Financing of new housing supply

Written submission from the Cambridge Centre for Housing and Planning Research

Summary

· This supplementary submission sets out a response on a number of issues.

· There needs to be clarity as to the future prioritisation of more limited housing grant and the future availability of Housing Benefit and its capacity to ‘take the strain’ in housing policy terms

· The state does have a role in lending and investment not least in terms of helping creating markets and building market confidence. The state has made significant ‘investments’ in housing as it has in other industries. Given housing is both a consumption and an investment good there is considerable locked in value and the potential of this now needs to be properly explored.

· Support in kind is important but currently the mechanisms in place have been put into question. It is important that we have clarity going forward as to their use and impact.

· Institutional finance is already in place in housing via housing associations. There is clear potential to go further both with respect to that sector and in relation to private renting though here it is unlikely to dominate. Investor requirements have to be properly understood and met to secure this desirable outcome.

· Private finance for housing associations has been one of the most significant success stories in this area. The market is now under pressure for a number of reasons and government policy changes have created a degree of uncertainty. It is important to re-stabilise this market.

· The new arrangements for local authorities should create a capacity to fund new development and this is to be welcomed. It is unlikely to replace existing funding capacity.

The Submission

1. This is a supplementary submission by the Cambridge Centre for Housing and Planning Research (CCHPR) following our initial submission with LSE and the University of Sheffield. CCHPR is one of the longer established research centres in the UK specialising in housing and planning issues. The Centre has long experience in work around housing finance and housing supply (see our website for further details (http://www.cchpr.landecon.cam.ac.uk/)

2. This is an important Inquiry posing fundamental questions as to the capacity of the government and public and private sectors to meet the nation’s housing needs. With cutbacks in government expenditure and reductions in housing supply and mortgage finance alongside the continuing growth in the number of people and households there are real challenges to the continued health of both the economy and society in the UK.

3. The Committee asks a number of questions and in this supplementary memorandum we seek to provide responses:

(a) Making best use of limited capital and revenue subsidy in terms of stimulating supply.

This raises considerable challenges. In many respects funds should go to the areas where unmet demand and need is highest – but these tend to be the most expensive so the subsidy applied produces fewer homes. At the same time the potential to lever in additional resources through borrowing or equity investment is greater in higher priced areas because the risks are lower and the returns are higher. One option would be to focus funds on regeneration areas where the market is very weak and on the infrastructure for residential development in higher demand areas. In this way it would support areas where the market is either very weak or where the impact of modest subsidy would be greatest in terms of triggering a supply response.

There has been a long standing debate in the UK about what is the most effective sort of subsidy. We can distinguish capital subsidy, revenue subsidy and personal subsidy. Capital subsidy covers the costs of development above and beyond what might be met through rents or mortgage payments by means of a capital grant. An alternative is to pay a revenue grant to cover borrowing that was raised to pay for the development. Up front capital grants are preferred over revenue grants because they are less vulnerable to political change. An alternative is to supplement any capital or revenue subsidy with personal subsidy. This is the route the government has chosen. It is clear that DWP wishes to curb the rising £21 billion housing benefit bill and this tension now sits at the heart of housing policy. It impacts upon the decisions of providers, funders and investors. It is important to secure some clarity as to the future course of housing benefit and the willingness of DWP to ‘take the strain’.

(b) The role of the state in terms of lending and investment as distinct from grant

It is clear that for the most part the housing market should function as a market and be based on private sector activity whether as individuals or companies. The state can assist that market to meet the demands of households – not least by easing tax requirements/providing tax reliefs, eg, capital gains tax, as part of its policy stance. Setting aside direct state funding via the different types of subsidies, the state also has a role with respect to lending and investment, first through the rate setting via the BoE and the general management of the economy. Second, the state can play a significant role in creating market confidence and activity through lending and investment – ie, advancing funds which are repaid with or without an uplift reflecting the performance of the underlying asset or the organisation to which those funds were advanced. Currently the government is proposing a ‘build now, pay later’ scheme whereby public land is developed by private builders and the land cost will be repaid on sale. This has some merit though it should not be without ’strings’ including ensuring at least that part of the development is for affordable housing. It also funds equity loans for house purchasers through housing associations. These funds are repaid to the association with uplift according to the HPI. Though there is the potential to repay this to government that is only done if the funds raised are not re-used for housing development within three years. So uplift is achieved and it feeds back into the housing programme. This is sensible. Both help the market and providers/supply. The question partly is the opportunity cost of using that explicit/implicit investment elsewhere and with better returns. There is no evidence to suggest that this evaluation takes place.

Currently there is a live debate about the £40bn of government grant which has been made to housing associations over the decades to help fund development. This sits as a repayable charge on housing association balance sheets. With the reduction in new grant funding some large associations have been exploring whether this grant could be written off so that it increases the balance sheet capacity of housing associations. Alternatively some have asked if it could become an equity investment though this raises the question of how big the premium might be and how this is paid for on top of the current costs/profit structure. It would imply higher rents. At present the costs of raising equity are probably higher than raising debt. Some associations are moving towards being fully leveraged within current borrowing terms and thus need to find new ways of raising funds, eg, the recent Places for People unsecured retail bond issuance. Given that all developing associations will be increasing their leverage in order to raise finance for development alongside the new affordable housing regime this exploration is important. It is one possible solution for a group of associations rather than a solution for the sector as a whole. It also raises a range of governance/constitutional issues including the public/private status of housing associations, whether and how the equity investor has any say in the running of the business, how that equity might be traded and whether this could lead to conventional mergers and takeovers? None of these issues have been resolved to date. Overall, this suggests that although we are moving towards a greater role for lending and investment, equity might only be a partial solution.

(c) The role of support in kind

This is important and has grown in significance as access to grant funding has declined. The rise in the role of Section 106 agreements whereby developers agree to provide free or discounted land in exchange for development rights on the remainder of the site is a case in point and this was discussed in our initial submission. Support in kind is however vulnerable in that it only works in so far that the mechanism in question is operating. Section 106 development slowed in the downturn and thus associations reliant upon this found their development programmes stalled. Moreover because it is in kind it rests on the ‘random’ distribution of those opportunities rather than providing funding directly where it might be needed most.

Guarantees have been a neglected part of the UK housing system. The current Mortgagee Protection clause used in shared ownership to protect lenders to the borrower from losses in the event of default has a number of weaknesses which have not been resolved despite protracted debate between the FSA, CML and the NHF with the consequence that mortgages for shared owners are less readily available. Similarly mortgage guarantees provided by local authorities to underpin higher loan-to-value lending by mortgage lenders have fallen into disuse reflecting lenders’ concerns about the terms under which they were offered. In other countries state or private mortgage guarantees are used to encourage lenders to offer higher LTV loans to first time buyers. This is a common solution but it is one that does not currently exist in the UK. There are a number of technical reasons for this – mainly surrounding the credit standing of the mortgage guarantee insurance providers. The state could provide this cover as is the case in a number of countries.

The barriers are many and varied – the absence of strongly resourced MIG insurers, misunderstanding about the cost and use of Local Authority guarantees and the tensions between the EU CRD legislation and the current SO mortgagee protection clause. All of these could be sorted out if government took a lead in the process.

(d) The availability of long term private finance from institutions

There is a tension in the UK mortgage market between its reliance on short term savings instruments to bring money in and lending on longer term mortgage products. This mismatch has been managed over the years but the tensions have increased since the downturn and not least because the FSA is now requiring firms to give much closer attention to liquidity and basis and interest rate risk. This tension has led some to focus on the possible role of pension funds which have long term liabilities in the form of pensions and need long term assets to match them. Given that housing prices and rents move roughly in line with RPI/wages there is a good fit. However pension funds have shown no real appetite to invest in residential real estate beyond being active buyers of housing association bond issuance. Recently there appears to be renewed interest in investing in residential real estate though it has been slow to crystallise into actual new funding.

The barriers appear to be many and varied but include lack of experience and the mixed characteristics of residential real estate – a mix of gilt (stable) and equities (volatile) characteristics which is hard to position, the absence of daily pricing measures, periodic limited liquidity and reputational risks. There are a number of current explorations into the barriers and the committee should consider the progress being made and what could be done to expedite this.

If institutional investors wish to invest in residential property, then it makes sense to do so by holding a diversified range of bonds issued by different landlords – there is no particular virtue in institutional investors like pension funds actually owning property directly and as noted above institutions do already hold HA paper.

The barriers to entry for new large scale private landlords are high – it is difficult to acquire a portfolio which is simultaneously sufficiently diversified but also spatially concentrated (for economies of scale in management), and to do so within the short time frame required by investors.

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.

A further strand in this is the linking of shared equity with institutional finance. There are a number of public and private shared equity schemes in place which assist first time buyers. Ultimately if the provider of the shared equity is government or the property provider –builder, local authority or housing association there will be balance sheet constraints. There is potential for Institutions to buy up performing loans books and thus allowing the original funder to recycle its funds into more activity. Builders have over £1 billion of shared equity loans on their books and housing associations will have an even larger sum. There is some evidence that institutions are wiling to explore this potential and it would be helpful if this was taken further.

(e) Increasing private finance for housing associations and ALMOS.

Higher rents will support more borrowing but potentially will change the role of the sector. A number of changes have been made in terms of borrowing rules which have eased the raising of private finance including for example the use of security trustees, taking account of first tranche sales for shared ownership, and allowing sales and disposals to be taken into account – all these have increased the capacity to raise finance but they are modest. Some large associations have secured credit ratings to widen their appeal in the funding markets and others have formed borrowing clubs which allow small associations to bundle together their funding requirements.

At the same time the number of lenders of debt to the sector has been shrinking reflecting changes in financial markets and mergers. Much of the back book of private finance for housing associations is loss making for lenders – loan terms granted in the highly competitive market evident up to 2008 were extremely fine with the upshot that as funding costs have risen the returns on these loans are far lower than the current cost of funds. This loss making is hardly conducive to expanding loan books and indeed this has meant a number of lenders have now looked to reasons to re-price loans. This is a new and unfortunate tension between lenders and HA/ALMO borrowers.

(f) Reform of the Council Housing Revenue Account system and more funding for housing supply

The principle of HRA reform is to redistribute existing debt among local authorities with retained stock so that each local authority has the maximum amount of debt that its income stream will support. In these circumstances, local authorities will not have any room for manoeuvre to increase funding until they have either increased their rental stream (which they cannot increase by more than the government’s annual guideline without carrying the cost of any additional Housing Benefit), or reduced their debt, either by diverting income to do so or by selling assets.

The ability to reduce debt, particularly by asset disposals, is not distributed equally across local authorities, and there is no guarantee that those authorities with the greatest capacity to dispose of assets will either be in the greatest need of reinvestment in adding to stock, or necessarily be willing to do so. Due to past quirks in the subsidy system, a number of local authorities have less actual debt than their allocated debt ceilings, and so could borrow more immediately, if they had the income stream to support additional debt. The number of such authorities is not known. DCLG collect the necessary data from the subsidy returns, and it would be helpful in estimating the scale of this capacity if this data  were published.

November 2011