As the social housing sector begins its post-pandemic recovery, Partner Ruby Giblin asks whether the lending landscape has fundamentally changed – and what role security now plays.
Pre-pandemic, we were all familiar with the well-established investment cycle of developing, charging and then funding future developments with the charging proceeds, but that is no longer the default choice. The lending market has moved on, and bricks and mortar are no longer the only game in town.
Different funding models from potential lenders have never been so diverse. The funding landscape, with different risk profiles, has changed.
Unsecured lending is one such model; for a fee, security is no longer needed. While there will usually still be an unencumbered asset test, this should give access to a wider pool of options (including properties that are traditionally difficult to charge).
It will also remove timing constraints and reliance on local authority search departments, as well as reducing the cost and expertise needed to manage the charging process. Unsecured lending is slowly increasing the traction of capital markets investment, too.
For instance, retail charity bonds for RPs, which may be unsecured, and some European Medium-Term Note (EMTN) bonds too, which – like private placements – are particularly attractive to overseas investors and have added to the flood of North American interest.
The cladding crisis, in particular, means that many significant high-rise assets are no longer chargeable at economic rates, or at least require expensive remediation. Environmental retrofitting poses a similar problem – high numbers of buildings that were once robust and reliable may start to look increasingly costly.
Tied up with building safety, RPs are considering the cost of retrofitting and decarbonisation. Savills and the National Housing Federation recently estimated the cost to the sector to be at an eye-watering £36bn. With average retrofitting costs starting at about £24,000 per flat and zero carbon targets to be hit by 2050, budgets are inevitably under pressure.
Charging assets for these purposes does not carry an upside whereby the charging proceeds can be ploughed into the next development. The monies will be swallowed up instead on increasingly expensive retrofitting works. An application to the £3.8bn Social Housing Decarbonisation Fund grant, when open, without any charging, may well be the better choice. And of course, RPs face the challenges of environmental, social and governance (ESG) targets.
Following the publication of the government’s sustainable investing roadmap in October 2021, sustainability will be an increasingly crucial part of development going forwards and have a major impact on lending and borrowing.
Put simply, the roadmap makes it clear that all entities, including developers and RPs, will soon be required by law and/or investors to make “sustainability disclosures” at some level. Solid and demonstrable ESG credentials will become mandatory. With the roadmap promising a new framework for all borrowers to demonstrate environmental and social value, there is still uncertainty in the air – something that is never good for lending.
Shared ownership for new builds has been remodelled, with one of the consequences being the staircasing increments of one per cent increasing administrative costs for RPs, making these assets less attractive to funders, who have always capped the number of shared ownership units they are willing to charge anyway (typically up to 25 per cent of each portfolio).
If the smaller increments are popular, how will this affect charging of shared ownership units? Funders are concerned that predictable cash flows may become uncertain, with a higher administrative burden, and the pool of shared ownership assets could fluctuate. There will be smaller upfront payments to the RP, too.
The 10-year maintenance costs that the RPs have to bear may also be onerous. Will this lead to increased stock rationalisation activity instead of charging them, perhaps selling them to the for-profits, which typically hold 40 per cent of shared ownership assets as part of their portfolios to slot into their business models?
Since March 2020, RPs now have the ability to raise rents by Consumer Price Index plus one per cent, generating a £0.2bn surplus in the last financial year, which may make up for some of the shared ownership losses.
The new First Homes new build scheme has also threatened the RP’s tried and trusted charging pipeline – the Section 106 agreement. Twenty-five per cent of these new build properties now have to be sold to first-time buyers, leaving only 75 per cent available to charge and rent out.
Coupled with supply chain issues exacerbated by COVID-19 and Brexit, finding suitable chargeable assets could be challenging. Again, many RPs, partly due to such policy initiatives and to encourage slicker and more cost-effective management, are simply selling off stock and streamlining operations. It looks like we may have another bumper year of stock rationalisations, and RP mergers are on the agenda again.
We are also seeing the rise of for-profit RPs whose model is primarily equity-based. Charging to secure debt to arms-length mortgagees is a peripheral part of the model. Although they comprise a small percentage of all housing, for-profits doubled their numbers in 2021 to some 20,000 units. While debt makes up some part of the picture, for-profits are investing for long-term returns, often through lease structures, which may or may not involve charging.
However, is this the whole story?
December 2021 saw the first rise in interest rates by the Bank of England for some years. Although the increase was only to 0.25 per cent, is this the first sign that the wheels are slowing down?
With inflation at 5.1 per cent and the imminent cost of living crisis, while the EMTN and private placement market continues with £15.1bn borrowed in the last financial year, do RPs have to be faithful to the secured lending model?
Rather than security being under attack, is it business as usual, with the charging landscape evolving to fit the increasingly complex demands of RPs in the twenties, as one size no longer fits all. Does charging itself have to evolve too?
This article originally appeared in Social Housing (£)