Written evidence submitted by Midland Heart [FSS 014]

 

The current state of financial resilience of social housing providers

It is difficult for us, as a single association to assess the financial resilience of the sector as a whole. However, it is clear that the sector faces a challenging financial framework melded to new economic and political realities and this will last for some years to come.

 

High inflation has caused difficulty for the sector. In addition to general price inflation, as measured by the CPI (Consumer Price Index), registered providers (RPs) have had to find significant annual salary increases for staff to protect them against inflation and themselves against the potential for staff flight to other employers/industries. It is also clear that the ‘basket of goods’ that RPs spend on is rising faster than general inflation (see BCIS indices and PMI (Purchasing Managers Index) data) as well increased expenditure on services such as insurance and audit. Despite predictions in the Chancellor’s autumn statement that inflation would fall, this has not yet happened. Even when general inflation does ease, the levels of investment required of RPs will mean borrowing at levels not seen for a decade or more. Increased interest rates will mean higher borrowing costs and lower interest cover. This is where there have been lender ‘carve outs’ on covenants regarding borrowing for ESG (Environmental, Social, and Governance) works – although Midland Heart does not need to take this route.

 

In addition to the increase in costs caused by inflation, the Government has also imposed a rent increase ceiling on the sector for 2023/24 with the possibility of a further ceiling if inflation does not reduce as predicted. Even if inflation does decrease and the sector returns to a CPI+1% increase, it seems likely this will still be a significant increase for our tenants and may not match the inflationary increase in our costs for the reasons given. Whilst we agree that the rent increase ceiling is the right thing to do, indeed we would not have increased rents by the otherwise allowed CPI+1%, it must be acknowledged that this policy breaks the link between income and costs, thus increasing borrowing at a time when interest rates are also increasing.

 

This inflationary uplift in costs and limitation, albeit temporary, on income needs to be considered in the context of the new political and economic context that RPs find themselves. The tragic events at Grenfell Tower and death of Awaab Ishak have rightly shone a light on sub-standard living conditions in some social housing and on building safety. Whilst these two issues should be an absolute priority for all landlords, as they are for Midland Heart, the additional costs that will be incurred by RPs investigating and remediating safety, quality and decency issues cannot be ignored. These, and other cases, and greater activity by the Ombudsman have also raised greater awareness of landlords’ responsibilities to tenants and this has led to greater demand on resources also.

 

Registered providers are facing a ‘perfect storm’ of increasing costs relating to building safety, quality, net-zero requirements and developing new homes. The rent ceiling (with which we agree) adds to the problems in meeting these challenges. As a responsible landlord, we firmly believe that our priority must be building safety and the living conditions of our existing tenants including the decency and EPC (Energy Performance Certificate) performance of their homes. This means that we are prioritising expenditure on quality, building safety, remediation and retrofit; inevitably meaning that it is the development of new homes that is reduced as we face limits on what we are able to do within our financial plan. This suggests it is therefore unlikely that the social sector will be able to deliver anything like the number of homes needed, let alone provide the type of counter-cyclical balance described, and sorely needed.

 

On the question of the overall viability of the sector, both the reaction to the rent ceiling and recent regulatory judgments offers some idea of the picture. Whilst most landlords appear to be able to absorb the single year seven per cent rent ceiling, in its response to the consultation Government was clear that part of the reason it settled on seven per cent was that some responses indicated a lower ceiling would mean viability issues. This indicates that any further ceiling in 2024/25 would prove problematic for some. The Regulator has also downgraded several landlords from V1 to V2, this has been largely as a result of the changing macro-economic environment rather than changes in the fundamental economic position of those providers. RPs have also moved their credit rating from A2 to A3 or even BBB as a result. These downgrades further increase the cost of accessing borrowed funds, these have obviously increased in any case due to the rising Bank of England base rate, thus putting further financial pressure on providers.

 

In terms of housing association balance sheets, increases in house values will have had limited impact on these, as houses are held at ‘cost’. However, increased property values do mean increased collateral against which to raise loan finance and/or greater sale values. However, many housing association properties are subject to limitations on sale or other disposal because of grant conditions. Therefore, whilst they may act as loan collateral (again subject to increased borrowing costs, they are less able to be used as a means of generating short term liquidity. It is difficult to know whether a downturn in the housing market will lead to unsold equity in either low-cost homes or outright sales. Within the sector there will be market exposure, potentially reducing the generation of cashflow, which for some housing associations was acting as cross subsidy.

 

The cross-subsidy model has always had limitations in that it provides a limited income stream to fund investment. Surpluses generated from sales do not fully fund the building of other new homes and the sum available to do so is largely dependent on the number of homes built for sale. Landlords are therefore required to build 60-80 per cent for sale, to fund the remaining affordable programme. This is particularly a problem now, as providers look to cut back their development programmes in response the economic environment and the other spending pressures they face. The number of new affordable homes being built will inevitably decrease. Given the investment demands that all registered landlords face alongside the need to build a substantial number of new homes, it is difficult to see how all this can be achieved without the need for significant government grant for affordable homes – particularly those for social rent.

 

Wider challenges

The sector also faces some wider pressures on its resources which create a degree of uncertainty. Government and lenders expect homes to be ‘decarbonised’ at a rapid rate, whilst this is not necessarily unreasonable, retrofit technology does not yet have a readily available supply chain and new technology is emerging all the time. Accreditation on the technology and the standards homes must meet are both stringent and so elevate costs further.

 

Government has also been proposing to address the quality issues in the sector by updating the Decent Homes Standard; it is not currently clear what the new requirements will be and therefore what this means for RPs. This is an area of significant uncertainty for the sector, as well as significant likely expenditure. It seems likely that the revised standard will increase requirements around building safety and decency in relation to weather tightness and damp and mould. A recent report by the Housing Ombudsman also highlighted ambient noise e.g. traffic in urban areas as a significant issue. It seems likely then, that soundproofing may also factor into a revised decency standard. There may also be requirements around broadband connectivity in response to lessons learned from and changes due to, the pandemic. The government has suggested that any new ‘environmental’ requirements will be addressed separately to the revised decent homes standard, however, what is certain is that the sector will face further significant investment costs as a result of both revised decency and environmental standards e.g. requirements on fire safety and electric vehicle charging points.

 

The sector also, of course, faces pressure to continue to play a significant role in increasing housing supply in England. The supply of general housing is lagging well behind the numbers needed to meet supply and this is truer of social and affordable housing then either market rent or outright sale. Legacy social landlords face not only the cost of developing additional supply, but also the costs detailed above as they are required to remediate and improve their existing homes. This may mean that ‘for profit’ RPs and other new entrants to the sector become the primary vehicles for new development as others struggle with the increased costs and limited incomes discussed. The sector should also expect to see increased merger activity as some landlords look for ‘safe harbour’, and the possibility of the regulator stepping in to broker rescues of providers facing viability issues.

 

It is difficult for us to say to what extent private equity investors are entering the market, particularly from overseas. However, it is evident in Birmingham, our primary area of operation, that there has been significant entry of private ‘for profit’ providers into the exempt accommodation sector for supported housing. Whilst data is not available to say for certain that this is leading to the quality issues we are seeing, it does appear that some are taking advantage of the ‘exempt accommodation’ rules to claim higher rates of payment whilst not providing the quality of accommodation and support required. This has been borne out in research by the city council. Landlords such as Midland Heart are facing significant expenditure to retrofit some of the oldest housing stock in the country to meet environmental requirements. Alongside the other pressures mentioned, this limits the funds available for development of new homes. As new entrants to the market, the ‘for profit’ providers are not so encumbered, there is a risk that they become the primary developers of affordable housing and current social landlords become managers of deteriorating stock. In our view, this would be to the detriment of the sector.

 

Mergers

Mergers will doubtless continue to be possible where struggling providers seek safe harbour from larger, more stable organisations. However, there also exists the likelihood of regulator mandated mergers as either less viable providers look to the regulator, or the regulator requires a ‘bail out’ merger as a result of regulatory activity. As one of the more financially robust organisations in the sector, we would be concerned if we were required to enter such an arrangement at the detriment of our own condition and status. There have been occasions where landlords have been downgraded as a direct result of taking on ‘bail out’ mergers and we do not want to find ourselves in this position. Midland Heart also holds one of the highest credit ratings in the sector and we would not want this to be at risk.

 

On the issue of size, this has been a long running debate in sector – how big is too big? Many Housing Associations were set up and developed in the 1980s in response to the criticism that local authority landlords had grown too big to be responsive to their communities, as well as an ideological suspicion of local government. Housing associations were therefore promoted as smaller, more responsive, community-based organisations. The largest housing associations are now considerably larger than the largest local authority housing departments ever were. The recent issues surrounding conditions in some social housing and damp and mould do lend credence to the idea that some larger landlords are out of touch with conditions on the ground and with what their tenants think and are saying. However, it would be wrong to say that this is problem exclusive to larger landlords. The new Tenant Satisfaction Measures may provide some clarity in this area if they show a connection between landlord size and negative tenant opinion. This is a line of analysis worth pursuing.

 

 

 

What are the policy and regulatory challenges to the Department and the Regulator?

DLUHC (Department for Levelling Up Housing and Communities) and government more generally need to place far greater focus on social and affordable housing, with the emphasis on social, as a solution to the housing crisis. Recent analysis by the Chartered Institute of Housing showed that some 56 per cent of government expenditure on housing goes into support for the private market including the ‘Help to Buy’ scheme and ‘Lifetime ISAs’. The remaining 44 per cent is spent on the Affordable Homes Programme and other such initiatives. This means that the government could significantly increase the level of funding it puts into social and affordable homes by reallocating funds away from support for the private market – no additional funding need be allocated.

 

Secondly, housing (particularly social and affordable housing) needs to be defined as ‘infrastructure’ and therefore benefit from the additional priority this redesignation would bring. Housing is just as, if not more, important than roads or industrial development. Given the focus on public health following the pandemic and long-term government concern about obesity and drug and alcohol use, housing also needs to be seen as part of an integrated ‘public health strategy’. The benefits of good quality housing to health are well known and have been for many years. The Housing and Town Planning Act 1919 (Addison Act) acknowledged as much over 100 years ago, as did the Beveridge Report in the 1940s.

 

One of the most effective interventions the government could make to support public health, would be the provision of safe, secure, decent, and genuinely affordable housing. It has also become clear, that at worst, poor quality housing can lead to death. The provision of good quality, affordable housing should therefore be considered essential, national infrastructure and part of an integrated strategy to improve the health of the nation.

 

Homes England

The issue is not so much that Homes England is appropriately directed or otherwise, but rather the stated objectives of Homes England, which we do not think are the right ones. These objectives are largely concerned with intervention in the private market to maximise the number of new homes being developed and mitigating some of the negative effects of an unfettered market. In our view, and as we have set out above, Homes England should be playing a much greater role in funding and delivering much needed social and affordable homes.

 

Exempt accommodation

As we said in our response to the call for evidence to that inquiry, it is our view that to be eligible for the enhanced payments that go with ‘exempt accommodation’, providers should be required to be registered with the Regulator for Social Housing and subject to their standards. Good providers will have nothing to fear from this and many will already be registered as they provide social housing.

 

That said, we also note the Supported Housing (Regulatory Oversight) Bill is currently before Parliament. The requirements of the Bill, for local authorities to have a supported housing strategy and national standards for supported housing, should address many of the issues the sector faces. The regulator should be engaging with supported housing providers to encourage them to register, and local authorities should have the option to be able to only grant enhanced funding to registered landlords.

 

Regulatory powers/competence

This is an area where we believe the regulator could do more. We note that the regulator has said it is gearing up with more staff who are knowledgeable in this area. However, the experience of the government’s problems in pursuing foreign companies, or companies with opaque financial structures, in relation to building safety remediation costs suggests this is an area where there is a need for greater expertise. Generally speaking, we think that the regulator has the powers it needs to ensure value for money and manage risk from registered providers. The removal of the ‘serious detriment’ test is a positive development that will enable to regulator to intervene earlier where it has concerns, we also welcome closer working between the regulator, Ombudsman and Building Safety Regulator.

 

Delivering new homes

It is unavoidable given the financial challenges the sector faces that the current affordable homes programme will not deliver the planned number of homes due to the combination of financial pressures the sector faces. We work closely with our local authority and other partners on the type and size of homes we build. Local authorities should have (although many do not) a local plan that states the type and size of homes needed in their area and we work together with them to deliver this. However, overall sites still need to be viable and this also effects what can be delivered e.g. the mix of flats and houses, and of market sale and affordable and social rent. We strive to provide the maximum of affordable and social rent on a site that we can.

 

Conclusion

Boards are faced with investment decisions and a reducing resource base will inevitably mean a choice between maintaining and improving existing stock and new build. This will either mean less new build provision or the potential for greater home disposals so that receipts generated will be used towards new build. Either way, there is a risk that less homes will exist in the social housing sector.

 

To begin to remedy and reverse this reality, government should:

 

 

May 2023