HC 1652 Communities and Local Government CommitteeWritten submission from Riverside

1. Summary

1.1 Any attempt to improve the financing of additional housing supply needs to be based upon a business model which is sustainable in the long-term, and transparent about the subsidy required to ensure the homes delivered are affordable. We do not believe that the Affordable Homes Programme in its current form represents such a sustainable model, and would urge Government to commission a thorough review even at this early stage.

1.2 We believe that any credible system of provision of affordable housing requires significant subsidy. This can be delivered in a range of ways, however we believe a system based upon more generous supply side subsidy (upfront grant) represents the best way forward, given:

uncertainty over long term revenues because of the need to contain the welfare benefit bill;

the condition of financial markets in general; and

the opportunity to provide an economic stimulus through increasing supply.

1.3 Lender (or investor) confidence is paramount, and we find the approaches of CLG and DWP strangely at odds, with one attempting to stimulate delivery through a high-risk model based upon increased revenues, and the other trying to contain revenues through fundamental welfare reform. This contradiction needs resolving.

2. Introduction

2.1 The Riverside Group is one of the country’s largest and longest established housing association groups, owning and managing over 50,000 homes. We provide a mixture of social and non-social rented homes and housing for low cost home ownership. The Group welcomes the opportunity to provide a memorandum for the CLG Select Committee’s inquiry into new housing supply.

2.2 Riverside has been providing affordable housing since 1928 and over time we have adapted to provide new homes under a range of funding regimes. We have managed to balance a very strong track record for governance and viability—we currently hold top regulatory ratings for both—with an appetite for innovation and appropriate risk taking.

2.3 The size of the organisation has doubled over the past ten years, both through the development of new homes and growth through local authority stock transfer, merger and PFI. Over the past three years alone we have built over 2,000 homes for rent, affordable home ownership and outright sale.

2.4 At the same time we have been undergoing a process of significant stock rationalisation, to ensure we maintain a “footprint” that enables us to provide efficient services to tenants, and focused leadership in the neighbourhoods and communities in which we work. This has resulted in the disposal of 2,700 homes over the same period, mainly to other housing associations, although this has also included sales of some long-term empty properties to individuals through our discounted home ownership scheme “OwnPlace”.

2.5 We have been able to deliver new housing through a range of routes including:

The HCA’s National Affordable Housing Programme, leading the largest development partnership outside London and the South East (by grant allocated) under the 200811 programme.

Working with private sector house builders to deliver homes through s106 agreements, particularly in the Midlands and North East of England.

Developing housing for outright sale through our commercial development subsidiary Prospect, which has recently increased its capacity by acquiring a series of strategic sites from a private sector developer.

Building further affordable housing in genuine mixed tenure communities through Compendium, our joint venture with house builder Lovell, with live projects in Stoke on Trent and Liverpool, and a major project planned in Derby.

Building new homes, and refurbishing council housing, through two Private Finance Initiatives in the Midlands.

2.6 In order to maximise our financial capacity to enable us to develop more homes and provide better services, we have implemented major changes to the governance of the Group via a process of statutory amalgamation which has brought all the significant assets of Riverside into the same legal entity. We have also restructured our operations to deliver efficiency savings of over £2 million pa.

2.7 We believe we are well prepared to continue to build more homes and provide improved services, even in these challenging times. Drawing upon our direct experience, this memorandum addresses two of the specific lines of inquiry identified by the CLG Select Committee. It is structured accordingly.

3. How effective the Government’s “Affordable Rent” proposals are likely to be in increasing the funds available for new housing supply, and how sustainable this might be over the medium to long term

3.1 We believe that we have developed a sustainable approach to development which balances an appropriate appetite for risk characteristic of a successful property developer, with the long-term, customer-orientated view of a charitable housing association. This has been recognised by our regulator, the Tenant Services Authority. Whilst it is hard to talk about a “typical” housing association in such a diverse sector, our experience might be regarded as a useful barometer to help judge the sustainability of the Government’s new funding approach.

3.2 Our experience of the bidding process for the Homes and Communities Agency’s Affordable Homes Programme has been challenging. Despite the short term national headlines, we think our own position illustrates some weaknesses in this new higher risk model, which has shifted the balance further away from up-front capital subsidy, to long term revenue funding. This places a far higher reliance on private finance at the very moment the lending market is contracting and future rental streams are at risk because of welfare reform. Whilst to date, the HCA has published no information on the relative “fortunes” of other established providers, we would be surprised if our experience is unique.

3.3 The original Riverside “offer” to the HCA under the Affordable Homes Programme (201115) was based on the following:

Maintaining our development momentum1 through the delivery of 1,600 new dwellings (predominantly for rent) over three years in five regions. This would have required £36.5 million HCA grant, and £122 million borrowing and sales receipts.

Delivered through very competitive build costs—a 5% reduction on current prices—because of effective procurement through a framework arrangement.

The use of other resources, including recycled grant accumulated from previous property sales, and subsidised land delivered through s106 agreements. A fifth of our “offer” was on a nil grant basis.

An imaginative approach to the setting of Affordable Rents for both new homes and re-lets, based upon a mechanism which “caps” 80% market rents to ensure they are affordable to both those in work (based upon 30% of the 30th percentile of local gross household income) and those on benefit, reflecting likely changes being introduced through the Welfare Reform Bill.

Cautious but credible financial modelling assumptions, given impending welfare benefit changes, longer-term political uncertainty over rent setting and the imperative to avoid the excessive leveraging of our balance sheet.

3.4 We believe we submitted a credible, rounded bid, requiring an average grant per unit of £23,000, representing a reduction of 60% on the previous three year programme. However even then, the borrowing required would have taken our gearing2 substantially closer to the maximum level permitted in the legal covenants set out in our loan agreements. In other words, at the end of the programme we would have found it difficult to create significant further development “headroom”, without renegotiating our loan covenants.

3.5 The HCA’s response to our “offer” has been an allocation of funding to deliver fewer than 600 units—less than 40% of Riverside’s original offer. Whilst in one sense this leaves much of Riverside’s remaining development capacity intact, it is still disappointing.

3.6 We believe that the HCA allocation was driven by a number of factors:

Our programme required a marginally higher than average level of grant per unit. The programme attracted a significant number of new entrants who were able to bid on a very low or even “no” grant per unit basis, offering free land, and taking up the one-off opportunity to increase rental income from a low base. The programme is likely to be successful in unlocking their financial capacity on a one-off basis, and whilst there were elements of these approaches in our own bid, the extent to which we were able to do this was limited by our own starting point.

It relied on a high proportion of conversions of re-lets to Affordable Rents to the scale of new provision proposed, partly because of the impact of “capping” affordable rents to ensure affordability, particularly in higher value parts of the country.

Our offer was underpinned by a cautious, long-term view of development and the risk involved. In particular we took a relatively conservative view of the longevity of the affordable rent regime (ie the length of time we will be able to charge the new, higher rents), and the likely impact of welfare reform. Very aware of our gearing covenants, we also took an approach which ensured we would have some remaining development capacity at the end of the three year funding programme.

Our offer was based on a national approach in which we tried to use the advantages of scale and operation across a range of housing markets to take a “pooled” approach to resources, costs, income and subsidy. However whilst we had to submit a single offer covering the whole country, the advantages of this national approach were lost as we were still required to isolate individual regional bid lines and make each one deliverable in its own right. This has led to a situation where we received no allocation to develop in an individual region where we had a strong track record of competitive delivery.

3.7 We accept that the programme is likely to be successful in unlocking the development capacity of a number of new developing organisations, at least for a period of time, and has been less suited to our own unique circumstances This approach may well be necessary at a time of exceptional public funding constraint, however it is worth reflecting on the underlying issues, and what they say about the new model as an approach to funding new development in the longer-term. We have drawn a number of important conclusions:

Despite headlines, the Affordable Homes Programme in its current form does not provide a sustainable future for the provision of sub-market rented homes.

Whilst it is possible to incentivise the “sweating” of assets on a one-off basis, many contributions to the programme use finite resources—free land, the capacity to increase rents from relatively low levels, recycled grant, and the value of balance sheets. We believe that it will become more difficult, if not impossible, to repeat this approach.

It is impossible to reduce up-front subsidy by more than half to a grant rate of c20% without significant effects into the future. The economics of the development of affordable homes at these grant rates simply doesn’t work, even with higher affordable rents, and whilst there is some capacity to reduce grant rates from those enjoyed under the previous National Affordable Housing Programme, especially given a higher rent regime, a more sustainable figure lies somewhere between the two. Maintaining the current rate into the future will only result in the rapid depletion of finite resources, the very antithesis of sustainability. Whilst this approach may suit a uniquely tight set of fiscal circumstances, it is essential that the real impact is widely understood, and that there is no illusion of success.

3.8 A model which relies on the potentially dangerous leveraging of the balance sheets of not for profit providers must set alarm bells ringing, particularly as regulatory capacity is scaled back. The recent report published by L and Q and PWC3 estimates that in order to deliver the programme and other important financial commitments, providers will see their gearing increase to 95% without significant efficiency savings. Arguably, efficiency savings will be “wiped out” by the need to increase bad debt provisions as a result of welfare reform.

3.9 We urge the CLG Select Committee to recommend that the Government commissions an independent interim impact assessment of the Affordable Homes Programme, even at this early stage of delivery, to inform planning for post 2015. This assessment should consider:

The total public subsidy consumed by the Affordable Homes Programme in terms of capital grant, increases in housing benefit associated with the affordable rent regime, and the value of “in kind” contributions such as land and recycled grant. This review should assess whether the programme really delivers better value than the previous National Affordable Housing Programme.

The geographical distribution of subsidy (again capital, revenue and in kind) and the success of the model in delivering homes in different geographical locations and housing market situations.

The potential weakening impact on providers’ financial capacity as measured through their balance sheets (gearing), and I and E accounts (interest cover), and the extent to which the programme is repeatable given competing priorities for resources.

The impact of the programme on the views and activities of lenders, and on the credit ratings of providers (when seen in conjunction with welfare reform).

3.9 Our final observation on the programme is that there remains a mismatch between the principles that underpinned the original vision of Affordable Rents and the reality. This manifests itself in two important ways:

(a)The new approach was brought in under the banner of “freedom and flexibilities”, encouraging consortium working and bold approaches to longer term planning. We initially saw this as a great opportunity, securing longer term funding commitments and working to maximise the buying power this would bring which would lead to increased efficiencies. Unfortunately the process has conspired against any real flexibility. The HCA’s Framework Delivery Agreement is a straightjacket that limits flexibility and speed of reaction through a complex system of “Programme Change notices”, and this ultimately informed the degree of caution that underpinned our bid. A review of the programme should address the extent to which the mechanics of its administration has tempered appetite for risk.

(b)The concept of charging higher rents to those who can afford more appears reasonable and in keeping with the earlier “intermediate rent” system. However this issue has been fudged and the guidance is clear that allocation of affordable rents must be on the same basis as social rents. So far from opening up a new market to provide for a less benefit dependent customer group, the Affordable Rent system has become a new, expedient way of funding an old product. This means that calculations about the future reliability of income streams in the context of welfare reform have also driven caution.

3.10 If these two issues could be resolved then the longer term framework developed could have a place in helping reduce procurement costs and reducing the subsidy needed to house people who can afford to pay more than social rents.

4. How housing associations and, potentially, ALMOs might be enabled to increase the amount of private finance going into housing supply.

4.1 In order to increase the amount of private finance into the supply of affordable housing, providers require two things:

(i)An income stream that is sufficient to meet increased loan repayments which are inherent in the affordable rent model, to create a balanced and sustainable economic model of provision (see 2 above); and

(ii)An income stream that is reliable over the long-term in a way which engenders lender confidence, particularly as the traditional lending market contracts. There are far fewer lenders active in the UK social housing market, compared to five years ago.

4.2 On the former (i) we have already argued that it is impossible to deliver affordable housing at any scale without some form of subsidy—either capital (supply side) or revenue (demand side), or a combination of the two.

4.3 Some economists would argue that for housing, demand side subsidy is generally more efficient than supply side, and can be better targeted at the households who need it most, for the time during which they need it. But this is only the case in a functioning housing market where supply responds quickly to increased demand, and prices are stable. This is not the position we have in the UK, and a model which increasingly relies on demand side subsidy (ie increased rents covered by the benefit system), will not necessarily yield the private finance required as providers become increasingly leveraged and cautious, and Government becomes increasingly anxious about containing the welfare benefit bill.

4.4 In these circumstances we believe a funding model based on adequate supply side (capital) subsidy is likely to be far more effective, and will better retain the confidence of lenders and other investors who have already provided an unprecedented level of cheap private finance to the sector over the past two decades. Upfront capital subsidy not only ensures ongoing affordability, but rapidly stimulates supply which brings wider economic benefits in a flagging economy. A 2009 study commissioned by the UK Contractors Group4 demonstrated that construction is one of the best ways of stimulating economic activity, estimating that for every £1 invested in construction the wider economy benefits to the tune of £2.84.

4.5 After the completion of the current Affordable Homes Programme, the Government needs to return to an approach which balances supply/demand side subsidy to deliver affordable housing, with grant rates returning to levels which enable providers to break even on their investment. This approach needs to continue until we reach a point where supply and demand are balanced—ie for the foreseeable future. This would require an increase in average grant per unit, although if the changes to the programme recommended in 2.9 are implemented, this would not necessarily be to previous levels under the NAHP.

4.6 On the latter point (ii), providers (and their lenders) need to be confident in their long-term rental streams. There are two elements to this:

There needs to be a clear national rent policy. Having had the certainty of the target rent system for practically a decade, and a system of inflation pegged rent increases, a new two tier system (target and affordable) has emerged. Whilst initially the Government seemed to be heading in the direction of a gradual conversion of the majority of social tenancies to higher affordable rents (at least for developing providers), our experience of the HCA Affordable Homes Programme suggests that this is no longer the case, and that conversions to Affordable Rents are being severely rationed because of the impact on the benefit bill. We believe that this approach is not sustainable and the Government needs to make up its mind on its long-term approach to rents and future increases. Whilst the current four year guarantee on rent increases is welcome, we need a longer term approach with better joined up thinking between CLG and DWP.

The threat of further welfare reform overshadows longer term confidence. The benefit system for social housing (post introduction of universal credit) needs to be underpinned by a long-term commitment to pegging benefits to actual rents. Again the Government’s current position is ambiguous. In the short term the link between housing benefit and actual rents is maintained, however the Welfare Reform Bill as currently drafted will enable separation. Indeed in the Universal Credit White Paper the Government has only committed to maintaining a housing element (for social housing) which is pegged to actual rents in the “short to medium” term, and any eventual separation—for example a system of fixed rate payments pegged to CPI similar to the Private Rented Sector—would be disastrous for the sector and the future of affordable housing supply.

4.7 In addition to these longer-term risks, the “known” changes to housing benefit set out in the Bill are likely to cause significant problems for providers seeking to secure private finance at favourable rates. The proposed end of the option for the majority of tenants to choose to have their benefit paid directly to their landlord is likely to lead to increased rent arrears and bad debts. A recent survey commissioned by Big Issue Invest5 reveals that 93% of social housing tenants questioned think it is better to have their benefit paid directly to their landlord, with 35% saying they would not be confident in being able to keep up with their rental payments if the direct payment option is removed. This has not been lost on lenders, who are campaigning hard against this change through the CML. It is only a matter of time before credit ratings begin to decline, and the price of private finance (where margins have already crept up) increases further.

4.8 In addition the proposal to restrict housing benefit for those under-occupying their homes (with little prospect of downsizing) will further undermine income streams. At Riverside we estimate that around 7,000 tenants will lose around £4.5 million of housing benefit per annum after 2013. As a result, we have doubled the bad debt provision in our business plan from 2013 to a figure which, ironically, is greater than the additional level of affordable rent we would have generated from the 1,600 unit programme of our original offer to the HCA.

4.9 Whilst there is considerable debate about future markets for private finance—whether they are traditional bank lending, the bond market or even the introduction of equity investment—it is important to recognise that they all rely on sufficient and secure income streams on the part of the borrower. There is a danger that the debate moves to the form of funding or investment, without the more fundamental questions of development economics being resolved. For example traditionally equity has been a more expensive form of financing than debt, and whilst the notion of an entirely different funding model may be seductive, potentially it increases, rather than reduces, the need for subsidy.

4.10 Ultimately, we believe that the best way to increase the amount of private funding going into affordable housing supply at a time of heavy rationing—whatever the form of borrowing or investment—is to ensure that the model of provision recognises the need for ongoing subsidy and certainty of rental income streams. It is this that has led to unprecedented private finance investment in social housing (over £60 billion) and we prejudice this at our peril. History suggests that housing providers and investors can and will be innovative, and find new sources of funding for the sector. However this will only happen, if the fundamental building blocks of a sustainable business model are in place.

October 2011

1 Albeit at a lower level, with “outputs” reduced by 20% compared to the previous three year period.

2 Gearing is a measure of borrowing as a % of the total asset value measured in relation to grant plus reserves.

3 Where Next? Housing after 2015, L and Q Group/PWC.

4 Construction in the UK Economy: The Benefits of Investment, LEK, 2009.

5 Social tenant attitudes to payment of housing benefits direct to tenants, Policis, 2011.

Prepared 1st May 2012