The social housing opportunity

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty”
Winston Churchill

Social housing debt has not made up a significant proportion of pension fund fixed income assets in the recent past. Over the past decade or so the banks have provided the vast majority of funding for the sector – indeed some 85% of funding came from just five banks. However, as the ramifications of the financial crisis become clear it appears likely that the social housing sector will be coming more to pension funds and insurance companies for financing and this presents a very interesting opportunity.

So, what do we mean by the social housing sector? This sector provides almost 10% of housing in the UK through a large number of Registered Social Landlords (RSLs). They are non-profit organisations, usually registered charities, which provide and manage accommodation for rent and sale and are directly regulated by government agencies. The largest RSLs manage and own tens of thousands of properties which they offer at below market rent and as such are highly significant parts of their local area’s infrastructure.

“The banks are now pulling away from providing long-term loans to RSLs as a whole lot of new regulation starts to bite.”

The reason that banks were so happy to lend to the sector was because it offered low risk lending. The RSLs have long-term tenants providing a strong and predictable rental income, much of which is provided directly to the RSL from housing benefit. These rents rise, in general, by a little more than inflation allowing RSLs to plan for long-term building projects backed by these predictable cash flows. Similarly, the RSLs receive funding directly from the government to help finance these building projects.

Furthermore, almost all lending to the sector is secured so an investor has a first mortgage over particular residential properties. Finally, the sector is regulated with particular focus on the economic stability of the RSLs. The upshot of this belt and braces approach is that lenders have never made a loss when providing funding for social housing groups. If an RSL has got into any difficulties the regulator has acted quickly and decisively to protect tenants and stakeholders. Social housing is a concrete example of how good regulation improves the functioning of a whole sector.

The banks are now pulling away from providing long-term loans to RSLs as a whole lot of new regulation starts to bite. As across many other areas of bank lending, it has become far more difficult for banks to hold the 30 to 40 year loans that suit the social housing world. This in turn means that they are far less willing to offer the borrowing terms that would be attractive to RSLs.

“We look to match the inflation-linked rents that RSLs receive with inflation protection that can be sold to pension funds.”

With the banks moving out of the sector, we believe that social housing fits pension funds like a tailored glove and that the safety of this investment is only part of the story. It becomes more interesting for pension funds as we look to match the inflation-linked rents that RSLs receive with inflation protection that can be sold to pension funds.

At the moment it is not that easy to get hold of simple instruments or assets that provide inflation protection. The conventional channel for pension funds is through the index-linked gilt market. However, the level of demand for inflation protection, even before the advent of quantitative easing both in the UK and the United States, means that real yields (before inflation adjustment) are low. The 30-year index linked gilt for example now pays a real yield of just 0.8% compared with almost 2% in 2003 and almost 4% in the mid-1990s.

“Investors receive a better return compared with the gilt market for a secure inflation-linked asset.”

Social housing could well provide some of the answer. First, investors receive a better return compared with the gilt market for a secure inflation-linked asset. Secondly, the long-term nature of the lending is a good match with the requirements of the RSLs – with all RSLs planning over a 30 year horizon. It will take a while for the markets to migrate from the banks to the more natural providers of long-term finance, the pension funds and insurers, but we are confident that this is happening and will continue.
M&G has been involved in the sector since the 1980s, and our commitment has never flagged with a large number of investments. However, with the focus on government spending social housing has now received mainstream media attention, occupying everything from the pages of The Guardian to a panel on Newsnight. The coalition has not only announced funding cuts, but also changes to the regulation. The Tenant Services Authority (TSA), which is responsible for economic regulation of the sector, is to be disbanded. So where does all this leave Social Housing?
First, the government have been very clear that economic regulation will be unchanged. As such, we can look forward to the same regulatory approach that has been successful in the past continuing into the future. Secondly, the cuts in grants will just take us back to the 2006-2008 settlement levels, where a significant amount of building took place. We expect construction to continue, especially as there is a clear political consensus that we need new houses. RSLs will still want to borrow.
Ultimately, the news, while very significant, has little impact on the fact that this is a sector looking for a new source of finance and with a natural link to inflation. RSLs and pension funds make a pretty good couple, and as such our aim is to bring them together.

Bernard Abrahamsen, head of institutional sales and distribution at M&G Investments