Retrofit - wild goose chase or golden opportunity?

The seeds have been sewn. Already the first tentative shoots are emerging. But if retrofitting in the UK is to grow - really grow - from a fledgling sector largely characterised by government subsidised pilot schemes into a commercially viable £12 billion a year market within the next three years, then something magical is going to have to happen.

By 2050 carbon emissions from housing in England, Wales and Scotland are to by reduced by 80 per cent. Following the warm homes standard announced by the Gordon Brown’s government in February, housing emissions must fall by 29 per cent by 2020 and the social housing sector is expected to lead this charge. On these targets - which equate to the retrofitting of 13,400 homes a week - there is broad political consensus and little room for compromise. Does this mean fast progress is guaranteed, however, and what hurdles still remain in the way?

With an estimated price tag of £500 billion over the next 40 years the biggest problem will be funding. Since social housing accounts for around
20 per cent of the UK stock, this could equate to an eye-watering £100 billion tab. Given the state of the public purse and the scale and speed of growth required, some might consider the financing of this to be the stuff of fairy tales. However, seemingly not everyone.

‘I think there is an element of it doesn’t get much better than this for social housing providers,’ enthuses David Adams, head of external affairs at Knauf Insulation and director of Zero Carbon Hub. He is one of a growing number of social housing sustainability experts who are adamant that not only are these targets deliverable, but that retrofit presents a golden opportunity for social landlords to generate significant new income streams and with it, increased financial independence.

‘By investing in retrofit social landlords are making and saving money while creating jobs and reducing fuel poverty at a time of economic recession when investors are looking for areas of growth. I am confident this can be delivered as long as the financing is set up in manner that fits the scale.’

Golden opportunity

A report entitled The future of low carbon retrofit in social housing set to land on the lap of the new government this month from the Energy Efficiency Partnership for Homes examines exactly how this could be achieved. Penned for EEPfH by a finance task group made up of government officials, social housing sector stakeholders and sustainability agencies and funded by Department of Energy and Climate Change, it warns there will be ‘no new public money for retrofit’. This is not a great surprise given that the retrofit overheads coincide with the UK economy creaking under the weight of a £178 billion debt pile that must be halved over the next five years through aggressive public sector spending cuts.
However, it also identifies several opportunities for the sector to take advantage of a predicted ‘energy crunch’ - a result of North Sea oil and gas drying up - which will trigger a rise in energy prices by developing new markets and creating economies of scale. To do this, it will recommend the government puts in place a regulated framework that could pool various funding sources on the back of the long-term income streams from energy technology and emissions reductions.

Many of the mechanisms to create these income streams have already been established. Last month feed-in tariffs were introduced, enabling both private and social landlords to sell electricity produced by technology such as photovoltaic panels and wind turbines back to the national grid.

Meanwhile, the last government scheduled the introduction of the renewable heat incentive for April 2011 - a scheme similar to FITs for heat energy generated from devices such as ground source heat pumps. This appears likely to be continued regardless of the election result.
Mr Brown’s government also set in motion a ‘pay as you save’ scheme which allows homeowners and landlords to repay the cost of installing micro-generation technology over a long period of time using the ensuing efficiency savings. The scheme is being piloted in Birmingham, Sunderland and Stroud by social landlord Gentoo Homes alongside energy company British Gas and DIY store B&Q. Each of the main political parties advocates forms of this scheme.

As a result, private sector companies are now coming to the table to form partnerships with social housing providers to take advantage of these developments. For example, Newcastle-based green services company Eaga has used the FIT to develop a clean energy programme in which it will invest and install the technology for free, but will retain the income from the energy sold back to the grid.

Finding funds

However, what still has not been established is where the upfront financing for all this technology will come from. The last government started to answer this question in its ‘warm homes, greener homes’ green paper. Despite being scant on detail, it stated that from 2013, it would introduce a new energy company obligation to replace the carbon emissions reduction target, that would foot two thirds of the £19 billion cost required to reach the 2020 target without increasing fuel bills.

However, several government department sources privately cast doubt on whether this is deliverable. None of these services were able to comment due to pre-election purdah. Nicholas Doyle, head of sustainability at housing association Places For People is among the sceptics.
‘I can’t see how the numbers stack up,’ he says. ‘Energy suppliers have already been hit with a £200 billion bill from the government to pay for sustainable infrastructure - which they will do because it benefits them too. At the same time, paying for two thirds of the cost of meeting these [specific] targets is going to be an extremely tall order. We can still use the new energy company obligation, but we need to do so with some imagination and treat it as seeding for much greater private sector investment.’

One option that is being mooted is to set up carbon investments funds. These would require either loans from banks or a long-term, bond-like investment from institutions combined with cash from the new energy companies obligation that would pay out a return from the combined emissions saving and energy sold back to the national grid. Organisations, ranging from social housing providers to supermarkets, would then ‘bid’ for cash from the fund using PAYS to finance carbon reduction measures.

‘The funds would be established on the basis that the energy supplier contribution would be fixed for an agreed period,’ explains Mr Doyle. ‘They could either be energy company-managed and regulated through energy watchdog Ofgem or the Homes and Communities Agency, or they could be government-managed also using national funding streams such as the “warm front” scheme.’

The cost of borrowing is one of the biggest hurdles to overcome in attracting private investment. Right now, on the open market, banks’ best commercial loans offer a 7 per cent interest rate over 10 years - although housing association get preferential rates of around 5.5 per cent. Mr Doyle says that to make the funds work, the cost of borrowing will need to fall to between 3 and 4 per cent with a loan term of around 20 years. With bank lending, even at commercial rates, looking thin on the ground, this does not seem likely to happen any time soon.

Mr Doyle is undeterred: ‘This would create some serious cash - and none of it from the public sector,’ he says. ‘Right now we are close - but still no cigar.’

But the potential for big bucks is there and other possible funding sources are also emerging. Already there are early talks underway with institutional investors - pension funds and life funds - attracted to the prospect of secure bond-like returns from carbon investment funds. One such institutional investor is Aviva Investors-backed sustainable fund manager, Igloo.

Alternative investors

Chris Brown, chief executive of Igloo, warns that retrofit financing must be an entirely commercial proposition with only the framework supplied by government. Therefore, while it is exciting, institutions would need returns closer to 5 per cent - around 0.5 per cent above what they would get from bonds - to make it attractive. This means that if institutions are to act as bankers, then around an extra 1.5 per cent must be added to the Places for People calculations.

‘The market is not there yet,’ says Mr Brown. ‘But it will be in the next two to three years and we see it as an area to move into; it is going to be an industry that is bigger than house building.’

Another option causing ripples of excitement in the social housing sector is Alastair Darling’s pledge to commit £1 billion into a green investment bank in his last budget. This would be used to leverage private investment as a government-seeded alternative to carbon investment funds.

John Doggart, chair of the Sustainable Energy Academy, points to existing models for a green investment bank in Germany where the government put up an initial €850 million which then stimulated €5.5 billion of investment.

‘If you take that model into the social housing sector where £2 billion to £3 billion needs to be spent each year on retrofitting, then it can be funded by less than one sixth of what the German government loaned,’ he reckons. ‘The investment will create jobs, which will also reduce welfare spend, so around £9 billion to £10 billion could be saved every year through a £1 billion investment. That is extremely cheap.’

On top of this, some believe that there is hope of funding to come from the European Union. This could take the form of European regional development fund cash that has already started to emerge through the regional development agencies - or even through the European Investment Bank, which Mr Brown argues is well placed to lend against retrofit investment.

Piers Williamson, chief executive of the Housing Finance Corporation, a not-for-profit finance company, confirms that this is a real prospect that could be delivered within 12 months. He says the HFC is in talks with the EIB to distribute loans to housing associations to fund retrofit - a sector he says is a ‘big priority for the EIB’ - at 1 per cent to 1.25 per cent less than most other banks. ‘If the next government creates flexibility for housing associations on rents and service charges, then this could lead to hundreds of millions of pounds of loans,’ he says. ‘But it also depends on how much housing associations are prepared to go out on a limb in an uncertain funding era.’

So which model is best? According to Mr Adams there is no ‘silver bullet’. ‘You are always looking at a combination of these,’ he says. ‘It is how you combine these components that presents the challenge.’

Overcoming barriers

There are plenty of other challenges too - though, conversly, there is no lack of willing. A survey of housing organisations representing 803,582 dwellings in the UK, which was carried out earlier this year by social housing sustainability consultancy Sustainable Homes on behalf of the HCA, showed that 76 per cent would act as a partner to reduce emissions in private sector housing around their stock. The results showed 54 per cent of respondents would be ‘very open’ to reducing emissions if they could work with ‘the right incentive’. This is where the problems emerge.

Given the state of the public purse, this incentive must be in the form of income from energy generated and savings from energy efficiencies. At the moment it is the tenants who pocket the benefits since they pay the bills. As a result, social landlords cannot recoup their investment in retrofit technology through PAYS and FITs or through increased rent or service charge as both are capped. The Energy Efficiency Partnership for Homes report will propose that ministers commission a review of social housing rental formulas to allow providers to use increased rental revenue to secure debt.

Alan Yates, director of regeneration at Accord Housing Association says: ‘We do need to secure finance, and consequently a mechanism to adjust rent levels when investing in retrofit, as it has the potential to unlock significant investment.’

But it will take a brave political move to do this given that much of the rents are paid for using benefits anyway. There are also concerns this could open the doors for landlords to charge tenants for other projects.

There are other difficulties too. For instance, it is also unclear whether investment in micro-technology or improving insulation will increase the value of landlord’s properties.

Another hurdle is that the cost of the income-producing technology remains high and is likely to fall rapidly as the market becomes more established, so there is little incentive for landlords to lead from the front and pay current prices. In the past three years alone the cost of photovoltaic panels, has fallen by 40 per cent. Now supermarket giant Tesco has started to sell them and prices are likely to drop further.

However, behind-the-scenes talks led by Communities and Local Government department officials are underway over the creation of a large-scale market for low carbon retrofit technology. It is understood to be looking to set up a retrofit consortium made up of Whitehall departments including health and defence, as well as housing associations that could buy this technology in bulk.

‘Right now there are only about 50 homes in the UK that have their emissions reduced by 80 per cent, so inevitably the costs are higher than they eventually will be,’ says Andrew Eagles, managing director of Sustainable Homes. ‘A large scale purchase would make the process much cheaper, in line with projected changes to market prices so prices up to 20 per cent below market value could be negotiated.’

It would seem then, that instead of mourning the loss of government funding, many social housing providers are already approaching the retrofit challenge in an increasingly entrepreneurial manner. Gentoo, for example, is understood to be looking at ways that it can make returns from carbon trading, while Birmingham Council, which is also test driving PAYS, is examining ways of making FITs benefit both social landlords and tenants.

So while public sector funding for retrofitting, such as the £17 million Retrofit for the Future programme, is set to become a distant memory, the future promises an array of alternatives. Social housing providers appear willing to head up the rapid investment, but the government needs to set about growing its green finance framework - and fast. Because if the sleeping giant of climate change stirs, then the 2050 fairy tale ending is well and truly over.

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