Written evidence submitted by First Priority Housing Association [EXA 062]

About First Priority Housing Association

First Priority Housing Association is a small not for profit register provider focussed on the provision of Specialised Supported Housing (SSH). Unlike some other forms of exempt accommodation, the support is separately commissioned, usually by adult social services, directly with a third-party provider while we provide, manage and maintain the accommodation.

First Priority leases all of its stock from third parties and does not own any. In 2018 First Priority went through a creditors’ voluntary arrangement (CVA) enabling it to renegotiate its long-term leases onto a basis that we believe is more sustainable, which transfers risk to the appropriate party within the structure.

While our operations, experience and responses are limited to the provision of SSH we believe that the points we raise are applicable to other forms of exempt rent.

Corporate View of Commissioning and Regulation of Exempt Rents

We strongly believe that all exempt accommodation should be:

• Commissioned to ensure that the most appropriate solutions are delivered.
• Subject to a single set of rules and regulations with regulatory oversight being delivered by a single organisation.

We believe adopting this approach would ensure that the provision of exempt accommodation meets both quality of home and service that vulnerable tenants need.

Inquiry Questions

1. What is the quality of exempt housing provision?

As a single organisation we are not able to answer this question beyond referring to publicly available information which indicates that the quality of both accommodation itself and the associated support is variable.

2. Is the current model of exempt accommodation financially viable, and does it represent value for money?

To assist in the evaluation, we believe it is helpful to have an overview of the typical contractual structure for a SSH property

Contractual Structure

Typically, the provision of exempt accommodation is through the use of leases, with long leases (15 to 25 years) in many cases. The leases have been modelled on commercial properties (modified to reflect differing client group) and are in the main Full Repairing and Insuring leases (FRI). Under this model the risks of ownership are transferred to the Registered Provider (RP) who is obliged to pay the freeholder (usually a fund) a fixed rental per month for the property.

The rent is usually calculated based on 100% occupancy, with an initial yield of 5% indexed against CPI, usually with caps and collars to prevent rent decreasing and limiting increases to 4% in the event of high levels of CPI.

To support this rental the RP usually contracts with the commissioned Care Provider who will underwrite the voids, with some allowance for reletting. The diagram below sets out the typical contractual relationships for a scheme

As can be seen from the above diagram the provision is not straight forward and there are some inherent difficulties with the structure that mean viability over the full lease term, as originally envisaged, is uncertain at best.

Risks

The Regulator of Social Housing has, in its addendum to the 2018 Sector Risk Profile[1], highlighted several the contractual risks which we will not repeat here. Essentially these can be summarised as the RP bearing the downward risks of ownership (voids, repair levels, contract renewals) without the associate rewards (share of rental income and capital growth).

The setting of rents for HB reinforces this with the lease rent being the underlying building block of the rent and service charge to tenants with RPs effectively recovering service charges (which under the Landlord & Tenant Act can only be reasonable costs with profit excluded).

Initial yields are typically 5% of investment value (though this is slightly circular as value is calculated by reference to the rent resulting in rental valuations that are c125%[2] or more of open market rental value – vacant possession.)

These rental levels exacerbate the associated risk of the lease as the rent levels are significantly higher than comparable market rent net yields

The above graph shows the weekly lower, median, and upper quartile market rent net yields (assuming 20% operating costs) for 1 bed market rent against the average lease rent per week for quoted SSH funds based on the units they had at year end (green column).

Are initial rent yields too high?

As mentioned above the lease rental yields are typically noted at 5% of investment value wherein the funds do not take risks (at least contractually at the outset). It is worth comparing this return to other residential sectors and more traditional RP debt funding

Build to Rent (BtR) investors focusing on market have looked at net yields of between roughly 3.5% and 5.5%[3], with the big difference being they retain both the risk and reward associated with ownership.

RPs traditionally build grant funded schemes utilising debt to cover costs not funded through grant. In 2021 Golden Lane[4]  (graded G1/V1) issued a 10-year Retail Bond at 3.25%. To compare it to the quoted funds and BtR investors we need to convert to an initial yield. Assuming an average inflation of 2% it would equate roughly to an initial yield of 3%. This is probably as close as we can get to a risk-free return on the open market. It should also be borne in mind that Golden Lane (unlike private equity) has access to grant which reduces the rental (as it would fall under regulated rents in accordance with the Rent Standard[5]).

With the above information it is reasonable to observe that the yields are relatively high for the risks the investors bear and consequently it is unlikely to be financially sustainable. The market approach would be to renegotiate rents at point of failure; however, that approach puts RPs at odds with our regulations and potentially can be a risk to our tenants as management time will be taken up in managing the renegotiation rather than the welfare of our tenants.

How can we make exempt rent sustainable?

We believe there are 2 main options to address the issue if we are not to increase the charges to tenants:

Option 1

The RP earns a margin on rent to manage the various risks it is supposed to manage. As service charges cannot include profit under Landlord & Tenant Act 1985 this can only be achieved through reducing the amount of core rent to the funds

The quantifying of a level of profit is a complex process and there is no certainty that it will be sufficient to entirely safeguard against failure in the future. Funds, understandably, do not want to forgo returns. The public quoted ones are further hampered by their offering to investors which are based on the acceptance of FRI for effectively management fee income. The alternative to reduction in returns to the funds would require a risk margin to protect the RP, however, that is not realistic given it would increase the cost of provision further.

Option 2

The leases are varied such that the risks are passported back to the funds who own the property. This relatively straightforward, requiring little change in the way of splitting income and better aligns the interest of the funds, RP to provide.

This would bring the returns of the funds in line with those of BTR investors.

There would be a complication for the funds as assessing the Net Asset Value (NAV) which is a key performance indicator for a property fund, will be more complicated.

While more complicated than current models we believe it would be possible as RPs currently value their own properties using a cash flow method through Existing Use Value – Social Housing (EUV-SH)[6]. We accept that estimating some maintenance costs and their recover would be difficult

Is it value for money?

We believe the conclusions of the “Funding supported housing for all”[7] report that SSH provision does deliver value for money and has a positive impact on people’s wellbeing when compared to the alternatives of placements within Registered Care Homes or Inpatient settings

Could it be better value for money?

This is a harder question to answer, and there are a few things in reaching a conclusion on value for money

a)      Cost of finance: Grant Funding vs Private Equity

Rent funded by Private Equity usually seeks an initial 5% yield indexed by CPI (usually capped at 4%). The government approach to measuring future benefits is based on the Green Book which has a discount rate of 3.5% which approximates to an initial indexed yield of less than 2.5%. In essence the introduction of grant would reduce the return required as it reduces the relative capital investment in the property (as it already does within traditional grant funded social housing). Grant is, after all, effectively the state paying to reduce future rents (this is true even in general needs housing).

There are a few challenges if this option were to be pursued, not least the fact that exempt rent is predicated on the basis there is no public investment in the property and that the potential recipients are not registered providers.

b)      Cost of delivery

Schemes for this client group tend to be smaller and therefore economies of scale achieved in providing residential accommodation for general population are not there. Consequently, even before considering any adaptations or design implications the cost of delivering homes that meet the exempt housing standards are higher.

c)       Funding availability

Exempt accommodation is not grant funded and therefore is usually funded through varying combinations of equity and debt. At the present time a significant amount of the funding is secured through managed funds (quoted and unquoted). This is primarily due to the inherent risks associated with the provision which include potentially significant void periods. This makes equity funding more appropriate than debt as the former is prepared to take greater risks than typical long term debt finance. Equity funding is typically more expensive than combinations of debt/grant reflecting the risk the equity providers are prepared to take.

1. Are there significant geographical and regional differences in the provision and the problems of exempt accommodation?

In our experience there are some differences in the approaches of various local authorities. The differences typically reflect how knowledgeable, informed and integrated a local authority is coupled with how good working relationships between commissioning and Housing Benefit (HB) are.

2. What is the proportion of exempt accommodation that is provided by registered compared to non-registered providers, and is an appropriate balance being struck?

As stated earlier our corporately we believe that all accommodation should be regulated either through the regulator of social housing

3. What is the proportion of exempt accommodation provided by commissioned compared to non-commissioned providers, and is an appropriate balance being struck?

We strongly believe that exempt accommodation should be commissioned only for the following reasons:

a)      Commissioning ensures that identified needs are met

b)      Commissioning involvement has a greater chance of ensuring quality provision

c)       Avoid speculative interest in properties which can distort local residential property markets adversely.

To commission services effectively it is important that future as well as current needs are identified as provision of new housing requires some lead in time, regardless of method of procurement.

As part of our planning, we carried out a survey of Commissioning authorities in 2020, using freedom of information requests, to establish future needs for specialised supported housing.

Overall, we had a good response rate (80%) though the quality and details of the responses were mixed. We asked about future needs over a 3-year period and 34 of the responding authorities were unable to provide a response.  48.5% cited the information was not held and a further 15.2% refused to respond on cost grounds, while more positively 30.3% did not respond as were developing their strategy and/or had just published their market engagement.

More troubling was the fact that 42 of the responding authorities were unable to provide numbers on properties needing mobility adaptations with a number indicating that they do not record such details outside of individual files.  This suggests a lack of forward planning on the part of some adult social services departments.

4. How does whether a provider is registered or non-registered, or commissioned or non-commissioned, impact the quality of provision?

We have no evidence to respond to this question

5. How should exempt accommodation be provided and what should the service cost?

We believe exempt accommodation should be commissioned and provided by regulated organisations based on a single set of rules that focus on the provision of quality accommodation.

What should a service cost?

We recognise the desire to have cost certainty for services, however, all services are not identical and a “one size fits all” approach is not appropriate. Our tenants’ needs should be at the focus of any solution as it is ultimately their needs that determine the cost of a service, over and above the core rent.

Rent & Service charges

The weekly charge to tenants can be broken down into 2 key elements

a)      The core lease cost of the property (plus insurance costs)

Core lease costs are covered in Section 2 above

b)      Service charges covering repairs, management, and utilities for a scheme

As we let using Assured Shorthold Tenancies we are governed by Landlord & Tenant Act 1985 which limits service charges to the recovery of reasonable costs. Consequently, the approach we have adopted has been to set a budget for initial year based on expected costs and modify subsequent years based on actual experience. This has meant that individual cost lines have increased/reduced as we gain experience with a property and its tenants.

Some of the costs will be driven by the needs of our tenants (e.g., hoist maintenance, etc.) and would not be standard within all the homes we manage, as well as the number of tenants sharing the cost.

We work with the relevant local HB department providing evidence to support any significant increase in cost as part of our submission (to avoid delays as HB departments would challenge those increase in any event). Operating, in essence, an open book approach.

We believe the current system of checks from HB departments is a robust system for challenging service charge costs

6. How should the regulatory oversight of exempt accommodation be organised?

We believe that a single regulator overseeing all exempt accommodation is the best way forward. We believe this would ensure the following could be achieved

1. Standardisation of regulations
2. Creation of a level playing field
3. Simplify funding routes for Local Authorities

7. What should be the regulations governing exempt accommodation and how should those regulations be enforced?

At the present time exempt accommodation is regulated through a few documents (HB guidance, Rent Standard, etc.). The application of these regulations is managed by different organisations (HB Department, Regulator of Social Housing) which can and has resulted in situations where 1 determines the property meets the criteria whereas the other states that it is not satisfied that the conditions have been met.

Consequently, we believe that the regulation governing exempt accommodation should be set out in a single set of regulations and governed through a single authoritative organisation to avoid the current position wherein two bodies governing the regulations can effectively contradict each other.

8. Is there sufficient publicly available information about exempt accommodation?

We do not believe that exempt accommodation is widely known much less fully understood, not just by the public but, based on our interaction with partner organisations, also by some of the participating organisations and investors.

A significant contributor to this is the current set of rules and regulations that apply to the exempt accommodation which have been built up over time. As a direct consequence there are several anomalies with Rent regulation, HB rules understanding and application which gives rise to confusion (i.e., HB are satisfied the accommodation is exempt, but the Regulator of Social Housing does not). This can be particularly difficult when discussing financial arrangements with investors who see/have seen HB departments, as the sole arbiters of rent exemption.

A single consistent set of rules, regulations and guidance which cover all forms of exempt accommodation would provide a better basis for ensuring exempt accommodation is

Misconceptions

a)      It’s all paid by the DWP via Housing Benefit.

There is a common misconception that SSH is fully funded by payments from DWP and indeed it is explicitly stated as such in the literature of some quoted funds. Even some of our care partners refer to the rent and charges as HB Rent. This view ignores the important element that it is in fact the tenants who are liable for rent and service charge and HB is only paid where those tenants are eligible for HB.

Currently over 1% of our tenants are not entitled to support from HB and consequently pay rent & service charge from their own funds. We would be surprised if other providers of SSH did not have some individuals who were in a similar situation.

b)      Service charge is a margin

Under Landlord & Tenant Act 1985 we are allowed to recover reasonable costs through the service charge and, rightly, need to justify increases or changes to those charges over time. Unfortunately, this is not fully understood by all partner organisations (and in some cases investors). While the Regulator of Social Housing has made the point publicly several times feedback from Care Providers and potential investors indicates this message has not been received by all relevant parties.

January 2022