Inside the government’s ‘disastrous’ military housing deal

Why was such a bad deal struck in the first place?
And what is in store for military housing as the government steps up its spending on defence? Inside Housing spoke to people close to the deal to find out.

Beginning of a bad deal

In the early 1990s, the UK Conservative government led by John Major wanted to manage military housing more effectively. It tried to set up a non-profit housing trust to do the job, according to the National Audit Office’s (NAO) analysis of the deal in 1997. But the Central Statistical Office (predecessor to the Office for National Statistics) found this would not constitute a transfer of risk to the private sector. So by August 1994, the government was committed to privatisation.

By 1996, the government had formulated a plan to sell off 999-year head leases for its Service Family Accommodation – then known as the Married Quarters Estate – and rent them back on 200-year underleases. Rents were to be discounted by 58% for 25 years, at which point they would be renegotiated. Every five years, rents would be reviewed and indexed to local markets.

Waiting in the wings to snap up the homes was Guy Hands. He had joined Japanese investment bank Nomura to lead its securitisation and structured finance teams in 1994.

The MoD’s sell-off was the perfect target for Mr Hands, whose team had been picking up portfolios of rolling stock, pubs and betting shops. Most of these were sold on, often for stupefying profits.

The proposed sale was sensitive. Housing is “part of the offer” of the Armed Forces, says General Sir Richard Barrons, former head of Joint Forces Command and a commissioner on the Kerslake Commission on Armed Forces Housing. “It’s part of why people join, why they stay and how they do a quite difficult job.”

There was political opposition. After meeting a few investors with a financial stake in the sell-off, Lord David Clark, then the shadow defence secretary, commented during a parliamentary debate in July 1996 that he understood why the deal was known as the “goldmine of the decade”.

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But Mr Major and then-defence secretary Michael Portillo pushed on and the deal went ahead. The sale was completed on 5 November 1996. Out of 19 bids, Nomura won with a £1.66bn offer to buy 55,000 homes, plus more than 2,000 surplus units. It created Annington to take on the properties.

In retrospect, the deal appears almost ludicrously bad for the government. The MoD kept responsibility for repairs and maintenance, and paid for utilities and rent – including on empty properties. It had to periodically renegotiate the discount to open market rates, which fluctuated beyond the government’s control and left it open to potentially unchecked rent increases.

On the other side, Annington pocketed rent, jumps in property values when it sold off surplus homes, and a dilapidation fee paid by the government for homes that were in a particularly bad state of disrepair.

The sale released £100m, which was supposed to be spent on upgrading the homes. The idea was the government would be spurred on to find surplus properties, surrender the leases and stop paying rent.

Yet, the deal significantly underestimated the future value of the homes. The MoD assumed property prices would rise by 1% per year above inflation over the next 25 years. To make selling the homes a better deal than keeping them, the growth in property prices would have had to remain as low as 0.2% to 0.5%.

“It’s very, very hard to understand what the thinking was there,” says Robert Razzell, chief financial officer at UK Government Investments (UKGI), the government’s corporate finance advisor arm. “If you’d asked any property professional in 1996, ‘Are we at the top of the market or the bottom?’ [they would have said,] ‘We’re quite close to the bottom.’”

In 2018, the NAO brought out a damning report estimating that the MoD was between £2.2bn and £4.2bn worse off than if it had retained ownership of the properties, largely due to the dramatic rise in house prices during the period.

Between 1996 and 2018, UK property prices rose by 284%, according to Nationwide’s house price index. At that point, the vacancy rate was 19%, almost twice the MoD’s target and similar to the void rate before the deal, while the size of the estate had failed to drop in tandem with the reduction in the size of the Armed Forces.

Annington’s investors – first Nomura and then private equity firm Terra Firma – had expected an annual rate of return of 9.7%. Instead, it received a bumper 13.4% between November 1996 and March 2017.

Worse, the investment in the condition of the homes – which was the MoD’s responsibility – had failed to materialise and maintenance costs in 2016 were 27% higher than the MoD had assumed in 1996.

Many of the homes built in the 1950s and ’60s had reached the end of their “useful economic life of 40 to 50 years”, Mr Razzell says, and needed replacing. “The problem was the MoD as [the] tenant couldn’t redevelop the estate. What tenant could ever redevelop an estate?”

Yet, Annington was not incentivised to redevelop, Mr Razzell says. “They were getting a government rental stream. There’s no risk to that. Why would they tear down those units and redevelop them, taking all that construction and development risk?”

“They didn’t have many obligations under the lease. In fact, it’s hard to think of any obligations they had.”

One attempt to redevelop a site at the Royal Air Forces’ Brize Norton station saw the MoD pay £21m for the land, demolish the existing homes, but eventually defer the planned 800 homes due to a lack of funds. It nonetheless was required to pay rent on the so-called ‘ghost’ properties it had demolished.

From Annington’s perspective, departmental restructures and senior staff changes within the MoD had made maintaining a contractual relationship difficult, the firm told the NAO in a report from 2018.

A senior source close to Annington tells Inside Housing that everyday relations were constructive, but “at the upper echelons [of government], there was never any real co-operation or any real desire to exploit the transaction”.

“There were numerous attempts on all sorts of levels to try to reach some sort of sensible arrangement on management, maintenance and redevelopment,” they say. “Attitudes within government and the MoD remained pretty embedded in relation to the vehicle. They were pretty anti it and never embraced it.”

Rent and relationship review

A full rent review was due in 2021. With this in mind, the MoD brought in UKGI in 2017 to advise on its relationship with Annington. At that point, there were theoretically 488 rent reviews to carry out, Mr Razzell says.

“There wasn’t any market comparison out there. That’s because no one else would have ever entered into a lease as lopsided as the one the government entered into.”

Daniel Walmsley, director of prime central London residential at JLL, says: “As valuers, we had to try and work out what the hypothetical person taking on the lease would be prepared to pay for the rent.”

It was an enormous undertaking, involving around 70 professions from different sectors. Lauren Hunt, head of prime central London residential at JLL, says it will likely rank as “the biggest challenge” of her career.

The variation in sites was huge – one could be surrounded by potato fields, while another might be a stone’s throw from a tube station. The hypothetical lessee might be a private rental sector investor, or a local authority offering temporary accommodation.

At this point, the MoD’s relationship with Annington was “intense. Very intense. This was a really complex, elaborate process”, Mr Razzell says.

“The problem was the Ministry of Defence as [the] tenant couldn’t redevelop the estate. What tenant
could ever redevelop an estate?”

The second problem was the discount the MoD should receive on those rents, a decision the financial markets were following closely because Annington had listed debt. “Annington’s value was essentially a function of the rent the MoD was paying,” Mr Razzell says.

The markets predicted a discount of between 30% to 35%, and Annington’s opening bid was “in that kind of area”. “We couldn’t get close to that, so we had to go to formal arbitration,” he says. The arbitration panel resulted in an agreed discount of 49.6%.

Crucially, the rent review process established that the MoD could serve enfranchisement claims, which would allow the government to buy back the head leases without Annington’s agreement. This looked all the more appealing given that Annington’s owner since 2012, Terra Firma, had plans to sell the company.

In late 2021 and 2022, the MoD served enfranchisement notices on eight sites. “We were under no illusions that Annington would challenge it vigorously. It went straight to the valuation of their business,” Mr Razzell says.

Annington claimed that using enfranchisement law to improve the government’s commercial leverage was unfair, Mr Razzell says. “Basically, Annington was arguing that our behaviour was a little bit sharp.”

But in May 2023, the High Court declared the notices were valid and, although Annington appealed, the two parties reached a deal for the government to buy back the homes for £6bn. This helped avoid going through “37,000 individual valuations, claims and potentially tribunal hearings”, Mr Walmsley adds.

The government puts the taxpayer savings at £4.3bn.

The Annington source offers the counter view. “In many senses, you can’t justify this government paying £6bn to buy back what it sold all those years before.”

Meanwhile, Annington has moved on. The Sunday Times reported last year that it was eyeing acquisition targets such as L&Q’s market rent business, Metra Living. Ian Rylatt, chief executive of Annington, says the firm is “well placed to play a major role in the UK affordable housing market and to play our part in addressing the current housing shortage”.

The MoD is working on a new military housing strategy, set to feature a “generational renewal of Armed Forces accommodation”, new opportunities for Forces homeownership, and better use of MoD land to support the delivery of affordable homes.

Chancellor Rachel Reeves’ Spring Statement in March included a £2.2bn uplift to the MoD’s budget, with some earmarked for refurbishing service family housing.

The subject is still sensitive. The Defence Infrastructure Organisation advised the Army Families Federation not to speak to me in person for this article. Our interview was cancelled and could not be rescheduled before press.

Could the government strike an uneven deal again? Mr Razzell does not think so. He says: “The government now has a far more professionalised property function. I would like to think that we would be far more sophisticated in how we share the long-term benefits.”