Written evidence submitted by the Regulator of Social Housing [FSS 017]

Sector capacity

The private registered provider sector continues to demonstrate a resilient overall financial position, committing to record levels of expenditure in their existing stock and seeking to maintain consistent levels of development. This is taking place within a challenging economic context with increased costs and constrained income, tightening the financial headroom in the sector. Providers will need to make some trade-offs between investing in existing stock and developing new supply but they have good access to the finance they need to deliver their future plans.

Since private registered providers last submitted detailed business plans and financial forecast returns to us in June 2022, the economic context has changed significantly. This is most notably seen with respect to the rent cap and the faster than expected increases in inflation and interest rates. We expect these challenges, and the strategic decisions made by Boards about their future plans, will be reflected in the returns providers submit to us in June 2023.

The level of investment individual providers need to make in their existing stock, and their capacity to do so, varies significantly depending on their business model and other circumstances, such as the age of their stock or whether it was transferred from a local authority. In general, the most significant financial pressure on the sector relates to investment in existing stock. This is driven, in the main, by a combination of inflationary impacts, remedial works and anticipation of future requirements.

Private registered providers spent £6.5bn on repairs and maintenance in 2021/22, significantly above pre-pandemic levels[1]. The last projections they shared with us showed a commitment to sustain and increase investment in existing stock to £7.7bn in 2022/23[2]. This is a direction of travel we expect to continue given the government’s focus on stock quality – for example around Minimum Energy Efficiency Standards and the Decent Homes Standard. The record level of investment is partially driven by ‘catch-up’ spend on works delayed during rent reductions between 2016 and 2020 followed by the pandemic, and wider macro-economic factors. Since 2016/17, UK building cost inflation has been 9% higher than CPI inflation. However, building safety and stock quality were also important drivers of increased spend. In aggregate, private registered providers estimate that building safety accounts for more than 10% of total maintenance and major repairs spend over the next five years[3]. While most private registered providers have included some level of safety spend in their forecasts, spend is concentrated; ten private registered providers account for more than a third of forecast expenditure. In addition, decarbonisation and energy efficiency are an increasingly significant component of asset management spend. Almost all providers have made allowance in their plans to meet EPC C by 2030.

Following lower development during the peak of the pandemic, total spend on new supply recovered to £12.3bn in 2021/22, a 12% increase on the previous year[4]. The number of social homes completed in the year also increased by 9,000 to 49,000 which is on a par with the immediate pre-pandemic period[5]. There are some signs that private registered providers are planning to scale back on development activity. Their latest projections include slightly lower levels of development expenditure over the next 12 months. We expect trade-offs to be reflected in business plans under preparation and development plans may be revised downwards in the June 2023 financial forecast returns.

Most development expenditure is financed by debt that is supported by the rents of new and existing homes. The proceeds from the sale of homes into the general market or other cross-subsidy make up the remainder of the funding mix for investment. Different private registered providers have different levels of exposure to the housing market with properties developed for outright sale concentrated in a relatively small number of larger private registered providers. Reliance on this cross-subsidy varies and we have seen private registered providers pull back on market sale activity. The proportion of forecast development that is delivering units for outright sale has decreased over recent business planning rounds. The 18-month projected pipeline for the delivery of units for outright sale is now at its lowest level for seven years[6]. By contrast, business plans submitted in June 2022 included a higher proportion of new social units with a greater number of homes developed for either sub-market rent or for shared ownership sale.

In recent years, construction works have been affected by supply chain issues, impacting the availability of both materials and labour. These have delayed some schemes and development programmes. While there are some indications that constraints in the wider construction market are beginning to ease off nevertheless our quarterly surveys show more than half of providers are still reporting delays relating to their supply chain.

Investment in existing stock and new supply is taking place within a challenging economic context. Costs have increased due to inflation and a tight labour market. Income is constrained following the capping of rent increases at 7% for most social and Affordable rented homes. This means that providers have less financial headroom and a reduced capacity to manage downside risks. This can be seen in tighter operating margins (the overall operating margin fell to 19% in 2022, the lowest since 2011) and decreased levels of interest cover (down from a peak of more than 170% in 2018 to 128% based on financial results for 2021/22). Recent quarterly survey submissions show a continuing deterioration in levels of interest cover as result of sustained investment in existing stock and rises in interest costs.

We have also seen more covenant waivers due to intense periods of expenditure on building safety works and longer term spend on decarbonisation. The financial capacity of individual providers is reflected in their viability grading and there has been a significant increase in the proportion of providers graded V2 in recent years. V2 graded providers are financially viable but have less capacity to respond to adverse events than providers with V1 grades. We use our quarterly survey to monitor the position of private registered providers and seek further information if necessary. As has been the case in the last few years there are a small number of private registered providers that are non-compliant in relation to financial viability. We are actively engaging with all non-compliant providers to ensure that they return to compliance.

Recent data highlight that liquidity remains robust and the sector remains an attractive proposition for investors. Debt reported on balance sheets continues to grow and increased by £2.9bn (3%) to £89.2bn in 2022. However, levels of indebtedness are stable with growth in turnover and growth in the net book value of social housing assets matching debt[7]. Current aggregate available facilities would be more than sufficient to cover the forecast expenditure on interest costs, loan repayments and net development for the next year, even if no new debt facilities were arranged and no sales income were to be received[8]. Where this is not the case for any individual provider, we engage with them to ensure they have credible plans in place to address this. The risk presented by rising interest rates is mitigated to an extent by the proportion of current debt that is fixed. Our work in progress on the recently submitted January-March Q4 quarterly survey returns indicates that more than 80% of debt held by the sector was fixed for one year or more[9].

For-profit providers

As at March 2022 there are 69 for-profit providers registered with us. They have a combined stock holding of 21,000 properties and total combined equity and debt investment of £3.2bn. By contrast, the not-for-profit sector is considerably larger – large not-for-profit private registered providers had 2.8 million properties valued at £173bn as at March 2022. This means that for-profit providers do not have a significant effect on the sector’s overall financial performance and robustness. However, they are starting to have an impact at a sector level in terms of the proportion of new supply they are delivering. We have seen some evidence of joint ventures, transactions and partnership working between not-for-profit and for-profit registered providers. These could add to the amount of private capital in the sector; its ability to deliver new homes; or to its ability to invest in existing stock – depending on how the private registered providers involved decide to utilise any capacity generated. These structures will carry different risks and rewards from the traditional debt-funded model.

Our regulatory framework

We regulate registered providers of social housing to promote a viable, efficient, and well governed social housing sector able to deliver and maintain homes of appropriate quality that meet a range of needs. Well governed and financially viable landlords are essential for providing good quality accommodation and services to tenants as well as wider society. Social housing is not just another asset class but peoples’ homes. It can offer individuals and families a safe, affordable, and secure place within a thriving community. Registered providers are custodians of these homes and we expect them not to lose sight of this.

Our objectives are set out in the Housing and Regeneration Act 2008 (the Act). We set standards for governance, financial viability, rents, and value for money which apply primarily to private registered providers, as well as standards about the quality of social housing and tenant services which apply to all registered providers. We are directed by government on a number of areas of our standards, including rents. The Act requires us to exercise our functions in a way that minimises interference, and (so far as is possible) is proportionate, consistent, transparent, and accountable.

Our economic regulation helps ensure that the private registered provider sector as a whole continues to be an attractive investment, is well governed, that new homes are delivered, and that tenants are protected from the risk of losing their home should their private registered provider become unviable. While we do not, and cannot, guarantee the viability of any individual provider or debt, no secured creditor has made a loss from investing in social housing, and to date we have successfully resolved all cases of financial distress without tenants losing their homes. This security and stability also enables the delivery of key government policy aims, including building new homes and improving the quality of existing homes. Lenders continue to have confidence in the social housing sector, allowing it to benefit from borrowing at favourable rates. The review of regulation carried out alongside the social housing white paper concluded that our economic role is working well, and the results of our stakeholder survey demonstrate a high degree of confidence in our regulation of the sector.

Our understanding of the sector’s financial position is informed by our ongoing regulatory engagement as well as a suite of standard financial data returns – annual financial forecasts and accounts, and a quarterly survey focusing on key financial indicators and emergent sector risks. Our analysis focuses on the financial status of the over 200 private registered providers who own or manage at least 1,000 homes and who together represent more than 95% of the sector’s stock.

While our standards on the quality of social housing, tenant services and rents apply to local authorities, given their much wider responsibilities we do not have a role in relation to their financial viability, governance or value for money. However, it is clear that many of the financial pressures outlined above are also impacting on the local authority sector. Local authority registered providers generally have lower rents than private registered providers yet face similar demands for investment and cost increases.

Regulating complexity, including non-profits

Recognising that the sector is becoming increasingly complex with a diverse range of private registered providers and business models we keep our skills mix and capacity under constant review to ensure we are well placed to regulate the sector effectively.

We set outcome-based standards which allow us to set requirements for a diverse and varied sector. Our assurance-based approach enables us to regulate informed by individual providers’ circumstances, while protecting tenants in their homes. Registered providers need to notify us of disposals and constitutional changes, however deregulatory measures implemented through the Housing and Planning Act 2016 removed the requirement for providers to seek our consent for these actions.

We expect all registered providers to meet our standards, regardless of whether they have a for-profit or not-for-profit business model. All private registered providers should be well governed, financially viable, and provide safe and good quality homes for their tenants. There are, however, differences between for-profit and not-for-profit providers which we need to take into account when assessing governance and financial viability. In particular, for-profit providers have different capital structures and cash flow dynamics and are often part of wider groups of connected companies rather than standalone organisations. Our regulation therefore focuses on the registered provider itself, and its financial and decision-making interactions with other elements of its corporate structure. We make clear in our judgements when we are reporting on a for-profit provider.

We welcome the new powers set out in the Social Housing (Regulation) Bill which will strengthen our ability to act across a range of different risks and scenarios, including broadening the range of powers we have available for regulating for-profit providers and improvements to our powers for managing insolvency. These changes give us more tools to be able to continue to manage the risks arising from the diversification of the sector now and in the future.

Mergers

Providers may consider mergers as a response to a range of different issues, for example around value for money, improving service delivery, or strengthening financial capacity. One of the reasons mergers are used is in response to a provider being in financial difficulty and no longer being viable as a standalone organisation. Registered providers are responsible for considering whether a merger is the right response, in consultation with their tenants and other stakeholders.

Any merger with a provider in financial difficulty will require a robust partner with enough financial headroom to support the merger. In general, candidates for this would be larger private registered providers the majority of which now have financial viability judgements of V2 and have seen some reductions in their financial capacity. These remain compliant grades. However, the ability to find a merger partner for a specific failing provider depends very much on the facts of the case. Many potential partner providers continue to have significant financial capacity. Any decision by the providers involved would need to consider individual covenant restrictions, market constraints, the strategic focus of the private registered provider, and varying risk appetite levels.

Providers do not need to seek our consent before a merger. Dependent on the nature of the merger and which providers are involved, we may need to make a registration decision on the new body for which we can set criteria. Our focus is on whether the merged entity meets our governance and financial viability standard at the point of registration; demonstrates it can sustain its financial viability on an ongoing basis; and has in place management arrangements that enable it to demonstrate the capacity to meet the other regulatory standards. We can take appropriate regulatory action if that is not the case. To ensure transparency about our view of merged providers, we generally issue interim regulatory judgements based on the existing grades of the merging private registered providers. These are then re-considered in due course so that we can fully assess the new provider after it has been in existence for a period and a substantive grade is awarded.

The housing administration regime provides a vital safeguard providing time to facilitate a complex rescue, including that of a very large private registered provider, should that be required. However, our aim will always be to identify and manage any viability issues as they emerge before a private registered provider becomes insolvent in order that we can better protect tenants’ interests.

Voluntary registration

All providers apart from local authorities are voluntarily registered and there are incentives for them to do so. We have a clear registration process and engage extensively with providers who are considering registration. Private registered providers can apply for voluntary deregistration but before they can deregister, they must satisfy us that the appropriate criteria are met, including those that ensure the continued safeguarding of social housing, tenants, and the capital funding provided for that housing.

Value for money

Our approach to regulating value for money aims to ensure that private registered providers articulate and deliver a comprehensive and strategic approach to achieving value for money in meeting their organisational objectives. Providers report against a range of measures on an annual basis and we also proactively seek assurance through our in-depth assessments using a range of sources.

Given the need for registered providers to respond to the financial and economic pressures imposed on them due to high inflation, rising borrowing costs and increasing demands to invest in both the existing housing stock and new supply, we will continue to seek assurance that providers have clear plans in place to make on-going improvements to their value for money.

May 2023