No place like home

Rather than mourning the loss of PFI, housing could be the first sector to attract institutional investment, writes Colin Leopold

Last month, the Commons communities and local government committee announced an inquiry into the financing of new housing. It will examine the role of state lending instead of grant funding, and consider how private finance can be brought into the social and affordable rented market.

Unfortunately it’s cold comfort for many involved in the housing market.

Neither housing nor the PFI model have received much political love since the coalition came to power, despite a generation of first-time buyers being dumped onto the rental market.

Although 13 schemes had their PFI business cases approved in the summer following a value for money assessment, many in the industry now agree it was simply because too much time and money had been invested for them to fail. At the same time another 13, much earlier down the track, were left to hang in the balance.

It now seems likely housing PFI will be “dead and buried” after the current round, says Richard Parker, head of housing at financial advisory PricewaterhouseCoopers (PwC).

But rather than mourning its loss, many local authorities have instead been preparing for the changes to the Housing Revenue Account (HRA) that come into effect next April.

The national subsidy system for new schemes is to be replaced with a new selffinancing model, where for the first time in 50 years, local authorities will hold onto the rents they collect to reinvest in new projects.

In effect, there won’t be any need for central government to invest additional capital funds on council housing, says Parker.

More than that, the changes could create up to £54bn of surplus net rental income nationally over the next 30 years, according to PwC figures.

“If local authorities are rational about their investment decisions, approach it with appropriate debt management techniques and control costs and increase their rents as they are allowed to, their housing accounts will contain and build up surpluses. The fact that they can’t use these surpluses on non-housing schemes creates massive opportunities.”

PFI has never followed a smooth path in housing. Unlike schools or hospitals, it was always only one option on the table. And, in a lot of cases, a slow and laborious one at that, says Stephen Sellers, a lawyer at Wragge.

“The whole housing PFI model has hardly been a great success in terms of cost and time,” he says.

“For the people that have stuck with PFI housing and made it through it has probably been worth it,” adds Mark Baigent, project director at Greenwich council. Not that he thinks it is worth the effort.

“We looked at PFI in 2004 and came to the conclusion that it was a lot of work and a lot of risk and we didn’t think it would give us certainty as a solution. It just hasn’t proved reliable. The bigger you [scale] it up, the more risky it is that PFI is just going to take a scheme off into this netherworld where you’re not sure whether it’s going to be delivered.”

Learning curve

Paul Longshaw, PFI programme director at Salford City Council – the first council of the 13 schemes to have its business case approved in July – admits he couldn’t revisit the delays to procurement seen so far. But he believes there are lessons to be learned for future models.

“We have a significant amount of land so [there’s a] real opportunity to drive forward PFI regeneration under a new name.” He talks about a “patchwork quilt” approach, using a range of models.

A number of councils are already starting to look away from the PFI approach, and at the rental market to identify new ways of financing future schemes.

Sellers suggests authorities will be interested in having a long-term relationship with a manager of stock, pointing out this already happens in some cases. But he’s less convinced that the relationship will be on the PFI model, which is all about risk transfer and termination agreements. “Authorities will see potentially simpler ways of delivery without the complexity of PFI contracts.”

As in the waste sector when a number of cancelled PFIs resized and uncovered corporate finance and PPP solutions, the 13 cancelled housing schemes will prove a test case for others.

“What we’ve said to those authorities is we would try to work through other options with them with our local teams,” says Steve Trueman, head of housing PFI at the Homes and Communities Agency (HCA).

He mentions “alternative sources of funding at a local level, that might differ from project to project”. But as in the waste sector, some of these schemes will prove more attractive to the private sector than others.

“Estate regeneration would be the most difficult to take forward,” he says. “[But] there might be a readily available solution for new build housing on cleared sites – it’s an easier proposition for the private sector to quantify in cost, rather than asking them to take responsibility for stock they haven’t built.”

For the harder to swallow schemes, Baigent believes breaking things up into bitesize solutions that work for investors is the way forward.

“We’re doing a major estate regeneration in Woolwich. It’s a very challenging
environment, looking at what we have to give to enable us to go ahead. We need to build in
agreements that enable us to share in any return at the end of a programme rather than get a big injection upfront. But it’s a chicken and egg scenario as we need some money now to clear the site.”

In the past, HCA grants made it easier to negotiate a healthy level of affordable housing. “The HCA starting point now is that we will receive no grant unless we can prove it’s essential for its viability,” Baigent continues.

A bit more innovative

But as negotiations persist on regeneration schemes such as that in Woolwich, Greenwich council has also been busy identifying a solution for other sections of the market, notably family-sized units – an area traditionally overlooked by housing associations.

Thirty Greenwich properties have already been transferred into a management company where the rental surplus will be used to slowly grow the business – all without the need for any private finance, in the early stages at least.

“Once it’s got a couple of years’ track record then we will start looking at how to leverage the asset base and how to get investment into it and turn it into a development vehicle,” says Baigent.

When the funding markets eventually settle down, the model is open for an equity partner to come in and do a 50/50 split, or for the council to go into the bank or bond market, he adds.

“We could also ask a developer to provide units into the company. We’re all hoping there will be a bit more liquidity in a couple of years’ time. At the moment, everyone is having to be more innovative.”

Although hardly a panacea for all schemes, such a model is interesting because it raises the prospect of institutional investment – something that has previously eluded other models and sectors.

“I think now there is a real appetite among institutional investors,” says Ken Jones, head of housing strategy at Barking and Dagenham council.

“In some instances we have institutional funders who are looking for a very safe and unspectacular yield. There has been a real wakeup. It’s partly a reaction to this whole ‘generation rent’ thing and the difficulty [for buyers] accessing mortgage finance.”

The HCA’s Private Rental Sector Initiative (PRSI) also whetted the appetite of some of the
big institutions, says Jones. This scheme is aimed specifically at institutional investors such as
pension funds, with houses being built for rent but with the potential for newly built properties to be considered as ‘seed assets’ for more schemes.

As the strength of rental demand has grown, the PRSI has given investors the confidence to get involved.

But although institutional investment currently goes into some housing associations through intermediaries, there is not clear path into the type of schemes being talked about by Jones and Baigent.

“There are still some big issues to resolve,” says Parker. “They are looking for scale; also is the social housing sector able to deliver the returns they expect? Over the next two to five years there are opportunities to get them into the market, the only issue at the moment is noone is quite sure what that market will look like.”

Without grant funding from the HCA or PFI credits, land assets will be key. By April, all Regional Development Agency land and assets will have been transferred to the HCA. So in cases where councils do not have the right offering for the private sector, there may be opportunities to work with public sector landholders such as the HCA, the NHS or the London Development Agency.

Sellers says there has also been talk about some authorities joining together to access the capital markets. But because of the continuing Eurozone turmoil, the Public Works Loans Board has made that unnecessary at the moment by offering shorter term deals until things settle down.

Whether PFI returns to the housing sector depends on the commercial details of the schemes seen over the next few years. Large regeneration programmes in London or Birmingham may need more support than a cleared site in Cornwall or Brighton, and the MPs will surely need to focus on this difference in their review.

Some of the techniques and thinking around restructured finance and the potential for properties to return to councils after 20 or 30 years will be useful, but the whole “rigmarole and bureaucracy that held back the previous schemes”, as Jones puts it, is unlikely to be seen again.