In many ways housing associations are facing a perfect storm of financial challenges. By way of example:

• Annual build cost inflation for new homes has run into double-digits for much of the last 18 months[1]
• Our cost of borrowing has risen significantly due to the sharp increase in interest rates that followed October’s mini-budget
• Rents – our main source of income – are rising well below inflation (by seven percent for 2023/24 compared to 11.1% had they risen as normal by CPI+1%)
• Investment in existing homes is necessarily increasing – across the sector, total spend on repairs and maintenance reached a record level of £6.5bn in 2022. Southern Housing has assigned almost £800m in our long-term financial plan to decarbonise our homes.

The severity of these financial challenges is reflected in the number of housing associations having their credit rating downgraded by credit rating agencies (which has its own implications for the cost of borrowing). And the number of housing associations which have recently had their economic viability rating downgraded by the Regulator of Social Housing. It is also notable that the most recent set of global accounts highlighted a deterioration in several of the sector’s key financial metrics. Earnings Before Interest Tax Depreciation and Amortisation inclusive of all major repair costs (EBITDA MRI) interest cover has fallen to 128%, down from a peak of more than 170% in 2018 and is set to reduce further as the sector continues to invest in existing stock and the cost of finance increases[2].

To date, these financial challenges have not significantly weakened the financial resilience of the sector. Housing associations remain capable and committed to delivering on their social purpose. Where they are having an impact is in the sector’s behaviours. Differential inflation and increased spending commitments on building safety and decarbonisation mean housing associations are being forced to make difficult decisions to ensure they can continue to deliver their social purpose. For some housing associations – including ourselves at Southern Housing – this has encouraged a recent increase in merger activity. The merger of Optivo and Southern Housing Group (through which Southern Housing came into being in December 2022) was driven in part by the added financial resilience associated with greater size. Merging:

• reduces our cost of borrowing (since a larger asset base helps us leverage greater debt finance at lower cost), which is especially important in an era of lower grant
• enables us to issue our own own-name bonds rather than via an aggregator or private placement (which is a less expensive way of raising finance)
• is likely to have a positive impact on our credit rating over the long-term (since credit rating agencies tend to see increased scale as credit positive)
• creates opportunities for operating efficiencies and improvements in customer service, including by making in-sourcing more viable

For many housing associations – including Southern Housing – the challenging operating environment will also mean a significant reduction in development activity. As socially-minded housing associations, we are committed to resolving the acute backlog of affordable housing. But differential inflation and the pressing need to invest in our existing homes means, for many, new-build activity will take a backseat over the short-term. By way of example, Southern’s development activity will fall to a low of 250 starts over the next few years, down from a peak of 2,300 starts by the two legacy organisations in 2019/20.

While housing associations’ financial resilience has not been adversely impacted to date, a further deterioration in the operating environment might have a more adverse impact. Traditionally, the sector has three coping mechanisms when facing economic stress; a reduction in development output, securing operating efficiencies and cutting back non-essential services. However, there is very little scope to employ these coping mechanisms any further. Development has already been cut back significantly, most housing associations introduced sweeping efficiency programmes following the enforced four-year annual one percent reduction in rents from 2016/17 to 2019/20 and discretionary services have been pared back. That means any further financial challenges are more likely to impact on financial resilience and the delivery of core landlord services.

Historically, housing associations have played an important role in continuing to deliver affordable housing through housing market downturns. With development programmes dominated by affordable tenures and Government capital grant subsidy accounting for a large proportion of development costs, housing associations have been able to continue to develop when volume builders reduced their output.

Now, though, that has all changed. Government capital subsidy for affordable housing has fallen from 75% of total development costs in the late 1990s to nearer 15% now. And – compensating for that reduction – many larger housing associations have incorporated homes for market sale into their development programmes to generate income to cross-subsidise affordable housing. The sector’s fortunes are now inextricably linked to the state of the housing market and wider economy. That means it is simply impossible for the sector to fulfil its historical counter-cyclical role with all its benefits for continued investment in the construction supply chain and labour force (not to mention continued provision of much-needed affordable housing).

Three Government interventions would help restore this valuable counter-cyclical role.

Firstly, a move to increase the duration of Affordable Homes Programmes from five years to ten to offer housing associations long-term certainty over the provision of capital grant subsidy.

Secondly, an increase in grant rates to nearer the proportions seen in the late 1990s. Grant would ideally be indexed to a measure of build-cost inflation to minimise the risks of differential inflation.

Thirdly, the provision of a new long-term index-linked rent settlement so housing associations can be confident in committing to the delivery of ambitious development programmes.

In the absence of these interventions, housing associations’ development activity will continue to become increasingly pro- rather than counter-cyclical.

Housing associations’ adoption of the cross-subsidy model has proven a highly effective response to a decline in Government capital grant subsidy on an overall and per-unit basis since the late 1990s. It has enabled housing associations to deliver hundreds of thousands of affordable homes over recent times, despite grant typically accounting for less than a fifth of total construction costs.

However, it has been widely acknowledged for some time that housing associations have now reached the limits of what can be delivered through the model. There are inherent limits to the amount of cross-subsidy that can be generated, including lender covenants limiting the proportion of housing association turnover resulting from open market sale to 30%.

We believe the model does have continued viability. But the only way to increase housing associations’ delivery of affordable housing – and ensure it is maintained through housing market downturns – is to implement the three recommendations raised in response to question three (long-term grant certainty, index-linked grants, and a long-term index-linked rent settlement).

Private equity investors have been entering the sector at a steady rate as demonstrated by the growth of for-profit registered providers, chief among them Sage and Legal & General Affordable Homes. This presents challenges for traditional not-for-profit housing associations, including increased competition for land and homes purchased through section 106 agreements. Given the profile of their stock, for-profit providers also tend to be much less encumbered by the issues of retrofitting and building safety.

However, the growth of for-profit providers also presents opportunities for traditional housing associations. For instance, prior to our merger, Sage purchased 420 grant-funded affordable homes from Optivo’s development pipeline. Optivo (now Southern Housing) will retain management responsibilities for the homes and receive £106.5m, net of grant, to invest in additional land-led development. The deal creates genuine additionality, supports our ambition to move towards land-led development, and delivers better value for money for those funding affordable housing since the initial grant allocations from Homes England and the Greater London Authority will enable the delivery of not one, but two phases of new housing.

Provided for-profits continue to be subject to the same regulatory requirements as traditional non-for-profit housing associations, we see no reason to be overly concerned about their continued growth.

Housing associations make carefully considered judgements about the level of spending directed towards new and existing homes. Our guiding principle when doing so is that the safety and wellbeing of our residents is paramount. In common with much of the sector, Southern Housing will significantly increase the sums it invests in its existing homes over the next few years. Our combined spend on repairs, maintenance, major works, building safety and decarbonisation will increase from £119.7m in 2022/23 to £271m in 2027/28. This increase is made possible by the operating efficiencies enabled by our merger and a significant downscaling of our development programme.

As housing associations invest increasing sums in their existing homes it becomes all the more important that the value of this investment is maximised. To this end, we recommend Government should:

• zero-rate VAT on all housing association activity, as well as making spending in recent years VAT-recoverable
• introduce greater flexibilities over the deployment of the Recycled Capital Grant Fund (RCGF) so this can be more easily invested in existing homes
• increase funding for regeneration and make it available for the replacement of homes demolished through regeneration, rather than exclusively to support the delivery of net additional affordable homes.

In drawing up plans for a new scheme, we are always cognisant of the typology and tenure mix of homes sought by the local authority.

As a rule, most of our development programme in London comprises flats, whereas outside London (South East England and the Midlands) most development is in the form of houses.

The nature of our development programme is also heavily influenced by regulatory requirements. For example, the proposed requirement for new high-rise residential buildings to incorporate a second staircase is likely to lead us to build fewer high-rise blocks given the viability challenges this requirement creates.

The impact is variable depending on individual housing associations’ stock profile. Some housing associations with few recently-built high-rise buildings have limited or no exposure. Others – such as ourselves – now face the prospect of a significant increase in expenditure on fire-related building safety works, especially given the limited availability of funding through Government’s Building Safety Fund.

Over the next five years, Southern Housing will spend £172m on building safety works, protecting tenants and leaseholders from additional charges wherever possible.

As stated previously, this level of forecast expenditure is already impacting on the size of our development programme over the short-term.

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For-profit providers may have made the sector as a whole more financially robust through the strength of their balance sheets. Given the nature of their stock profile – mostly new-build homes built to relatively high environmental standards and unlikely to feature flammable cladding – they are also less encumbered by the need to invest heavily in their existing homes. Their growth has also led to the potential for partnership working with traditional not-for-profit housing associations as our deal with Sage demonstrates.

Fundamentally, however, it is the financial resilience/robustness of individual housing associations (rather than the sector as a whole), which is key. As discussed, housing associations have to date proved resilient in the face of a very challenging operating environment. But further unforeseen shocks – in the form of a further freeze to rental income, for example – could jeopardise the resilience of some associations, especially as traditional coping mechanisms may not prove as effective as they have been historically.

As Sanctuary’s recent deal with Swan demonstrates, merger continues to offer an effective method for rescuing housing associations encountering severe financial difficulties. Nevertheless, the Committee is right to query whether mergers will always be able to fulfil this function.

Were any of the largest, most organisationally-complex, housing associations to encounter significant financial difficulties (or those with high exposure to the housing market), merger may not be a viable option. Few, if any, housing associations would be capable of making a rescue merger work. And banks impose their own limits on the amounts they will lend to any individual housing association.

In these cases, the only solution may be for the Regulator to intervene and split the association up into smaller geographical units more amenable to being taken on by stable, mid-sized housing associations.

Having successfully navigated multiple mergers across our two legacy organisations, we are very cognisant of the fact that mergers are not without risk. However, when executed carefully and in close collaboration with residents, mergers can be highly successful, resulting in both improved financial resilience and enhanced resident satisfaction. Indeed, we are confident our merger will lead to an improvement in customer service as our increased density enables us to bring more services such as repairs and maintenance in-house and forge stronger links with our partner local authorities.

It is also worth noting that many mergers do not result in umbrella groups, or allow for the collapsing and simplification of group structures over time.

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Shared ownership has proved a highly popular tenure among housing associations and residents since it was first introduced in the 1980s. For prospective buyers it offers an affordable first-step on to the housing ladder and the prospect of purchasing further equity over time as income and savings allow. Recent strong sales figures across the sector are testament to the enduring popularity of the tenure among prospective buyers. For housing associations, shared ownership offers a reliable source of income through first tranche sales and subsequent staircasing transactions, and a good means of creating mixed tenure communities.

That said, allocating half of the £11.5bn assigned to the current Affordable Homes Programme to affordable homeownership products (principally shared ownership) does inevitably mean funding for the most in-demand affordable tenures (most of all social rent) is insufficient to meet demand. In 2019, the National Housing Federation estimated it would be necessary to build 145,000 affordable homes each year, including 90,000 for social rent. This would cost on average £14.6bn in capital grant from Government each year for ten years with 86% allocated to social rent and just four percent to shared ownership[3].

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Southern Housing is in the process of preparing a formal response to DLUHC’s technical consultation on the design of the Infrastructure Levy.

We have previously expressed concerns about whether the new levy will be capable of delivering the number of affordable homes required. The risk inherent to a combined levy is that it will inevitably create trade-offs between affordable housing and infrastructure, with delivery of the former suffering as a result. The Levelling Up & Regeneration Bill lists eight forms of infrastructure with which affordable housing will effectively be set in competition from flood defences to medical facilities. We cannot expect affordable housing to win out in every circumstance. Government has set out a framework to ensure affordable housing delivery will be maintained, with “previous levels” as a minimum. This is a vitally important step and we look forward to engaging with the details of this through the consultation.

We have also previously expressed reservations about whether the Infrastructure Levy is fundamentally ill-suited to producing mixed-tenure communities. The key obstacle here is the proposal to charge the levy at the point of occupation. In another welcome move, Government has proposed to enable local authorities to specify what portion of the levy they should receive ‘in-kind’ as onsite affordable homes, through a new ‘right to require’. Again, we look forward to engaging with the details of this through the consultation.

As stated previously, objective assessments of housing need would suggest future Affordable Homes Programmes should allocate a much greater proportion of funding to low-cost rented tenures. Analysis conducted for Crisis and the National Housing Federation in 2018 found that 90,000 social rented homes are needed each year to address the backlog of housing need and end homelessness, as well as 30,000 for Affordable Rent and 25,000 for shared ownership. This would cost on average £14.6bn in capital grant from Government each year for ten years with 86% allocated to social rent and just four percent to shared ownership[4]. That compares to roughly £2.3bn per year assigned to the 2021 to 2026 Affordable Homes Programme, of which roughly half goes towards funding homes for shared ownership.

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The sector faces significant financial challenges in investing in its existing homes, while also continuing to supply much-needed affordable housing.

Government could support housing associations in achieving these dual missions by offering housing associations genuine long-term certainty. This should include:

• increasing the duration of Affordable Homes Programmes from five years to ten with grant indexed to a measure of build-cost inflation to minimise the risks to housing associations of differential inflation
• offering long-term rather than piecemeal funding through the Social Housing Decarbonisation Fund (with awards again index-linked)
• introducing a new long-term CPI-linked rent settlement

In addition, Government could:

• zero-rate VAT on all housing association activity, as well as making spending in recent years VAT-recoverable
• introduce greater flexibilities over the deployment of the Recycled Capital Grant Fund so this can be more easily invested in existing homes
• increase funding for regeneration and make it available for the replacement of homes demolished through regeneration rather than exclusively to support the delivery of net additional affordable homes
• reintroduce rent convergence, the continued absence of which will cost G15 members £340m over the next five years – rising to £2bn over the next 30 years, which would otherwise be reinvested in existing homes

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In response to the growth of FPRPs, the regulator and, to a lesser extent, the Ombudsman will need to ensure they have the requisite skills, budget and resources in place to manage providers with a more diverse range of operating and funding / investor models. Knowledge and experience of traditional, not-for-profit housing associations will no longer suffice. The Regulator will need staff with a strong commercial background, including those previously involved in regulating sectors where generating profit or shareholder value are explicit aims.

Rising build cost inflation and contractor insolvencies have already had a significant on Southern Housing’s development programme, making it much more difficult to achieve viability on individual schemes. Homes England and the Greater London Authority have demonstrated some useful flexibility over grant rates. The effect of this is to safeguard the delivery of individual schemes, but with fewer homes delivered as grant funding becomes concentrated on a smaller number of dwellings. We anticipate that the current set of financial challenges will reduce our planned development activity still further over the course of the current Affordable Homes Programme.