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Is the housing association sector still protected from the ups and downs of the property market?
The housing association sector has traditionally been seen as counter-cyclical, able to deliver even in times of economic hardship. But with more commercialisation, Rhiannon Curry investigates whether this is still the case. Illustration by Scott Garrett
Mere weeks after the UK voted to leave the European Union in June 2016, the Chartered Institute of Housing (CIH) released a paper laying out the claim that investment into sub-market housing could be the boost the economy needed.
The report suggested that it was likely that Brexit would result in weaker buyer sentiment and a fall in housing market transactions, at least in the short term. Instead, the government should consider investing in sub-market housing to make long-term savings in public borrowing via lower rents and reduced housing benefit spending, the paper said.
“Compared with other forms of counter-cyclical investment, new housing construction can be ‘shovel ready’ more rapidly than, say, new transport infrastructure and adds more quickly to GDP. It is also an investment area which is less reliant on imported materials, which are now more costly given the weaker pound,” the CIH wrote.
This may well be true, but have housing associations shifted their own focus the other way, away from sub-market tenures? The cutting back of direct subsidy to the social housing sector over the past decade has meant associations that want to develop now rely on commercial activity, such as homes for sale or market rent, to cross-subsidise their social properties.
Far from simply filling gaps in the market, housing associations are now fishing in the same pond as commercial developers when it comes to borrowing, buying land and developing. So can the social housing industry still be counted as a counter-cyclical business? And as the property market shows signs of slowing, how much does that matter?
The commercial exposure of some housing associations was made clear in January when L&Q, London’s largest landlord, revealed that its surplus this year would be £158m less than it had originally thought.
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In an email to staff, seen by Inside Housing, the association suggested that the drop in profit came about because of the property market downturn and rising costs.
Last month, Inside Housing revealed that another major London landlord – Notting Hill Genesis – has more than 400 unsold homes sitting on its books.
“As some housing associations have become exposed to market sales and other development risks, the sector risk profile has fallen more in line with the private development sector,” explains James Tickell, partner at advisory firm Campbell Tickell.
This has had a knock-on effect for lenders which now align some of the larger, developing housing associations with commercial entities and price their products accordingly.
Previously, as the housing market retracted, lenders would be more attracted by the long-term secure returns offered by subsidised rental housing. That meant that housing associations could borrow at relatively good rates and did not need to worry too much about short-term liquidity issues.
But now, lenders are more cautious. “The lending environment is healthy but at the same time lenders and investors are more aware of the commercial risks and probably want to probe a bit more in terms of how well managed those risks are,” says Phil Jenkins, managing director of financial advisors Centrus.
“Where this really applies is for organisations which are predicated on a mixed-use funding model, and that is particularly the case for larger developers in the South, South East and some other parts of the country,” he adds.
Traditionally the housing association sector had modest gearing (the ratio of debt to asset value), enjoyed high grant levels and had limited risk in terms of sales and liquidity.
But the way they operate has changed. According to figures from the National Housing Federation, which break down the type of homes housing associations started in the 2017/18 financial year, around 10% of starts were for social rent, while around 18% were for market sale or market rent. The remainder were for affordable rent or affordable homeownership schemes. Grant funding was slashed almost a decade ago and has yet to return to previous levels.
With almost one in five homes begun by housing associations in 2017/18 destined to hit the open market, what does this mean for businesses’ financial covenants?
Housing associations now face higher gearing, higher sales and liquidity risk. Centrus suggests that organisations could face a “drastic slowdown in sales and significant house price falls” if confidence ebbs away from the market. Added to that, the availability of mortgages for outright sale and shared ownership, as well as corporate lending, could reduce, placing increased pressure on balance sheets. Housing associations are also constrained in their ability to raise equity finance by their status as non-profit distributing, and mostly charitable, businesses.
Housing associations now face higher gearing, higher sales and liquidity risk
And if expected profit from joint ventures and commercial subsidiaries fail to materialise, companies could be forced to draw debt facilities sooner than anticipated.
“A few years ago investors liked [housing associations working in] London and the South East but there’s been a subtle shift of sentiment in the past couple of years as the market has slowed down, and the ratings agencies have pointed out the flaws in the model,” says Mr Jenkins.
However, there remain elements of the market that are counter-cyclical, not least those housing associations which are still driven by purely sub-market stock.
Peter Denton, group finance director at Hyde, says more caution in the funding landscape and a property market downturn would only affect the very largest organisations which are focused on development, rather than housing management.
A brief history of social housing finance
1964: The Housing Act established the Housing Corporation, a non-departmental public body which provided grant funding and took over the housing stock directly.
1980s: Further funding initiatives were established, including the first Housing Finance Corporation loan agreement and lending via high street banks which valued the security given by a government-backed borrower.
2009: The government bailed out mortgage lenders in the financial crisis.
2010: The coalition government cut the level of grant funding by 60%. It has remained low ever since.
2012: UK housing associations raised £4bn in the bond markets – equivalent to almost four times the previous annual record.
2015: The chancellor’s Budget announced plans to cut social rents by 1%, causing many housing associations to revisit their business plans.
2017: English housing associations were moved back to the private sector, which the government said would allow them to borrow more. The move also took £66bn off the public balance sheet.
“There are a small number of housing associations that have either the skills, the resources, the strategic desire or all three to take on full-scale land-led development,” he says. “The sector is a broad church of objectives and approaches, and there are perhaps only 20 associations that are providing meaningful land-led development.”
More than that, he suggests that the idea that housing associations must cross-subsidise their social activities in order to stay afloat is a myth.
“The affordable element is perfectly capable of being built and funded to a degree within its own financial context and that’s typically because land values are depressed for this type of development,” Mr Denton points out.
“This new alignment with the economic cycle means that associations need robust risk management” – James Tickell
“The cross-subsidy model in our view is quite different. We build about 40% homes for market and 60% affordable, and what that allows us to do is to churn our capital and keep our balance sheet roughly where it already is. It’s a sustainable model over many years.”
Certainly landlords and developers have long operated in an environment where the creation of mixed communities has been a policy goal.
“If you’re a land-led developer and you believe in the community benefits of building mixed-tenure places, then you can’t build 85% or 90% affordable in one location,” Mr Denton says.
That said, the pressures to deliver more homes is seen as having increased the financial risk profile of many of the more active housing associations, laying the foundations for a more cautious future.
“This new alignment with the economic cycle means that associations need robust risk management,” explains Mr Tickell. “A downturn in the property market has already started and is now spreading out from London. There’s no way of knowing how far it will go.”
The real risk to housing associations is in having planned development which they cannot back out of, leaving it then with a high liability in the shape of tens or hundreds of unsold homes.
During the last financial crisis, the property market was bailed out by the government, which helped banks avoid being sunk by mortgages which people could no longer afford to pay. But there is unlikely to be a second such bail-out, Mr Tickell warns.
“Housing associations need to make sure that they are building up their cash reserves to ride out any period of low sales,” he says. “If they have a few hundred properties in the pipeline for market sale then they need a Plan B and a Plan C, and those can’t necessarily rely on the kind of government bail-out that took place after 2009.”
Stress-testing needs to be a central part of any business, and organisations may consider carrying liquidity in order to be able to ride out a crisis. Sharing risk via joint venture agreements can also help confidence in the long term.
For the largest housing associations looking to pursue development-led strategies, their days as a clear counter-cyclical asset class may be over
“This financial year will be quite interesting because you will start seeing whether housing associations are impairing assets,” says Piers Williamson, chief executive of The Housing Finance Corporation. He says that some organisations may “run for cash” – pulling back from their commercial pipeline where they can as the wider property market slows.
But Mr Denton is quick to maintain that there is still a difference between housing associations and their commercial rivals.
He says: “I don’t believe that housing associations have become house builders in their approach. We are constantly questioning whether we’re doing something to contribute to our social purpose and the regulator is increasingly requiring that of us.”
This is having a trickle-down effect into lending, he says, with lenders keen to exercise their own social conscience by extending borrowing to housing associations which they know have a social purpose as well as a business one. Indeed, Hyde is looking for funding at the moment and has so far found the market “broadly unaffected” by wider concerns, Mr Denton says.
For the largest housing associations looking to pursue development-led strategies, their days as a clear counter-cyclical asset class may be over. But even if the sector is looking for funding in the same places as commercial house builders, at its heart it is still a very different beast.
