Financing the new housing supply

Written submission from the Association of Greater Manchester Authorities

Summary

· The nature of the UK housing market has fundamentally changed, and financing new supply on the traditional build to sell basis will not deliver the numbers of new homes we need

· Local authorities can act as enablers of new development, using their landholdings in partnership with institutional investors, and generating value from that investment in the form of deferred returns, and Greater Manchester is pushing forward work on turning that into a reality

· Government and other public sector agencies can act in a similar way and, if properly co-ordinated at a local level, much more can be achieved

· A new model of private landlord could be key to the achievement of high quality development at scale to meet the new realities and demands of the restructured housing market

· Housing associations have many of the skills necessary to deliver that new model, but the risks attached to the Affordable Rent model may act as a barrier

· Partnerships between housing associations and private investors may provide the best way forward, supported by local authority-led enabling work

· Government should urgently consider whether the short term nature of most private tenancies and the wider regulatory framework for the private rented sector fits with the changed nature of the UK housing market

· The New Homes Bonus should be recalibrated to better support delivery of volume housing

1 The changing nature of the housing market

1.1 In very crude terms, there are two main housing career paths emerging as the fundamental building blocks of the UK housing market, with the key distinction being between households who have (or can afford to acquire) equity, and those who don't (or choose not to):

· The first path is to live with family or rent for a while (this now becoming an increasingly long while), then buy (maybe with help from family), then trade up and for some invest in Buy to Let, then downsize/release equity later in life.

· The second is to rent for life – traditionally secure social rent, but now the emerging Affordable Rent option and, more strikingly, a return to private rent [1] as a long term option – either through choice or, as the decline in number and accessibility of social rented property continues, through necessity.

1.2 All information would suggest that the second route is increasingly common, since the first is becoming more and more difficult for households to achieve and sustain unless they are well dug in with their own or inherited equity. That suggests possible high level objectives around:

i. Making the traditional path via owner occupation more financially achievable;

ii. Building some bridges or breaking down the barriers between the two paths; and

iii. Improving the housing, quality of life, security and economic outcomes that the rental path offers, to try to reduce the economic polarisation that seems likely to result from continuing divergence.

iv. Re-evaluating the economic arguments between home ownership and renting for households – is the popular perception of renting as ‘dead money’ outmoded?

These should be looked at in a context where the primary requirement is to secure housing growth to meet a quantum of demand which, while subject to debate at the margins, is clearly in excess of current delivery by a worryingly substantial margin.

1.3 From a Greater Manchester perspective, we need to close that delivery gap as a foundation for economic recovery and growth, both to contribute to national recovery and as a basis for achieving our wider social and environmental objectives. With funding from both public purse and financial institutions increasingly scarce, and household budgets squeezed, the main traditional drivers of investment have stepped back from the market, with obvious results in terms of numbers of market transactions and new development. Homes & Communities Agency colleagues estimate that around 60% of all new housing starts in the North West currently have some form of public subsidy, illustrating the scale of market failure. As the gap between household income and the cost of entering owner occupation continues, there will be a growing cohort of people who cannot purchase, even with the help of shared ownership/shared equity products increasingly available from developers. But with supply also continuing to be constrained by lack of finance, it seems unlikely that house prices will drop substantially, as might otherwise be expected when a product (i.e. owner occupation) becomes unaffordable.

1.4 The role of the housing market in the UK economy means that this knot of related issues poses a significant economic threat, given both the place housing has as an investment and the direct importance of the housing industry and related services as a source of employment. But it also points to a growing crisis in housing if the supply of homes across all tenures remains substantially behind household growth, as it arguably has since the late 1970s, and certainly since 2006/07.

2 Opportunities and risks

2.1 In this scenario, where are the opportunities for change and substantial progress? We can suggest five areas of opportunity in terms of bringing new investment in housing delivery in the broadest sense (i.e. in delivering additional housing supply or maintaining and improving the quality of the stock we already have):

a) New investment models to match demand for housing with requirement for long term sustainable, stable investment opportunities in more risk-averse financial climate;

b) A more active and flexible use of public sector assets to invest in housing delivery, complemented by levers such as New Homes Bonus and Community Infrastructure Levy (CIL);

c) New models of support for households unable to access housing they can afford through the market, such as the Local Authority Mortgage Scheme being promoted by Sector Group;

d) Carbon reduction and domestic renewable energy generation as an investment opportunity given expected significant increases in future energy costs; and

e) The financial implications of an equity rich, ageing owner-occupying population.

We focus in this response on the first three, as perhaps the most relevant to new development. However, it may be worth noting and exploring the potential for the equity held by older households as a partial substitute for first time buyers in funding new development, allowing them to downsize later in life while releasing under-occupied larger homes.

2.2 In addition, we should consider the need to mitigate some key risks, including:

f) Increasing divergence between households (and in fact entire neighbourhoods) on each of the two housing career paths described above, and the economic and social impact that may have;

g) The extent to which a continued stagnant (or declining) housing market coupled with declining household incomes as the impact of recession and public sector cuts resonate through the economy will leave more households struggling to meet mortgage and maintenance costs of home ownership but unable/unwilling to sell their home because of negative equity;

h) The impact of reforms of Housing Benefit/LHA and the introduction of Affordable Rents on the way the market operates, the patterns of demand for housing (spatially and in terms of types of property), the rental income which can be generated by social and private landlords, and the resulting uncertainty around all of those issues which makes business and investment planning difficult for those landlords;

i) The impacts of a combination of increased demand for private rented homes at the lower end of the market and limited supply of new homes driving the creation of significant additional poor quality private rented homes as landlords acquire and sub-divide existing property;

j) The continued lack of available finance for both the funding of development and purchases by householders for an extended period, including the long term impact that could have on the development capacity of the commercial sector;

k) The declining ability of key public sector players to intervene as a result of reducing budgets and capacity in HCA and local authorities; and

l) The divergence between areas where values are sufficient to maintain some housing delivery through traditional business models and those – likely to include much of Greater Manchester and other Northern urban areas – where new approaches will be needed.

m) The barrier to development arising from the expectations of landowners of site values based on previously achievable prices rather than the new reality, added to the locked-in cost of sites already expensively acquired by developers in earlier times.

3 Elements of a new approach

3.1 In a complex system such as the housing market, these risks and opportunities are of course inter-related. We will try to sketch out in broad terms a narrative as to how we see these and other issues fitting together, but focusing on securing new housing supply.

3.2 Bringing the first two opportunities together, Manchester City Council are leading pilot work on a new model which is intended to be applicable across Greater Manchester. Briefly, the scheme requires an investor, the local authority as land owner, a house builder/developer and a housing managing agent. Schemes for new private rented housing can be developed on the basis of deferred receipts from the land owner and rental guarantees from the managing agent (possibly a housing association), which together are sufficient to give a lender/investor confidence that the income from the development is sufficient to service a loan and provide a return.

3.3 Current work on a detailed proposal revolves around five local authority owned sites which are a mixture of good quality/high demand sites and more challenging regeneration linked sites. Detailed appraisals of the sites have been completed including a detailed housing market analysis. Significantly, Manchester City Council is in close negotiation with an investor which would significantly simplify the model. The simple model is an investor and a landowner coming together in partnership and procuring a house builder and housing managing agent. Whilst the initial sites are likely to be a mix of private rent and outright sale, further work is going on to determine if the model will accommodate a mixed tenure approach. The intention would be to utilise the Affordable Homes Programme together with the investment model to help bring forward further sites. Part of the local authority’s contribution is to help manage risk by using knowledge about existing and future housing need and demand to ensure schemes are closely aligned to the local market.

3.4 Our intention is to demonstrate through the pilot that this model can satisfy the requirements of the investment market, while producing a (deferred) return to the local authority and development at scale of new housing which meets the needs and aspirations of local residents.

3.5 In part, we are using this to help change the perceptions of investment markets of the residential sector as a source of acceptable returns on the basis of rental income streams. The attitude to this in the UK has been out of line with other markets internationally, including the United States, where residential holdings are seen as a natural part of investment portfolios, and where returns are expected to be generated from rental income rather than, as has often been the case in the UK, capital growth. This is accompanied by longer term tenancies than provided by Assured Shorthold Tenancies, providing greater stability and security for households (and communities) and helping to make renting a more attractive prospect as a housing choice. Larger landlords are also able to offer tenants alternative properties to fit their changing requirements over time – arguably a level of customer focus not commonly found in the UK.

3.6 In summary, we believe the time is right to pursue an alternative model for private landlords – working at larger scale, developing homes designed to be rented out to a range of households, and within a community context. In many ways this replicates the skills and experience of housing associations, albeit aimed at the mainstream market rather than the social housing sector, and the Committee might usefully explore the potential of associations – either on their own account or with private partners – to drive that agenda forward. This new model for private rent could, in our view, be strengthened by regulatory changes to offer landlords the ability to offer greater security of tenure in the private sector as part of an overall approach to improving the quality of both the physical product and the management service to ensure that households whose best long term housing option enjoy high quality homes in stable, successful neighbourhoods.

3.7 Returning to the Manchester pilot, our intention is that, if successful, this could be replicated across Greater Manchester, using packages of sites in all ten districts to provide a range of opportunities of different types of development to match the likely demand in different neighbourhoods across the conurbation, allowing investors to match their requirements in terms of market segments, risk, tenure, etc. The Committee’s questions about the best use of public subsidy and the balance between grant and lending or investment by the state are relevant here. In all sectors, the Greater Manchester approach is increasingly to seek to secure investment and recycling the proceeds of that investment to bring repeated and multiplied benefits, rather than chasing one-off funding. Over time we will build our ability to invest in the agreed strategic priorities that will underpin economic growth in Greater Manchester, and in practice it also drives a different, focused attitude to the development of projects with real and lasting impact.

3.8 Specifically on housing supply, the approach we are piloting is based on securing deferred returns to the authorities contributing sites to the project, with the potential to reinvest returns in time to repeat the cycle. If Government was able to add to the investment pot as a partner, the pace and scale of delivery could be accelerated, and an agreement could be reached as to the sharing of proceeds over time. A further alternative would be local authority bonds, suggested recently as a means of raising greater levels of finance to build out rental developments where sufficient returns can be confidently expected.

3.9 But there is a further element to the possible contribution of Government. The Prime Minister has announced a new push to secure housing development on Government owned land on a ‘build now pay later’ basis. While we await further details of this, parallels with the model outlined above are obvious. We are already working with HCA and CLG in Wigan on a Capital & Asset Pathfinder project, seeking to exploit the public sector estate as an opportunity to drive development forward. Bringing those threads together, if we could manage local government, central government and other public sector landholdings such as the NHS in an integrated way, the scale of investment and delivery possible becomes much bigger. This would need to be done spatially, looking at places in an integrated way to construct a sensible pipeline of development to maximise both housing supply and financial returns to the various partners. We need to avoid opportunistic approaches from different parts of the public sector undermining collective returns through a lack of co-ordination and understanding of the impact on local markets. The Capital & Asset Pathfinder approach would appear to be a useful mechanism to help achieve that co-ordinated impact. With suitably strong support within Whitehall to secure a flexible and positive approach from across Departmental silos, more could be achieved.

3.10 The Committee also ask about the Affordable Rent model and its relationship to funding new homes. We are working closely with HCA and our partner Registered Providers (RPs) to ensure that Affordable Rent is implemented successfully in Greater Manchester, by which we mean that the funding the model makes available from HCA and via rental income from new build and conversions to Affordable Rent delivers the right homes in the right places to help meet local demand. However, there are clearly still questions for RPs in particular about the assumptions they should make about rental income, given the Government’s stated intentions around welfare reform. Housing Benefit changes (and uncertainty about their actual impact) can be seen as a risk to landlords’ income streams, and therefore might well result in a more cautious view from RPs about their ability to commit funds to back new development. Some RPs may see development for market rent or low cost home ownership as an option they might pursue in order to hedge against the risks in the social rented/Affordable Rent sector. The balance between those arguments is hard to predict at the moment, and may be different in different places, depending on development costs and rent levels and their relationship to Housing Benefit thresholds. Equally, Government will no doubt be reviewing the impact of Affordable Rent on the Housing Benefit budget, and whether this is an efficient means of subsidising new affordable housing provision.

3.11 A further concern for the medium term is how the future for affordable housing provision will look once the current Affordable Homes Programme round is complete in March 2015. It is far from clear that RPs will be in a financial position to continue to borrow and invest to develop indefinitely via the Affordable Rent model at current grant levels, and assumptions around numbers and types of property converting to Affordable Rent remain untested. Clarity is also awaited on the Prime Minister’s recent announcement on revitalising the Right to Buy and the guarantee to replace each home sold. As many RPs are stretched in securing borrowing to support Affordable Homes Programme development, and receipts after discounts are unlikely to cover the cost of replacement homes, even if councils are able to provide suitable land. HRA reform may, in some places, provide some flexibility for local authorities to make a more direct contribution, as might prudential borrowing, although many councils are already under unprecedented financial pressure.

3.12 Finally, the New Homes Bonus is one Government contribution to this agenda. In terms of maximising the return on that investment, Government’s approach does appear to be flawed if housing delivery is the key intended outcome. Currently, properties built in Band H attract three times as much New Homes Bonus as a property in Band A. However, our evidence of the limited new development still being funded by the market suggests that this is concentrated at the top end where buyers are still able to purchase new property, drawing from equity in their existing properties. This is not to decry the need to build higher value homes – indeed, their relatively limited supply in Greater Manchester is seen as a barrier we need to overcome in retaining more of our high net worth individuals and their economic contribution to Greater Manchester. However, this is an inefficient use of New Homes Bonus, producing only a small number of new homes. A flat rate payment based on the Band D average would switch the emphasis toward rewarding volume of housing delivery, rather than providing an incentive to provide more high value homes, regardless of what local needs might be. In turn, that might allow local authorities greater leeway to use New Homes Bonus imaginatively as a means of supporting investment to drive housing delivery.

4 The role of national government

4.1 We can suggest a number of areas where Government is uniquely placed to act:

a) Making the case for housing as a high profile national issue. This is beginning to happen, though arguably much of the debate has focused on the welfare reform agenda and on the planning system, rather than on the financial issues which have actually caused the collapse in housing delivery nationally. But fundamentally, we are not building enough homes to meet household growth (and this was also true under the previous Government). This partly explains why house prices have remained relatively high. It should be possible to agree on a cross-party basis that having positive answers to the question "Where will our kids live when they grow up?" is a central political concern at both national and local level.

b) Rethinking the emphasis on home ownership as an achievable ambition for all. The evidence from the market – in the North West and nationally – indicates a structural shift away from owner occupation has been underway since 2003, and history suggests that "government rarely manages to buck fundamental trends in housing tenure [without] a very large financial commitment in the form of direct intervention…or incentives such as Mortgage Interest Tax Relief" [2] . Renting is the growing sector, and government needs to re-examine both the legal framework for protecting landlords’ and tenants’ interests and how investment into the private rented sector can be increased to meet future demand (both to maintain and improve quality of the existing stock, and developing new homes for rent).

c) Using levers available to influence/direct financial institutions, including those in substantial public ownership, in their attitudes to investment in housing. While many of the financial issues currently facing the UK and other developed economies can be traced in substantial part back to ill-judged lending on residential property, paradoxically there are now opportunities in the housing sector to achieve stable, low risk returns for investors with a long term view. We should look to see what lessons can be learned from other countries where the private rented sector is seen as a long term stable option for both tenants and investors, and whether key elements can be replicated in the UK to support the development of an active market in institutionally-backed investment in the sector. This should include for example looking at longer term tenancies, and at stamp duty and capital gains tax rules as they apply to landlords. This should complement measures to unlock the mortgage market for those households who can afford to buy but are currently unable to secure finance from lenders.

d) Maximising the flexibility available to local authorities and their partners, including HCA and Registered Providers, to get things done in ways that work locally, and understand that the ability of those organisations to achieve more with less direct financial input from Government depends upon retaining and enhancing the capacity, experience and knowledge of regeneration, legal, housing, planning and other professionals. Procurement and State Aids issues often complicate the relationship between the public and private sector in this area, and this can get in the way of developing and testing innovative proposals, particularly with private sector partners. While the rules in place are there for good reasons, it may be worth Government exploring the potential for any flexibility that can be added without risking compromise of the key principles of sound governance in this area.

e) Ensuring Government Departments and Agencies are active partners mandated, encouraged and monitored on their commitment of landholdings and other assets into development proposals led by local authorities and their partners. The use of HCA as an enabler in this work is already a positive step – Ministerial and Treasury pressure to engage flexibly in this work and to accept deferred rather than immediate returns would be extremely helpful. The Capital & Asset Pathfinder work recently reported on by CLG provides some guidance on useful approaches, and we await details of the announcement by the Prime Minister on the eve of the Conservative Party Conference in regard to the ‘build now, pay later’ release of Government land for housebuilding.

October 2011