Research we published confirms that home-ownership remains overwhelmingly the tenure of preference in the UK. More than 80% of adults want to be owner-occupiers in the long term, and almost three-quarters (74%) aspire to be home-owners within two years. But despite a strong preference for home-ownership, owner-occupation has been in decline since 2003. Aspirations to owner-occupation are currently being thwarted by a combination of the affordability of property relative to incomes, a shortage of mortgage funding and the continuing weakness of the economy.
Lenders, of course, have a long tradition of funding housing in all tenures. Over the last two years, there has been a significant revival of buy-to-let lending as private landlords seek to meet demand created by the growth in UK households. Despite recent growth, however, buy-to-let lending volumes are currently only around one-third of their peak in 2007. But continuing demand for rented property is likely to fuel further growth in buy-to-let lending in the years ahead.
The other key area of housing provision is in the social sector, the main focus of this article. Lenders have already provided more than £60 billion worth of funding to a sector in which there are around five million homes in the UK. Some 55% of this stock is owned by housing associations, with the rest in the ownership of local councils.
Historically, the supply of social housing has been subsidised by the government. But this funding has been steadily withdrawn since the 1980s, and was reduced even more significantly in the 2010 comprehensive spending review.
Private finance also helps to fund the sector, with lenders helping fulfil short- and medium-term needs, and bond markets often providing long-term funding. But the continuing shortage of mortgage funding means that social landlords face greater competition for scarce resources, while questions persist about whether bond markets are deep enough or have the appetite to meet the needs of the social housing sector.
Over and above the funding challenges, the social housing sector is currently affected by a raft of new policy initiatives and regulatory reforms. How these are implemented will, in turn, be crucial in determining the future ability of lenders and bond markets to fund the sector. Some of the key questions for the sector are:
Can social housing providers attract investment on a scale that enables them to grow sustainably to meet demand, while continuing to deliver attractive rates of return for investors?
In challenging economic and financial market conditions, can the sector succeed in expanding sources of finance and/or income, so that lenders are able to continue to contribute as part of a range of different funding options for the social housing sector?
There are many areas of uncertainty that could affect the provision and funding of social housing, including policy initiatives by a government seeking to develop and implement a new housing strategy, as well as regulatory and welfare reforms.
Lenders want to work within the framework created by government, landlords and regulators to continue to help fund social housing. But current conditions create a series of challenges for each of these stakeholder groups if they want to encourage private funding.
From the government, lenders want to see:
- implementation of its plans to introduce universal credit in a way that does not undermine the confidence of lenders or other investors in the social housing sector;
- development of its recently published housing strategy, to provide greater clarity about the role of the social housing and how its growth is to be supported in an environment in which grant is being rapidly withdrawn; and
- broader engagement with lenders and investors on the wide range of evolving issues that could affect their ability to fund the sector.
From social housing providers, lenders need to see:
- robust and credible plans to maintain the strength of their core housing business while exploring ways of diversifying and developing new streams of income and sources of finance; but
- a commitment in an uncertain operating environment to avoid ventures that could undermine the viability and stability of the sector or the confidence of lenders and investors.
- Finally, from regulators, lenders want to see robust supervision of social housing providers, and measures that reinforce the existing creditworthiness of the sector and the confidence of lenders and investors.
Most rents are paid directly to social landlords through housing benefit. But implementation of Welfare Reform Act 2012 will see benefits paid to tenants instead. Lenders and other investors in social housing remain concerned about the impact this may have on the reliability of the future income stream of social landlords.
It is clear that the bond markets favour the current arrangements for paying housing benefit, which are generally seen as more likely to deliver a more dependable stream of income over the long term. Investors are concerned that paying benefit to tenants instead of landlords could possibly lead to increased arrears and reduced profitability.
This could have negative consequences for the credit rating of individual landlords, the level of risk associated with the sector generally and the cost and availability of funding. Reassuringly, the ratings agency Moody’s published an assessment at the end of last month which concluded that the introduction of universal credit remains a manageable risk for publicly rated housing associations in England.
It is clear, however, that social housing providers will need to continue to make a realistic assessment of, and respond to, the risks associated with the introduction of universal credit and other welfare reforms. Another proposed reform likely to be significant for the sector is the proposed "bedroom tax" on under-occupied properties. This could have different effects in different parts of the country, with perhaps a disproportionate impact in the north, where the housing stock tends to be larger.
In November last year, the government published a key document for the sector, Laying the Foundations: A Housing Strategy for England. Although some of its key measures were targeted at the owner-occupied sector, including the NewBuy proposals, there were some significant announcements for social landlords, including tenure reforms and an expansion of the right to buy. Landlords will need to assess carefully the implications of these policy proposals and how they are implemented.
Earlier, the government had also announced, as part of its 2010 spending review, proposals for a new, intermediate "affordable rent," giving landlords the flexibility to charge rents of up to 80% of local market levels, as part of an initiative to fund the building of more new homes. At this stage, however, affordable rent remains relatively untested. Its potential will vary depending on local market conditions, and it is not clear how widely it may be applied.
Increasing rents to up to 80% of the market rate could boost income for landlords, but the extent to which higher rents would be "affordable" for tenants is unclear. It is possible therefore that, in some circumstances, the move to affordable rents could lead to greater risk and uncertainty about landlords’ income levels. Another possibility is that a higher proportion of tenants will need support through housing benefit, at a time when the government is seeking to cut costs as part of its programme of welfare reform.
Developing new sources of income
Generally, the confidence of lenders in the social housing sector would be reinforced by measures that enable landlords to diversify their sources of income (as long as the benefits of this offset any increase in uncertainty about future income levels). A key requirement in achieving success in this area is for landlords to ensure they have the right skills at board and executive level.
Affordable rent is one example of how landlords may be able to diversify and expand their income, as long as they are able to assess its true potential in the local markets in which they operate. Similarly, landlords will need to make sure that their business plans are based on a comprehensive and reliable assessment of the impact of universal credit and other welfare reforms.
The government is also keen to promote innovation and competition by encouraging new providers of social housing. It has therefore recently introduced regulation allowing the entry into the sector of profit-making organisations. This could add to the sector’s diversity and potentially extend funding capacity.
Lenders do not have a preference for social housing providers solely on the basis of whether or not they are profit-making. The key requirements are that landlords are effectively regulated, operate to a credible business plan reflecting local market conditions and opportunities, and produce a reliable income stream and return for investors.
Lenders and other investors in social housing need confidence that the sector will be effectively regulated. Until April this year, all housing associations in England were regulated by the Tenant Services Authority, but this was abolished by the Localism Act 2012. Now, all major housing associations in England are regulated by the Homes and Communities Agency, which is also responsible for providing housing development grants.
Generally, lenders are less concerned about changes in the regulatory framework than they are about its future ability to ensure that the sector is properly supervised. Housing is a devolved matter, so Scotland, Wales and Northern Ireland have their own national regulatory bodies. Lenders operating in each of those countries will therefore continue to need to scrutinise regulatory developments to ensure that their interests are protected.
Messages for the future
Social housing providers need to develop and diversify their sources of funding in order to spread risk and maximise their potential to continue to attract investment from lenders and other investors. Their ability to do this will be particularly important in an environment in which the process of scaling back government grant has already begun and will accelerate.
There is a growing expectation among housing providers and those investing in them that government subsidy of the sector through grants could end completely after 2015. To enable landlords to plan effectively, the government needs to provide a clearer sense of direction, particularly on the options for landlords in the absence of grant funding. It is crucial for providers to prepare for the future, and greater clarity about government policy and funding would allow landlords to plan ahead more effectively.
Scale is important for social landlords. Many commentators believe that greater consolidation in the sector, through mergers, is inevitable, partly because larger housing associations will generally find it easier and cheaper to obtain finance from different sources.
Conditions in the social housing sector are challenging. But there are still good opportunities for landlords to raise finance – from lenders, through issuing bonds or from other sources. The most successful housing providers are likely to be those that keep abreast of developments in a rapidly evolving environment, operate on the right scale and devise sound business plans appropriate to local market conditions and individual circumstances.More Articles by Council of Mortgage Lenders (CML) ...