As all fans of ‘Yes, minister’ know, when Sir Humphrey described a decision as ‘brave’, what he actually meant is that it was barking mad. The word ‘innovative’ often seems to mean much the same thing. Take the example of the scheme to fund new social housing in the Highlands, which Alex Neil, the Scottish housing minister, has described as ‘innovative’.
To summarise, each time a house becomes vacant, Highland Council will sell it into a newly created ‘special purpose vehicle’, probably backed by a bank or a pension fund. The council will still allocate the house to someone on their register, just as now, and the special vehicle will subcontract the management and maintenance of the houses back to the council. After 25 years, the special purpose vehicle will give the houses back to the council.
Not so magic formula
So at first sight, nothing changes. The council decides who gets the houses, and looks after the properties. But the special purpose vehicle will give the council £31,500 per property, which comes to £94.5million for the 3,000 houses that the council plans to transfer. The council will use this money to build 650 houses over the next five years. Apparently 650 houses come from nowhere, as if by magic.
But as every economist knows, there is no such thing as a free lunch, let alone 650 free houses. Why on earth would the special purpose vehicle want to give the council £31,500 for each house that becomes vacant? The answer is that they are going to make £31,500 out of each property over the following 25 years. At first sight that comes to £24 per property per week, but it is rather more when you take into account the interest - the special purpose vehicle will pay the £31,500 up front, and get the rental back over the follow 25 years. Mathematically, it will have to make around £34 a week over and above the cost of maintenance and administration to cover the £31,500.
There is no suggestion that the special purpose vehicle will be more efficient in looking after properties - after all, it is going to subcontract the maintenance back to the council. Nor will it be reducing costs by cutting corners - for the same reason. Instead, it will make its money by raising rents - as the council acknowledges, stating that rents will be between traditional social rents and private sector rents.
So the long and the short of the scheme is that if you move into a council house in the Highlands in the next five years, your rent will be higher. Higher rents mean more profits, and those profits will be used to build more houses.
A democratically elected council has the right to say that it thinks the world would be a better place were new tenants to pay higher rents so the council has the money to build more houses. Local people might agree or disagree, and re-elect the council, or not, in due course. What makes no sense is the creation of a special purpose vehicle to achieve this.
It would be much cheaper for the council to borrow the money directly, either from the markets, via a bond issue, or from a bank or other financial institution. After all, it has a secure revenue stream - the profits from the higher rent tenancies - and it is not difficult to convert a future revenue stream into money up front. That is what banks do every day.
The special purpose vehicle is simply a costly version of a bank loan. Creating the idea has already cost real money, in the form of the time of the council housing management team’s staff time. Now the council is going to spend £100,000 to examine the feasibility of the scheme (it might be better for the council to save its £100,000 and spend 5p photocopying this article.)
If it decides to go ahead, it will take more staff time, and then real money. Drawing up a contract like this will not come cheap - the lawyers’ fees on both sides will be large, and ultimately, all of those bills have to be paid for by the council and its tenants. If the scheme goes ahead, there will be costs every year. Each year, for example, the council and the special purpose vehicle will have to negotiate over rents. The vehicle will want them as high as possible - they are a financial institution, and they are in it to make money. And they will have to negotiate over the fee for maintaining the buildings. This time the vehicle will want them as low as possible, while the council will want them to be as high as possible.
With the best will in the world, you can’t agree now how much the rent will be in 2035, or how much the maintenance will cost by then. There will be negotiations, and there will be disagreements, and those negotiations and disagreements will be costly.
We have a government that says that it is committed to localism. David Cameron claims to favour localism root and branch. So,
Mr Cameron, would you be happy for Highlands Council simply to borrow the money, and pay it back later from higher rents? If so, the council should do that for sure, rather than use this special purpose vehicle.
Of course, there is a reason why Mr Cameron might not be happy: many new social housing tenants receive housing benefit. Their
higher rents are paid for by central government, and a bigger housing benefit bill is definitely not on the government’s agenda. But that is an argument against higher rents being used to fund new build, whether by direct borrowing or via a special purpose vehicle.
In general, special purpose vehicles are bad news. They are expensive to set up, expensive to run, generally opaque, and often lock you in to deals you may later find don’t work. If you have a revenue stream and want the money now, then borrow it and be honest and straightforward about it.
Tim Leunig is an academic in the department of economic history at the London School of Economics