House of Commons - Financing of new housing supply - Communities and Local Government Committee

Financing of new housing supply - Communities and Local Government Committee Contents

2 Private investment

13. Given current limitations on both debt finance and public funding, there is inevitably a need to look to other sources if we are to raise sufficient finance to meet the country's housing needs. This chapter will consider the potential for investment by large financial institutions, both in the private rented and housing association sectors. It will then examine possible vehicles that could be used to channel investment into rented housing.

Investment from pension funds and large financial institutions

PRIVATE RENTED SECTOR

14. Some of our evidence suggested that large financial institutions and pension funds could make a significant contribution to new housing in the private rented sector. Ian Fletcher, Director of Policy (Real Estate) at the British Property Federation considered that the conditions were "all there for large-scale institutional investment in the sector", adding that it was "now or never".[37] The Resolution Foundation, an independent research and policy organisation, discussed the potential for a "new approach to build-to-let development using institutional investment", arguing that such an approach could help to meet "the housing needs of individuals and families on low-to-middle incomes who are unable to buy a home in the medium to long term".[38]

15. Not all witnesses were so enthusiastic about the prospect of "build-to-let" investment. Paragon Group, which provides mortgages to investors in the private rented sector, warned that investment from institutions might not produce the right type of housing:

The kind of properties that institutional investors are likely to invest in through "build-to-let" schemes, such as two-bedroom flats, in large purpose-built developments are unattractive to tenants and there is already an over-supply of this type of property caused by pre-credit crunch property developer and investment club activity.[39]

The housing charity, Shelter, said that institutional investment "would clearly be welcome, if it can provide additional sources of financing for high quality homes, but we should not expect a revolution in housing finance to come from this source". It added: "Even in countries with much larger private rented sectors and significant institutional investment in housing, it remains the case that the bulk of landlords are small scale investors, and particularly individuals, much as in the UK".[40]

16. In Laying the Foundations, the Government announced that it would be "putting in place an independent review of barriers to investment in private homes for rent".[41] Subsequently, Mr Shapps, the Minister, announced that this review would be led by Sir Adrian Montague, non-executive chairman of the private equity firm 3i.[42] On 21 February 2012, Sir Adrian issued a call for evidence. He set out two "fundamental questions" upon which he wished to focus: "Will the changes that the Government has introduced go far enough to generate significant new flows of investment? And, if not, what can be done to accelerate things?"[43]

17. Professors Tony Crook of Sheffield University and Peter Kemp of Oxford University, discussed attempts over the last 30 years to bring in institutional investment. They considered that successive governments had sought to adapt "existing schemes designed for other purposes" rather than bringing forward initiatives "with the specific needs of private renting in mind"; moreover, governments had not addressed "the fundamental barriers preventing the emergence of larger companies and institutional investment".[44] In the view of Nick Jopling, Executive Director of Property at Grainger plc,[45] the three main barriers were "scale, suitability of stock and yield".[46] He explained:

An institution wants to invest in scale; it is not interested in buying buy-to-let property. There is no stock for it to go and buy. There are no portfolios of rental stock for it. There may be some distressed portfolio, but they are not interested in that, because there is often a reason those properties are distressed in the first place. Suitability of stock: we address that through building purpose-built stock for rent. That is the multi-family housing US model. And then the yield. Yield has always been a challenge, because the cost of entry, against the rent and the net rent that comes off the bottom, has always been too high. In particular in London, the net yield is so small, so one has to deal with the cost of entry, and that is the cost of construction and the land.[47]

Alan Benson, Head of Housing and Planning at the Greater London Authority, expressed a similar view, saying that, for him, "the yield question" was "the absolute crux [...] of why institutional investment has not got off the ground in the UK".[48]

18. Grainger plc's submission gave details of institutional investment schemes in which the company had been involved. The G:res fund, which it said was the "UK's largest private rented sector residential investment fund", and in which it held a 22% stake, had approximately £400 million of residential assets in the UK.[49] Grainger's submission also described a partnership it had established with the construction company Bouygues Development Ltd, "with the aim of creating and co-investing in a new Build-To-Let Fund".[50] It was anticipated that this fund would "provide institutional investors with the opportunity to invest in scale into the Private Rented Sector [...] which to date has been relatively inaccessible". The fund had "a dedicated portfolio of purpose built PRS development sites in London and [the] South East of England".[51] Nick Jopling said that to address "cost of entry" issues, all four of the sites put forward were "on public land".[52]

19. Building on public sector land is a useful way of overcoming the key barriers to institutional investment: the release of large sites can enable the development of purpose-built stock at a viable scale. If public bodies are prepared to defer payment or enter into a partnership, this can reduce the costs of entry for the investor. Richard Hill, Deputy Chief Executive at the Homes and Communities Agency (HCA), told us about its work to make land available. He said that the HCA had a role in using "public sector land where possible for a variety of developments"; the agency would "be prepared to defer the return for a longer period, take some of the rental during that period, and look for capital return further down the line".[53]

20. We heard from the Association of Greater Manchester Authorities (AGMA) about a pilot scheme being developed by Manchester City Council with the Greater Manchester (GM) Pension Fund:

Discussions with the GM Pension Fund have been taking place to develop a Housing Investment Model in Manchester that will deliver both low and high rise mixed tenure options, capable of being applied across GM. The basic premise is very simple; there are two investment partners, the council with land to invest and the pension fund with cash to invest. Together the investors procure a house-builder, sales and marketing function and a housing managing agent with which it enters into a minimum 10 year lease. Through the lease, both investors are able to take a guaranteed revenue return on their investment and both share in any capital return on the sales properties. The new build housing is targeted at economically active households.[54]

AGMA identified a number of barriers and challenges, not least the need "to demonstrate to all partners that the model works".[55] While it is too soon for us to make a judgement on the scheme, it does raise some interesting issues, including the possibility of public sector pension funds investing in housing. Andy Hull, Senior Fellow at the Institute for Public Policy Research (IPPR), considered that local government pension funds could be an important source of finance "because they have in excess of £150 billion worth of funds, because they can be quite patient to see the return over time and because they have councillors on their management boards who should understand [...] what a crisis we are facing in terms of housing need".[56]

21. Another way in which local authorities could support institutional investment was to take a flexible approach to affordable housing requirements in section 106 agreements.[57] Grainger plc suggested that "reducing or altogether removing affordable housing requirements on [private rented sector] developments would greatly increase the viability of the scheme and improve yields".[58] John Stewart, Director of Economic Affairs at the Home Builders Federation (HBF), however, referred to "glib comments about, for example, making private rented sector schemes work by waiving affordable housing", adding: "I am always rather concerned when there is talk about reducing the regulatory burden for one source of capital or one particular provider within one tenure. I am much more a believer in a level playing field".[59] Responding to these comments, Ian Fletcher said that HBF "members are investing capital for the best part of a year at most, sometimes; my [British Property Federation] members are investing in capital for 20 years; there is a greater cost to their doing that and they should be treated more favourably".[60] We consider that there may be merit in a flexible approach, but this would need to be balanced against the impact upon affordable housing provision across a local area. The onus should be on the individual council to assess how best to strike the balance.

22. We heard about a number of steps that public sector organisations can take to encourage institutional investment in the private rented sector, addressing the key barriers of scale, suitability of stock and yield. We recommend that all public bodies, both local and national, consider the potential for contributing their land alongside institutional finance to support build-to-let initiatives. We urge local authority pension funds to be alert to the benefits of investment in residential property, whilst ensuring transparency and security for their investors. We would hope that their doing so would pave the way for private funds also to invest in residential property. Finally, we encourage local authorities to consider taking a flexible approach to affordable housing requirements in planning obligations on a case-by-case basis, where this will help to stimulate build-to-let investment and will not be to the detriment of the wider housing needs of the area.

INSTITUTIONAL INVESTMENT AND HOUSING ASSOCIATIONS

23. An alternative way of overcoming some of the barriers to institutional investment would be for investors to work in partnership with housing associations. Considering the prospects for institutional investment, the Cambridge Centre for Housing and Planning Research said that it was difficult to obtain "a portfolio which is simultaneously sufficiently diversified but also spatially concentrated (for economies of scale in management) […] within the short time frame required by investors". It suggested that housing associations could offer a solution to this problem:

In this regard it can be argued that the most practicable means of creating large scale, long term, institutional landlords in the private rented sector may be to encourage housing associations to expand into market renting, since they already exist, are of a viable scale, and have the necessary expertise. The key issue here would be to develop regulation to ensure that any cross-subsidisation is from private to public rather than the other way around.[61]

David Orr, Chief Executive of the National Housing Federation, said:

I think that there is a realistic possibility of housing associations bringing institutional investment into very significant institutions to provide a market rent product, and to help stimulate new supply of market rent, so that we are talking about housing associations expanding the range of things that they do—not replacing the things that they do, but adding to the range of things that they do, in an attempt to respond to the housing market failures at present.[62]

24. The housing association London and Quadrant Group (L&Q Group) set out some of the potential advantages of partnerships between investors and housing associations:

Housing associations are in a good position to attract private investment. They have a wealth of experience managing rented accommodation and through this have the capacity to continuously develop a range of housing products. There is potential in the future to invest in partnerships with others, including becoming key delivery vehicles for upstream institutional funders of market rent which would help to achieve scale. Housing associations also have the ability to act as guarantor of quality and a degree of security to the benefit of both consumers and investors.[63]

L&Q Group also discussed the possibility of attracting private finance by developing "a new form of market rented housing with a differential offer such as longer tenancy options".[64]

25. Another possibility put to us involved institutions investing directly in social housing. Newark and Sherwood Homes Ltd considered that the social rented sector had "a more stable long term return potential being less volatile than the majority of market driven investments". It gave the example of the insurance company Aviva investing in social and affordable properties with the Derwent Living housing association.[65] The British Property Federation also commented on this example, stating that while Aviva's investment did not contribute "to new stock per se", it released capital allowing the housing association "to invest in new build elsewhere".[66] Discussing new ways of providing funding for affordable housing, the Housing Forum, a membership body for organisations involved in the construction and repair of housing, said that institutional models might work "on a longer time span than current financial models (typically 30-50 years)" and called for them "to be explored and encouraged". It added: "This will be a significant catalyst to reshape the housing association sector".[67]

26. We took evidence from Peter Mahoney, Chief Executive Officer at R55 Group, about a model his organisation had developed to bring institutional investment into social housing. He explained that his model was "a funding solution and also a modular housing solution":

The funding solution is very much a lease-backed funding solution where it is directly targeting housing associations and local authorities who are providing modular housing that is responding to local housing needs, but it also comes fully funded. Effectively, the housing association or local authority would provide us with land. We would work with them, understanding their housing needs and the needs of the Housing Department, and together a solution is developed.[68]

He added: "it is not debt funded, it is not reliant upon social housing grant; it is purely funded by pension funds and life insurance funds that are looking for long-term, stable, low-risk solutions".[69] The Northern Housing Consortium and North West Housing Forum also referred to an emerging model of "lease backed funds" under which "ownership of the scheme transfers to the investor and is leased back to the provider until the loan is made". It warned that there were "concerns around this model, particularly its ability to manage risk given turbulent performance of pension markets in recent [years]."[70] Housing associations should play a role in attracting institutional equity investment, either by expanding into market renting and providing the economies of scale required by investors or by using finance from institutions to bring investment into social rented housing. We encourage housing associations to explore such opportunities and to establish a dialogue with potential investors. Later in the report, we consider the possibility of institutional investment being used to support "intermediate" products.

Investment vehicles

REAL ESTATE INVESTMENT TRUSTS

27. Our evidence discussed the role particular vehicles could play in the channelling of investment into both social housing and the private rented sector. A common suggestion was that Real Estate Investment Trusts (REITs), which have thus far only existed in the commercial property sector, could be used to bring investment into housing. Professors Crook and Kemp discussed the background to residential REITs:

The [...] Real Estate Investment Trust (REIT) initiative (from 2007 onwards) created the possibility of fully tax transparent residential REITs, notionally able to attract pension and life funds to invest without a tax loss for them. However, to date this has not resulted in even one residential REIT being established, although the great majority of commercial property companies have now converted to REIT status. This is partly because, despite the initial impetus to forming REITs being based on the desire to get institutional funds into the private rented sector, the initiative became transformed into one addressing investment in all property not just in private residential property.[71]

The British Property Federation suggested that residential REITs could also provide a way of attracting individuals' investment into housing:

Little of individuals' money (so-called retail funds) currently goes into collective investment schemes that are investing in property. Part of the problem is that small investors like to be able to buy and sell when they wish. That is difficult in a collective scheme, where most cash will be tied up in buildings that cannot be instantly bought and sold. The way around that is to invest in companies or Real Estate Investment Trusts [...] that invest in housing.[72]

28. Between April and June 2011, HM Treasury undertook an informal consultation on a range of measures announced in the 2011 Budget "to support the development and growth of the UK Real Estate Investment Trust market".[73] Following this consultation, the draft legislation for the Finance Bill 2012 included a measure to address certain identified barriers to entry and investment.[74] The 2012 Budget confirmed that the Government would legislate "to support entry to and investment in REITs".[75] The Budget also announced that in 2012 the Government would consult on the REITs regime, including on "the role REITs can play in supporting the social housing sector".[76] This consultation was launched on 4 April 2012.[77]

29. The Chartered Institute of Housing said that potential changes to REITs "could see housing associations becoming interested in exploring the potential of the model to increase the supply of affordable homes, as it creates easier access to equity capital markets and an opportunity for balance sheets to work harder".[78] The housing association, Places for People, described a proposal it had developed to create a residential REIT:

Our initial modelling of the REIT proposal works on the basis that around 5,000 existing rented properties are purchased by the REIT, including social rented properties that have been converted into Affordable Rent when they fall vacant. The funds generated by the sale of properties into the REIT would be used to finance additional development of new homes in affordable rented and market rented tenures, and once occupied these new homes would then be sold onto the REIT. This process or cycle could be repeated a few more times until the REIT needs to be reseeded or restocked with existing residential properties.[79]

Writing to us after giving oral evidence, Steve Binks, Finance Director at Places for People said that Places for People anticipated "that the Finance Bill will contain the amendments to legislation which will facilitate a Social Housing REIT".[80] Places for People estimated that, if the amendments were made, the REIT could "deliver yields of around 7% to investors which a number of them have confirmed is acceptable".[81]

30. Ian Fletcher, of the British Property Federation, wrote to the Committee following the publication of the draft legislation. He stated that "the current proposed reforms mark significant progress in reforming the REIT regime to support residential investment" but argued that there were "other reforms that we believe are essential if we are ever to see a significant number of residential REITs". He proposed two particular additional reforms. One related "to the way the traditional tax distinction between 'trading' and 'investment' activities applies in the REIT context". He explained that a property portfolio could "only fall within the tax-exempt ring-fence of the REIT rules if it [...] amounts to an 'investment' business in tax terms". There was, however, "a structural tendency in the UK residential context to rely to a greater extent on regular asset sales" than in commercial property; this meant that residential property businesses were "generally quite sensitive to the operation of the trading/investment test".[82] This issue was raised by a number of other witnesses, including Grainger plc, which had asked the Government to look at the trading versus investment distinction "specifically in the context of and for the purposes of residential REITs".[83]

31. The second additional reform suggested by Ian Fletcher concerned "the scope for using the REIT structure without the compliance burden of a listing".[84] He said:

In other countries with REITs a further evolution of their regimes has been the creation of private REITs that are unlisted. The rationale for only allowing listed REITs in the UK is understandable, which is that listing provides a degree of protection for investors, which unlisted REITs would not. However, because most residential REITs would be started from scratch and therefore be smaller than existing commercial property REITs there is an argument that allowing unlisted REITs would particularly be beneficial to the residential sector.[85]

32. In our view, REITs could be a useful means of bringing investment into the residential property sector. It is significant that no residential REIT has ever been established in the UK; it suggests that there are significant barriers to entry and investment. We commend the Government's efforts to identify these barriers and put in place measures by which they can be overcome. We also welcome Places for People's innovation in developing proposals for a REIT. We agree, however, with the view that further action is needed if the contribution of REITs to the financing of new housing supply is to be maximised. We recommend that the Government put in place measures to address concerns about the distinction between trading and investment specifically in the context of residential REITs. We further recommend that the Government allow the creation of private, unlisted residential REITs.

SELF INVESTED PERSONAL PENSIONS

33. The Residential Landlords Association (RLA) proposed that the Government "allow self invested pension funds to invest in residential units, up to a maximum purchase price of £250,000 per unit outside London (with a suitable adjustment for London prices)".[86] Mark Butterworth, Director of the RLA, wrote to us with further information about the potential for Self Invested Personal Pension (SIPP) investment:

There is £101.7 billion invested into just over 800,000 SIPPs currently. There are different types and characteristics but of the higher value more flexible type which would have funds and the ability to undertake the investments required there are 200,000 or 25% of the total number.[87]

He added that his estimate, given during oral evidence, "of 50,000 that would be interested or likely to take up such an offer would appear to be on the conservative side".[88]

34. Self Invested Personal Pensions could provide another source of finance for rented housing. We recommend that the Government look in detail at the contribution SIPPs could make and the risks and benefits for those investing in SIPPs. If satisfied about these risks and benefits, it should bring forward proposals to facilitate their investment in residential property.

HOUSING INVESTMENT FUND / HOUSING INVESTMENT BANK

35. The National Housing Federation called on the Government to support the establishment of a Housing Investment Fund run by housing associations:

Government support and underpinning of a pilot housing investment fund run by housing associations would enable the development of mixed tenure sector schemes at scale and would attract investors and create confidence in the market hopefully acting as a prelude to it increasing in scale. Housing associations could reach an agreement with government about underpinning the risk and guarantee on investor return, but the clear backing and support of government would attract and reassure investors and government could play a role as broker.[89]

36. The Confederation of Cooperative Housing (CCH) described its proposals to establish a fund through bond financing and institutional investment to finance the development of co-operative and mutual housing. Under these proposals it aimed to develop "between 1,500 and 2,500 homes through the development of between 30 and 50 new co-operative and mutual housing organisations". The CCH said that it had begun to draw a number of local authorities and housing associations together as "potential partners" and was "seeking to work with Government to implement the programme".[90]

37. Shelter proposed the creation of a National Housing Investment Bank:

A 'National Housing Investment Bank' could attract investment funds and provide loans for the construction of low-cost housing. In European countries such banks have proved effective at leveraging public funds to channel private finance into both house building and improvements to the existing stock, a model that RICS [the Royal Institution of Chartered Surveyors] have called on to be replicated in the UK. The government has partially adopted this approach through its Green Investment Bank: we would urge the committee to consider whether this model could usefully be expanded to include financing house building as well as green infrastructure.[91]

Roger Harding, Head of Policy, Research and Public Affairs at Shelter, responding to the suggestion that everybody would be competing for a limited pool of debt finance, said: "If there is a limited amount of debt, it is vitally important that we channel it towards new supply rather than inflating the market that we have got and feeding through into unsustainable loans".[92] IPPR also suggested the expansion of the Green Investment Bank into a national investment bank.[93] Its Senior Fellow, Andy Hull, told us that he and his colleagues were "arguing for a national investment bank from a number of different perspectives, not just a housing one".[94]

38. We saw for ourselves an example of a publicly-owned bank investing in housing during our visit to Netherlands, when we met a representative from the Bank Nederlandse Gemeenten (BNG; the Dutch Municipal Bank). We heard that this bank was 50% owned by the Ministry of Finance and 50% by the Dutch municipalities. The bank's lending was restricted to public and semi-public organisations, with 52% of its lending going to housing associations. 98% of its loans to housing associations were guaranteed. The bank had a 'triple A' rating from two of the three ratings agencies, was the fourth largest and second most profitable bank in the Netherlands, and, according to Global Finance magazine, the third safest bank in the world.[95]

39. Mr Shapps said that he was "all in favour" of a housing association-run housing investment fund and that his officials "have [worked] and will work with organisations who want to bring those types of things about".[96] He questioned whether such initiatives really needed government support, saying: "If [...] there is something Government could do, are not doing, and it does not cost a fortune, then come and talk to me, but most of the time my message out there to housing associations and to councils is, 'We are giving you all these flexibilities. Go and use them.'"[97] The Minister was unenthusiastic about the call for a national housing bank, saying that he was "not convinced by that argument at all. I think the banking system in this country needs to work for all industries and sectors".[98]

40. We welcome the Minister's enthusiasm for a housing investment fund run by housing associations. Such a fund could help housing associations, and smaller associations in particular, raise finance for house building. We support the establishment of a pilot housing investment fund run by housing associations, and recommend that, in discussions with the National Housing Federation, the Government explore how it can give its backing. The pilot should consider the viability of a fund, its ability to attract investment, and any risks to the Treasury arising from Government support. Subject to the success of the pilot, the fund could be increased in scale. We further recommend that the Government work with the Confederation of Cooperative Housing on the Confederation's proposals for an investment fund.

41. We consider that there is merit in the suggestion that a national housing investment bank be established. In other European countries such banks have proved effective at channelling investment into new housing development. The work already underway to create a Green Investment Bank offers a useful opportunity; there is a clear case for allowing this bank to invest in housing as well as green infrastructure. We recommend that the Government consult on proposals for the extension of the Green Investment Bank's remit to include the funding of new housing and, potentially, of wider infrastructure projects. The bank could play a leading role in offering new forms of finance such as REITs (considered earlier in this chapter) and retail bonds (which we consider later in the report).

37 Q 56 Back

38 Ev w88 Back

39 Ev 151 Back

40 Ev 87 Back

41 Laying the Foundations, p 33 Back

42 "Review to examine institutional investment in private rented homes", DCLG press release, 23 December 2011, www.communities.gov.uk Back

43 "Sir Adrian Montague calls for evidence on barriers to institutional investment in private rented homes", DCLG press release, 21 February 2012, www.communities.gov.uk Back

44 Ev w51 Back

45 Grainger plc is a property company involved in a number of institutional investment build-to-let schemes. Back

46 Q 130 Back

47 As above Back

48 Q137 Back