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Investing in UK affordable housing
Jenny Harbord
Principal, Head of Real Assets
If there's one thing the British like to talk about almost as much as the weather, it's the housing market... Over the past 20 years or so, institutional investment into the residential sector has grown significantly with residential now comprising 10% of the MSCI all UK property index.
Residential property incorporates a range of sub-sectors including student accommodation, build to rent or private rental product, retirement and care provisions and most recently social or “affordable” housing.
The size of the affordable sector is estimated to be circa £500bn with c. 99% currently owned by local authorities and housing associations. However, in recent years, there have been several deals of significant size made by institutional investors, recognising the attractively priced, secure inflation linked cash flows.
The UK affordable housing sector faces a crisis with around 1.3 million households on waiting lists, highlighting a massive and enduring shortage of social and affordable homes.
Long waiting lists mean that affordable housing properties are often filled within a week of becoming available and therefore there is little wastage through voids.
What is affordable housing?
The severity of the undersupply of housing in the UK is such that any route into increasing the supply of stock could be argued to be impact investing. However, there are some specific definitions setting out the type of product that qualifies for grants and allocations under planning rules. “Affordable” can broadly fit into three buckets: social rented, affordable rented and shared ownership. In addition to these, there are also other sub-sections of social housing, including assisted care and supported living space, which tend to have higher initial yields and higher rental growth mechanisms. For the purposes of this article, we shall refer to all of these classes as “Affordable”.
Breakdown of property classifications
Source: Savills Investment Management
As shown in the table above, rent for these sectors are typically set below market rate and the discounts can be significant, especially in the social rented sector. As you would expect, this translates to lower pricing for affordable homes, which are only made economically possible with government grants or through subsidies from broader development.
Government grants are allocated by Homes England and can only be received by regulated “Registered Providers”. Grants on a per home basis are set in the region of £50k - £100k for a rental home, with most new ones being affordable rent rather than social rent. The contribution towards shared ownership homes is lower at £40k - £60k per unit. For the period 2021 – 2026, the total grant funding was set at £11.5bn, which is around 160,000 homes over the five-year period. Although this is helpful, there is still a long way to go to compared to the estimated 1.3 million shortfall.
The other route to subsidising the build of affordable housing is through the planning system. For developers to deliver other projects, the planning rules incorporate a provision for affordable housing that must be delivered. Registered providers can buy stock from developers at significant discounts to the equivalent market value of privately owned or rented property. With grant funding expected to remain limited, this is an increasingly important route to meeting demand for social housing with stock being affordable rented or shared ownership.
Despite these avenues, the average number of new affordable homes built in the past 5 years is less than 60,000 p.a. This is far below the grant funding numbers and suggests that ramping up delivery may have other hurdles beyond financing such as availability of skilled labour to build them out. The severe undersupply and strong unmet demand creates an opportunity for institutional investment.
Institutional investment
There are many reasons for institutional investors to consider the Affordable sector. A key attraction is the stable and relatively secure cashflows. Long waiting lists mean that properties are often filled within a week of becoming available and therefore there is little wastage through voids. Also, empirical evidence demonstrates that bad debts are very low as tenants receive benefits, which they can use to contribute to housing costs. Tenants are incentivised to pay rent not risk eviction and to avoid removal from future waiting lists.
As well as being secure, rental income grows in line with inflation at either CPI +1% or RPI +0.5%, depending on tenure. For shared ownership, investors are also exposed to growth within the wider housing market. There are also other initiatives fund managers can use to further enhance returns, such as the use of financial leverage or development exposure. However, these initiatives must be carefully controlled to make sure they are accretive to returns and that planning, as well as construction cost risks, are mitigated.
Why now?
Investors entering the market today will benefit from pricing corrections that have developed over the past couple of years in response to rising interest rates.
Starting rental yields are now significantly higher between 4-6%. In addition, rental growth and portfolio enhancement means that investors could expect a total return of around 7-9% per annum from an investment made today.
This sector has strong ESG fundamentals. There is an obvious social benefit to providing good quality housing and this in turn has a knock-on effect in enabling education, increasing employment prospects, and providing health benefits. The combined effect should be to drive national productivity and reduce welfare and NHS costs. Affordable housing investments should also meet the needs of investors with strong environmental targets. New housing stock is built to more energy efficient standards where most managers target EPC ratings of B or higher. Further, buying existing stock from housing associations enables them to recycle capital to re-invest and upgrade the efficiencies of older portfolios.
Naturally, investors will be nervous of political risk and the threat of additional taxes or regulations limiting income receipts or otherwise increasing costs. However, any government would need to carefully consider the impact such measures would have on the delivery of desperately needed new supply. We understand that the new government has carried out extensive consultation across the industry with a view of encouraging investment. While we can’t give any assurances that there will be no adverse intervention, it would be counterproductive for the government to do so and would compromise the ability to deliver on election pledges.
Everyone’s a winner
There are a multitude of benefits from institutional investment in the social housing sector.
- For investors: Solid risk adjusted returns with secure inflation linked cashflows.
- Tenants: More available homes of a higher quality and tenures are usually long giving the tenant security within their home.
- Environment: New stock typically delivered to a minimum of EPC B and older stock being upgraded.
- UK Plc: Multitude of additional economic and social benefits that follow from meeting the need for good quality housing, such as health improvements and increased levels of education and employment.
