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How councils are using their pension funds to build homes
A handful of councils have struck deals to use their pension funds to build homes. Tom Wall finds out if these ventures could lead to a housebuilding boost. Illustration by Clare Mallison
In the wake of the 2008 financial crash, Britain’s construction industry panicked.
Thousands of construction workers were laid off and housing completions halved. But while the big house builders were still licking their wounds, Manchester City Council was proving the public sector could deliver innovative development.
The city struck a groundbreaking deal in 2012 with the Greater Manchester Pension Fund (GMPF) to build family homes for market rent and sale.
Although it sounded simple enough – the council provided the land and GMPF put up the money – Manchester believes it was the first time a council pension scheme had used its financial muscle to support a key council aim: building homes.
A string of other council pension funds – including Lancashire, Islington and the West Midlands – have followed Manchester’s lead. Could this be the start of a bigger trend?
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Paul Beardmore, director of housing at Manchester City Council, explains this first project was a child of its time. “It was a means of getting housing built in a very flat, depressed market,” he says.
Private sector house completions in Manchester had slumped to 510 in 2012 – down from 2,990 in 2007. Indeed, housebuilding is still languishing below pre-crisis levels.
Mr Beardmore is the first to acknowledge that none of the homes built so far under the scheme have been sold or rented below market rates, but he suggests 30% were “affordable” when set against average incomes in Manchester. He believes these kinds of deals put the council staff’s savings to work in their own communities and can boost supply.
“It helped us and the fund retain its members’ money in Greater Manchester,” says Mr Beardmore. “And we need to use all avenues available to increase housing supply.”
This was one example of an idea that has been discussed for a long time. But a narrow interpretation of the legal duty on pensions to deliver the best returns for their beneficiaries has on the whole scuppered the large-scale financing of housing projects. This could finally be changing.
The regulations governing council pension funds changed in 2016, making it easier for the funds to support their own objectives. Trustees now have to take into account social and environmental goals when they draw up their investment strategies.
Martin McFall, partner and pensions expert at law firm Trowers & Hamlins, says this is slowly altering the approach of pension trustees.
“The process is still germinating,” he says, pointing out that the funds only started drawing up their investment strategies under the new rules in April 2017. “But I think we will see a proliferation in the next few years.”
The regulations also allow councils to invest more of their pension funds in partnership vehicles. These vehicles are traditionally used to deliver infrastructure projects, including housing.
Mr McFall says pension fund trustees still have to make sure their investments generate good returns but they can accept lower rates for social and environmental reasons providing it is consistent with their overall investment strategy.
“Their fiduciary duties have not disappeared,” he says. “It’s just now that the regulations are supporting moves towards greater diversity in investment.”
Some funds have already dipped their toes into housing investment.
The Lancashire County Pension Fund and Lancashire County Council formed a company called Heylo in 2014, to provide shared ownership homes.
With the pension fund investing £300m, the company, which recently registered as a housing association, has been able to acquire more than 900 shared ownership properties on private developments across the country. It is now seeking to acquire thousands more over the next five years and do deals with Homes England to bring in grant funding for affordable homes.
The other notable local authority players investing in housing include the Derbyshire Pension Fund, Nottinghamshire Local Government Pension Fund, Staffordshire Pension Fund, Teesside Pension Fund and West Midlands Pension Fund. At the end of last year they together pumped £100m into a vehicle to invest in homes for private rent.
“We are not seeing traditional houses being built on anything like the scale we need.” - Paul Beardmore, director of housing, Manchester City Council
The vehicle, which is a joint venture between the funds and residential investment firm Hearthstone Investments, is targeting low-rise apartment blocks and family housing in areas of rental growth. Islington Pension Fund is also using Hearthstone to invest £54m in rental property across the UK. Housing association pensions have so far not been involved (see box: What about housing association pensions?).
There are very good reasons to doubt if the new regulations will herald an era of pension funds investing in affordable housing.
What about housing association pensions?
The Social Housing Pension Scheme (SHPS) does not invest in specific social housing build projects but it does own bonds issued by housing associations. Tom Murtha, a former housing chief executive who is drawing his pension, would like to see SHPS do more to support social goals, even if it means smaller returns.
“If we can find a way to use what is still a substantial pot of money to invest in the work we do, or work that relates to and complements the work we do, I would feel more comfortable with that,” he says.
Nick Horne, a former SHPS committee member, takes a different approach. He sees little need for pension finance in the sector and stresses schemes should focus on delivering pensions.
“Employees and employers want to know that the money they put into the SHPS scheme is invested in a way that gives an optimal risk and return ratio,” says Mr Horne. “Certainly, as someone who contributes to SHPS in a personal capacity I don’t want to be influencing how they are investing that money.”
Lord Bob Kerslake, chair of the London Collective Investment Vehicle, which is responsible for 32 London councils’ pooled pension funds, says the lack of government subsidies, rather than potential pension finance, is holding back affordable housing schemes. “The impediment for more affordable housing being built through councils and housing associations has been more about the availability of the grant than it is about the capital finance,” he says.
Lord Kerslake, who is also president-elect of the Local Government Association and chair of Peabody, points out that social landlords can borrow money at better rates than from pension funds. “Housing associations can access funding, either through banks or bonds, that is relatively low interest.
"Public Works Loan Board rates are currently around 3%, whereas pension funds expect rates of around 4.5% for long-term investments."
"They are not short of opportunities to raise funds generally. As long as they do it within the cap, local authorities can borrow from the Public Works Loan Board.”
Public Works Loan Board rates are currently around 3%, whereas pension funds expect rates of around 4.5% for long-term investments.
Natalie Elphicke, chief executive of the Housing & Finance Institute, who wrote a government report in 2015 recommending that council pension funds should invest 3% in local housing projects, agrees: “Changes to pension fund investment models have taken longer to come through – and that is partly a reflection of the availability of other types of finance.”
Ms Elphicke also points out there has been a lack of suitable investments as funds prefer investing in existing rental stock rather than taking on the risks of building projects.
Nonetheless Ms Elphicke still believes there is “an interest and an appetite” for such pension investments, which could help deliver housing.
A short history of modern responsible investment
Ethical investing first emerged in the late 1970s when activists campaigned for investors to pull out of apartheid-era South Africa.
But the first pension fund to adopt a responsible investment strategy was the main higher education pension fund in 1999. Since then, the number of pension funds adopting responsible investment policies has grown, with 25 pension funds in the UK now signatories to the UN Principles for Responsible Investment.
Other pension funds already operate policies of investing in line with the employer’s values. The Environment Agency Pension Fund, for example, aims to cut its exposure to coal investments by 90% by 2020.
The strategy is based on an analysis that environmental risks such as climate change pose a material financial risk to pensions.
Manchester’s experience certainly suggests pension finance can help build homes. Mr Beardmore is in the process of procuring builders to construct around 350 more homes for private sale and rent with additional money from the GMPF.
“We are still not seeing mainstream house builders building the volume we need,” he says. “The big numbers are coming through city centre high-rise developments, but we are not seeing traditional houses being built on anything like the scale we need.”
Mr Beardmore says the deal allows the city to raise more money than traditional council borrowing because Manchester – like many other councils – has limited borrowing capacity. It also pumps council workers’ savings back into the local community.
“The city council takes an equal share of the return, so while it may be cheaper to borrow, we do actually get a share of the higher return,” he says.
It seems the council and the pension fund are again stepping in to address the shortcomings of the housing market. “It is about upping the overall supply of housing in Manchester,” says Mr Beardmore. “This way we get control and make sure houses are actually built, rather than developers sitting on planning permission.”
