and all that goes with it. It includes a savings plan linked to a home with a reasonable rent which allows what we call the 'Trapped Generation' to live independently whilst saving to invest in their own future. It effectively guarantees that they save for a deposit.

 

Initial modelling has worked on the basis of a monthly fee payable by the occupant, part of which effectively acts as rent and part of which acts as saving. Within four years it would be possible to first of all be adequately housed and secondly to save up to a £12,000 bond (on the basis of a £500 month fee half of which acts as rent, half as a savings bond) which could be carried forward as a deposit for a new home.

 

3.4.5 'Donk'

 

The Group are currently exploring another solution for those unable to access housing at present (currently being called 'Donk'). This model would negate the need for a deposit and mortgage, while giving the feel of owner occupation (the ability to acquire equity in your home). The model also reduces the risks for the purchaser associated with a traditional mortgage by allowing them to fix their housing costs for five years and offers increased flexibility to reflect changing personal circumstances.

 

The model works on the basis of the property owner holding the mortgage, with the customer living there for the payment of a management fee whilst also giving the opportunity to purchase an equity stake of between 1% and 4% on annual basis. This will provide the opportunity to gain a foothold on the housing ladder and invest in an equity share that could then be used to move on into the housing market.

 

3.4.6 For both of these models there would be a subsidy requirement against the rental element but it would introduce a significant element of churn into the housing market. Homestart effectively assists 7 households over a 30 year period. The 'Donk' model increases churn by introducing a new financial product which will help people access housing. This would then stimulate turnover in the housing market and enable a larger number of people to gain access to subsidised housing than would otherwise be the case in a typical new home capital subsidy model.

 

3.4.7 In terms of wider support and assistance the Group would support the further development of mortgage rescue and assistance measures announced recently by Government. The reality of re-possession is that people are simply moved within the housing market often with an increased burden on an already pressurised affordable rented sector. Measures that allow people to stay in their own home but effectively switch tenure must therefore be supported.

 

October 2008