Financing of new housing supply

Supplementary written evidence from the Association of
Greater Manchester Authorities (AGMA)

Purpose of Report

1. At the Oral Evidence session on 19 December, the Committee requested a further note from AGMA on the barriers facing Manchester City Council in developing the pilot housing investment model with GM Pension Fund. The Committee also raised a question on the impact of procurement in general as they had heard previous evidence during a visit to Manchester suggesting that this was a significant barrier to development.

Background

2. The Manchester Independent Economic Review, conducted by leading economists from Harvard, LSE and Goldman Sachs, concluded that "outside London, the Manchester City Region is the area which, given its scale and potential for improving productivity, is best placed to take advantage of the benefits of agglomeration and increase growth." There are many factors that need to be aligned if the city region’s growth trajectory is to be optimised. Ensuring that the supply of housing meets the demands of a growing workforce and population is a fundamental requirement if the supply side of the economy is to function effectively, and AGMA is therefore committed to restoring housebuilding from the current low levels.

3. The Manchester pilot aims to respond to the current market and assist in delivering increased numbers of new properties. In parallel, work is being done on the issues that would need to be resolved to expand this both to a full GM footprint and a wider range of partners, in particular other public sector landowners. This model is placed in the context of a proposed wider approach to tackling the need to address market failure while also delivering a wider range of new homes including higher value family homes.

4. The previous housing delivery strategies which involved encouragement of home ownership based on borrow, build and sell models have not been replaced by any convincing alternative in the current and as development finance and mortgage finance continue to be squeezed there is little prospect of a quick return to the old model. Some analysts believe that this situation will be the new norm possibly for the next 10 years. Our approach therefore aims to make use of other key levers to generate the necessary investment to allow significant housing development to resume.

5. Unlike in previous recessions, public sector finance is not going to be around to provide a stimulus - there will be some, but it is likely to be peripheral. Alongside this the withdrawal of mortgage funding is leading to a restructuring of the housing market, both in the way development is funded but also in the product - for example we are seeing a steady rise in the demand for private rented sector, at both the top and bottom of the value scale, which is unlikely to be a short term phenomenon. Supporting this is a significant culture shift in the way we use our property, particularly in the 18 – 35 age bracket where job mobility, life style choices, and debt accumulated through higher education are all having an impact on the type of property demanded.

6. New delivery models critically need to respond to this new environment and be based on an understanding that there has been a fundamental move away from grant-led funding, based on need, towards recyclable investment, based on return.

The Manchester pilot

7. 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.

8. The model is being tested on the identification of a range of sites with varying values and in different neighbourhoods. The initial appraisal has clearly demonstrated that some low value sites do not work as a stand-alone investment, but higher value sites do. However, by packaging sites in a structured way, it is possible to ensure that the overall rate of return is sufficient to create a viable proposition which meets the requirements of the Pension Fund while generating a significant scale of new development (250 units).

9. In order to check the assumptions made in the development of the housing delivery model, Manchester and the pension fund have carried out a soft market testing exercise. There were three main areas of the model to test with delivery partners - construction, property management and sales. A number of organisations from the Homes and Communities Agency’s Delivery Partner Panel were invited to participate, including a wide range of expertise across national house building, contracting and property management. The model was very well received and some of the organisations were already looking into the build to rent concept. One organisation in particular was already delivering a mixed tenure development using its own resources to provide the investment finance. The detailed feedback from the sessions has been gathered, and is now being incorporated into a detailed brief.

10. Following approval by the City Council’s Executive on 18 January 2012, procurement of a house builder and sales and marketing advice is being undertaken using the Homes and Communities Agency Delivery Partner Panel. This will reduce the procurement time considerably as the panel has been through the necessary OJEU process. Separately a housing management agent will be procured through a straightforward lease arrangement using a range of Registered Providers selected with a mix of appropriate private sector managing agents. Procurement and appointment of the delivery partners is projected for Summer 2012, and following the detailed design work a start on site in Autumn 2012.

Key barriers identified by investment partners

Theoretical modelling v practical implementation

11. The key barrier is still to demonstrate to all partners that the model works. Modelling work done so far has taken this as far as possible with theoretical models using real sites, current values, and cost assumptions which we have tested with a range of potential bidders as a reality check. The final hurdle will be when the contractor and housing management agent are procured and the real costs can be properly modelled. Because of the nature of the investment proposals, very specific assumptions need to be made and incorporated into the model about the likely rental and sales income generated from each development – as with house prices, these vary significantly not just between different parts of the country, but between different sites within (in this example) Manchester.

Management lease and rent uplift mechanism

12. The investment partnership needs to minimise its risk on the rental properties through a lease to a housing manager. Key to the proposal is what cost the housing manager will put on that risk.

13. One of the main risks for the investment partnership is how the managing agent will offer rent uplift over the period of the lease. A simple RPI mechanism appears straight forward but this has caused managing agents some serious issues in the past. Market rent levels are by their nature, very market sensitive and specific to the locality. Linking increases to a national index can create strange distortions at a local level and can quickly make a development uncompetitive. Part of the bidding criteria will be to evaluate how each managing agent proposes to set rents and more importantly review them over the life of the lease. This is likely to be one of the main factors in determining the investors participation in the final scheme and therefore a key barrier.

14. Another key risk will be managing turnover. The management agent’s approach to the question of tenancy durations will be key, in particular whether the standard private sector Assured Shorthold Tenancy is felt to help achieve longer-term stability for both manager and tenants. All parties to date agree that keeping turnover to a minimum will be key and that offering longer term tenancy agreements will be a major incentive and product differentiation to the investment. However this has to be balanced against the mechanism for agreeing market rent uplift.

Governance

15. Under normal circumstances, the Council would need to invite a range of potential investors to consider the offer and to choose those offering the best deal in terms of rate of return required. This is difficult when developing a new untried concept as it is only by working through the issues with the investor that the scheme and governance arrangements can be addressed. It is worth noting that the City Council has been inundated with propositions from developers, consultants and individuals and without a procurement process it would be challenging to justify any one approach, especially as they all involve a requirement for the City Council to contribute its land as an investment.

16. However, MCC is in the fortunate position of being able to work directly with the GM Pension Fund given that both the Fund and the City Council are public bodies. Each is therefore able to enter into a Memorandum of Understanding without requiring a time-consuming and expensive formal procurement process. By working together on the development concept and understanding the partners objectives, we have been able to frame the MoU in terms that support the partners individual needs and aims.

17. Providing the model can now be practically demonstrated, Manchester and the other GM Districts will be in a much stronger position to offer out future phases to the market as there will be a clear and credible demonstration of what the model is and how it works on the ground.

Tax transparency

18. Tax issues are still being worked on. However one specific issue has emerged early on in relation to the type of partnership organisation used. There are two likely organisational structures, a Limited Liability Partnership (LLP) or a Limited Partnership (LP). Our current view is that an LLP structure would be the most practical solution, as it offers tax transparency (i.e. the partners pay tax on the income generated separately, rather than the partnership itself being tax liable) and greater flexibility in terms of implementation and changes at a later date. However pension funds are specifically excluded from tax transparency in an LLP making it impossible for them to opt for this type of partnership arrangement. A simple amendment to the Finance Bill could enable large scale investment proposals from pension funds to be tax transparent if they invested them through an LLP structure.

Procurement

19. Specific procurement issues have been mentioned above in relation to the Manchester pilot. However, there is a more general point that the Committee may wish to consider. The GM authorities have been approached regularly, particularly since the nature of the housing market has been radically changed over the last few years, by private sector partners with innovative proposals aimed at generating housing and mixed use development to test out different models from the traditional borrow, build and sell approach. While some may have been unconvincing, others have undoubtedly been deserving of further development, and may have become worthwhile additions to our (and Government’s) efforts to revive housing delivery. Most have involved local authority investment either through land or funding to acquire land.

20. However, procurement requirements mean that, other than through the partnership with the GM Pension Fund (because of it’s public authority status), we would need to openly procure potential partners to take those ideas through to delivery. Clearly, this requires the exposure of the innovative thinking underpinning the proposition, which private partners are understandably reluctant to agree. The outcome, though surely unintended, is that the procurement restrictions and the risk of challenge if not followed, have effectively undermined public authorities’ ability to partner with the private sector to test new ideas.

January 2012