UK: Risky Business Risk Profile For RPs Increases Following The Spending Review

Last Updated: 25 February 2011
Article by Jonathan Pryor

We look at the issues arising from the comprehensive Spending Review which will affect the activities of RPs.

20 October 2010 was undoubtedly a big day in the collective life of the RP sector. It signalled, quite probably, the most substantial change ever in social housing in the UK. The details remain unclear and it will be many months before the full significance of the changes are understood. However, it is clear that the changes will have repercussions for many parts of RP activity, in ways which, we suspect, were not fully anticipated by the Government.

At this stage, many RPs are exploring the repercussions and trying to evaluate what, if anything, the change to 'up to 80% market rent' will mean for their business plans, their development strategies and current and future tenants.

This article, unfortunately, does not provide any answers but does attempt to illustrate some of the issues arising. The key word in all of this is risk: whichever route your association takes, whether to embrace the opportunities and expand your development activities or to withdraw and become largely management-focused, the risk profile has increased substantially.

Unlocking value

At face value, for some RPs, the change in future rent levels may unlock significant value and enable a more substantial development programme to be released. To take an example, suppose the association has 10,000 units and for half of these the potential for an increase in rent up to 80% market rent is capable over time of delivering on average an extra £20 per week of rent at present day values. Suppose also that 1% of properties become void each year, there is a 4% void and bad debt loss, and the relevant policies on rent setting do not change. Assuming a 5% real discount rate, this then equates to a massive £17m increase in the net present value of future cash flows. Surely this could generate a sizeable acceleration in development capacity?

Stepping into the unknown

Unfortunately, there are too many unknowns for this simplistic calculation to be sensible.

  • Increasing the cost of a service (i.e. the rent) will have some effect on demand; some properties may become hard to let. The end of lifetime tenancies may also have an impact on void periods.
  • Now that a social rent is worth so much more to an existing tenant, we would expect voluntary movements of tenants to be less frequent. Therefore, expect the turnover of properties to slow to some extent.
  • The burden on tenants of the higher rental will be increased. This is bound to have some effect on bad debts and arrears, particularly for those not receiving full benefits. Even for those on full benefits, the move to a universal benefit will mean for some that their income reduces.
  • The restrictions on rentals (e.g. the local housing allowance) will need to be carefully assessed, as will the overall cap. This probably means that in London, for example, larger properties simply cannot be built under this mechanism.
  • Expectations will be raised. Tenants will be paying closer to the market rent and therefore will perhaps expect higher quality in maintenance and service; associations may need to model higher maintenance costs and longer periods between lettings. This might be offset to some extent by tenants taking more care over the property.
  • The dependency on local and central government not changing the rules is now a major threat. Even if a local authority is keen on the changes at the moment, would (following an election) a council led by a different party in say three years time have the same view?
  • How will local authorities react to situations where increases in rents in their authority are applied to subsidise new units in another authority?
  • Given that the risks are higher, surely the association's modelling of schemes needs to reflect a greater level of risk. This would either be via a higher discount rate or a more challenging internal hurdle rate; depending on how the association assesses its potential schemes.
  • Similarly given the higher risks, expect borrowing costs to rise and security requirements to increase.

What to expect going forward

There are two other areas hugely affected by the Government's general approach towards funding social housing and care.

We expect temporary housing to go through a boom; whether or not it is the most sensible use of Government money, this is the one area that seems to be a clear winner from the changes.

Secondly, expect some care and support organisations to get into serious financial difficulties. The 11% or so cut and the removal of ring-fencing from Supporting People funding, the severe contraction in local authority funding generally and the relatively easy process for local authorities to tender and achieve reductions in cost, are combining to make care and support organisations, particularly those with a dependency on Supporting People funding, extremely vulnerable. Furthermore, the costs of redundancy on some projects may be borne by the existing provider which, given the limited level of reserves held by some of these organisations, it may not be in a position to bear.

One further consequence we expect to see is an increase in the level of merger activity amongst RPs and similar charitable bodies; as such, all associations should review their merger and acquisition strategies.

The increased risks and a fundamentally changed landscape arising from the comprehensive Spending Review will require all boards and management teams to be at the top of their game.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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