Paying the rent

Government changes to the affordable rent regime will have an important impact on the partnerships industry, says Jonathan Jarvis, Partner, Trowers & Hamlins.

Earlier this month, the government decided to axe those housing PFI projects whose outline business cases had not been approved – including all the Round 6 projects.

Signed housing PFI projects and those in procurement continue to be supported, although the latter are to be subjected to a "rigorous demonstration of value for money".  Those outcomes are due later this month.

Assessing the value for money of a PFI project in four weeks seems, on the face of it, a significant challenge. Will this be an exercise in providing comparative data that enables the government to ‘tick the box’ that the National Audit Office report in June 2010 recommended? Or are there wider aspects of those projects that require scrutiny? Will rent levels form part of that scrutiny?

The Comprehensive Spending Review announced plans to reform the social tenancy regime. As part of that reform, the government proposes to create a new affordable rent entitling registered providers to set rents for new-build schemes (plus relets of existing tenanted stock) at a level equivalent to up to 80% of the market rent for that location.  

Under the government's "rent influencing regime policy" – with which registered providers have been bound to comply to date – rents were restricted to levels that were considerably lower than 80% of the market rent.

According to the government, this new affordable rent, together with  £4.2bn of grant, is capable of delivering 155,000 extra affordable homes by 2014. When you consider that only 153,000 homes are projected to be completed between 2008-11, even with over £9bn available during that period, you can begin to appreciate how significant the government believes the role of the new affordable rent will play.  

Registered providers recognise that increasing rent levels offers an opportunity to make more housing starts viable. But it also raises a number of considerations, all of which are no less relevant in the context of PFI transactions.

Does the housing of persons at these rent levels constitute a charitable activity? Most registered providers are charities and, as such, have to consider whether their activities are furthering their charitable objectives.  Housing persons at rent levels which are closer to the market rent – particularly when market rent levels may be volatile – makes that assessment harder and will make it incumbent on registered providers to undertake robust and frequent monitoring of market rent levels and their rents.  

Will these rents be affordable and will demand at these rent levels remain strong? The housing benefit and wider welfare reforms that are being proposed, and which are to be introduced incrementally, are expected to impact on the ability of tenants to pay their rent – particularly when (and if) the universal benefit cap is introduced. Will this mean significant increases in bad debt levels of registered providers?

Void levels could also rise. Prospective tenants may reject the properties due to these higher rent levels. But they may also reject them because of the prospect of fixed-term tenancies with a tenant's right to remain dependent, after the minimum term (which may be as little as two years), on their financial circumstances at that time.

What will be the attitude of the lenders? They have recently raised concerns over the relative paucity of margins in this sector. The prospect of greater risks attaching to their borrowers' activities may only heighten the sense that there needs to be a reappraisal of loan terms.  

These considerations, and the risks associated with them, will be difficult enough to manage in normal circumstances. But in the context of a PFI structure, they become more pronounced.

To date, non-Housing Revenue Account PFI projects (where the housing is owned by a registered provider, rather than the local authority) have been structured on the basis that the amount to be paid by the local authority under the project agreement takes account of the projected rent and service charge income that the dwellings can generate over the term of the project. The risk of that income not being realised due to demand dropping has not conventionally sat with the local authority or the project company. Rather, that risk has been left with the registered provider (as landlord).

If there is the prospect of heightened demand risk in the next few years, there may be a need for registered providers, their consortia and the procuring authorities to reassess what constitutes the most appropriate risk profile. Historically, where the risk has been passed to the private sector and quantifying that risk has proven difficult, this has tended to lead to aggressive risk pricing. Is that value for money?

It is not yet known whether the value for money scrutiny will focus on rent levels. If they do, registered providers, the project companies and the procuring authorities need to carefully consider the implications of any such changes. It is likely there will be pressure put on bidders to sharpen their pencils. But as the adage goes, "act in haste, repent at leisure".

If rent levels do feature in the scrutiny, then those with signed PFI projects (all of which provide scope for the authority to seek changes to the project) may be well advised to start considering what the implications are for their projects.