Affordable and social housing finance innovation - synthesis, reflection and implications for Scotland: international evidence

Framework for Analysis

A useful starting point for the evidence review is to recognise that affordable housing means low cost housing in the sense of construction and delivery, that is, at a below market price point, and if quality or service is not compromised (i.e. supplier cost expenditure is reduced) to achieve this and retain a normal rate of return, then somewhere in the housing supply system the difference between market and actual rent (in the case of rented housing) must be met by some form of state subsidy (directly or indirectly), alongside genuine cost or technology efficiencies, so that private interests can achieve a market return for the risk being borne. Working with Derek Ballantyne, Maclennan, et al (2019) recognised that there is a finite number and combinations of ways in which this can be achieved. What we term financial innovation is just a different way of assembling these possible fundamental options, as set out in Figure 1.

Source: Gibb, K (2019) in Maclennan, et al 2019 Shaping Future: Changing the Housing Story. See also Gibb (2018).

Plain text:

Four sources for reduced cost Affordable Housing

• Equity
• cash/operator surpluses
• capital grants
• investors/housing funds
• cash
• Land/density
• Location
• public contribution
• planning benefit
• asset re-use
• Construction costs
• built form
• construction
• in-kind contributions
• Financing
• low-cost funds
• extended amortization
• deferred capital/interest
• alternative capital sources

Each quadrant in Figure1 suggests one of the key building blocks: the injection of equity such as capital grants, but also provider surpluses (and which could be pooled as in the Netherlands or Denmark), or cash or investor funds; land/density relating to site amenity, public contributions of land, planning gain and asset re-use; construction costs can in principle be reduced by choices regarding built form and archetype, technologies such as MMC and off-site approaches (especially at scale e.g. standardisation increasing the speed of on-site works), as well as in-kind contributions reducing cost; and, financing through utilising low cost funds (perhaps linked to state guarantees), extended amortisation or deferred payments and alternative capital sources. This is far from an exhaustive list. Important additional specific elements include the potential use of revenue subsidy e.g. as historically was the case with council housing, balancing the Housing Revenue Account; subsidy in the form of tax concessions or tax credits; as well as demand-side subsidies to increase affordability for the consumer (the latter much debated: see Gibb and Stephens, 2024).

Ballantyne argues two further points (developed in Maclennan et al 2019, p.72): “First, he argues that the search for financial innovation… is probably not going to uncover radical new untapped opportunities. We know what is possible and that fundamentally the different stakeholders must co-operate around the irreducible fact that private sector participation, including construction interests, requires a given rate of return for the risk confronted…Inevitably, politics and current priorities determine the resources available but thereafter those resources need to be used effectively in whatever way they are co-ordinated... The second point is related - [all subsidy] elements …have public financing implications directly or indirectly. Scarce public resources must be well used where their impact is greatest. While governments may not always recognise the very existence of tax concessions, we can hardly support redistributive and progressive reforms to the housing sector that purport to increase efficiency if we do not at the same time recognise the continuing need to maximise public value for money.”

In an earlier paper, Hall and Gibb (2010, p.4) note:

“If we accept that, typically, new social housing will require an element of borrowing…., subsequent development, one way or another, will require borrowing capital and servicing the subsequent debt. This can operate through a series of models involving mortgage and other collateral debt (e.g. a charge on unencumbered assets), public sector loans and bond finance, but also, potentially, private equity and other partnership arrangements (e.g. Public Private Partnership arrangements with council housing or housing associations with private developers or local government, and this may but need not include planning agreements).

They continue:

Essentially, any funding package has to both allow development to take place and ensure that the repayment profile is affordable to the occupier and landlord in such a way that other related housing goals are met (e.g. provision for management, maintenance and major repairs as well as the servicing of debt). … One can think of the different generic models as alternative ways of matching the needs of the social housing provider with the financial interests of the ultimate lenders of funds”.

We see these fundamental diagnostic points nuanced in different but related ways elsewhere in the more recent grey literature e.g. Baum and Xiong (2019), Century and Parmer (2023), Octopus (2023) and Lloyds Banking Group (2024).

Baum and Xiong (2019) note that building sufficient homes, affordable and market sectors, will need skills, land and finance. They focus on the latter. Looking at affordable homes, specifically, they identify opportunities for institutional investment and within that for social investment and SEG possibilities. They note the low vacancy risk, strong regulation that lowers default risk, the supportive role of HB and the scope for long term index linked returns for debt-funding depending on rent settlements, etc. However, the main investor risk is ‘government interference’ (p.24). A key element for government will be to secure or guarantee the rent income stream.

Baum and Xiong also note that the Irish government set up in 2018 long term leaseholding agreements for social and affordable housing from the private sector (e.g. institutional investors). They argue that if the UK government[s] were willing to make these long-term affordable leases index linked and with suitable management and maintenance arrangements, this would be attractive to private capital as investor in new housing assets for this purpose (p.42).

Century and Parmar (2022) – identify the challenge as seen by investors and point to existing or imminent models possible to overcome such barriers. They stress the high levels of housing need but also the presence of important funding gaps for RSLs if they are to develop and meet this need. They note a lack of development capacity, urgent needs and political pressure to repair and make properties safe and also the requirement for long run decarbonisation investments. How might the gap be filled? Numerically, they identify a large increase in capital funding required i.e. £43bn a year equating to an affordable need of 145,000 affordable homes. They argue that capital funding for affordable homes can only come from three sources: debt (many HAs are at or close to existing borrowing limits); equity – not for profit HAs do not have the power to raise equity on their own balance sheets (and must be traded-off for other asset management objectives across the existing stock); and, subsidy – capital grant is at historic low levels and has been diluted into affordable products like LCHO [and search for cross subsidy e.g. from sales].

Going forward, Century and Parmar contend that the set of subsidy options available consist of: expanding the use of S106/S75; direct capital grant; tax concessions; debt guarantees; revenue subsidy; and, as discussed above, rent certainty. They conclude that institutional investment needs to be linked to for profit providers which could unlock affordable supply through the following models: Direct investment by institutionally owned For-Profit Registered Providers into new stock; development Joint Ventures with registered for-profit Housing Associations; existing stock acquisition partnerships between institutionally funded for profit Associations and non-profit Associations i.e. purchase of existing assets creates capital for investment by the housing association.

Octopus (2023) discuss English affordable housing need and finance possibilities in similar vein (though here focusing on not for profits working with institutional investment and government). Registered providers’ finances are under pressure: bond yields have risen increasing the cost of debt to registered providers while at the same time there has been a deterioration of interest cover, as well as rising interest rates and reduced credit quality. To solve this, the government, the HA registered providers and the investment sector have to work together, they need a stable rent settlement, new sources of debt such as equity partnerships, improved planning partnerships, new ways to fund decarbonisation and unfreezing LHA.

Finally, Lloyds Banking Group’s (2024) diagnosis stresses long term challenge and, critically, the imbalance between demand and supply subsidies in the UK (i.e. nearly 90% of housing subsidy is demand-side personal income related subsidy). They argue, like Octopus, that what is needed are new funding partnership models. They propose a specific solution: their social housing contract model, one which “would provide a payment to housing providers, additional to the rental payment, linked to homes being made available for social rent. This mechanism would increase the guaranteed revenue being paid providers of social housing, and, in so doing, increase the upfront private capital that can be raised to finance the development of new housing for social rent”. The idea is that payments under the Social Housing Contract are spread through time enabling a transition in subsidy from (demand) housing benefits to (supply) supporting the delivery of new housing while reducing upfront government borrowing.

Lloyds banking group further argue that, as the cost in HB for a social renting household is lower than for a household living in the private rented sector and if payments are set equivalent to average savings in housing benefits, then there would be no net additional cost to government for homes financed through the partnership. In effect, the rent differential would fund the building of more homes for social rent.

This is in a sense a return to revenue subsidy that effectively enhances the payment to debt finance based at the unit level on the average difference between HB payments in social and private renting (presumably the LHA for the PRS case) and is on the face of it, a clever way to start to modestly rebalance the supply subsidy-demand subsidy imbalance measured earlier. It is important to stress that these averages will vary hugely regionally, depending on the absolute level of LHA per property/size and also by average social rents; HB take up rates also vary considerably across tenure, and there is further pressure to establish a long term determination of rent change but now for both sectors – and there is considerable countervailing pressure to up the level of LHA support beyond the 30^th percentile (and to permanently end its freezing). So, it is not a simple comparison but something that is surely worth further investigation.

Implications for Scotland

• We should not expect to uncover radical financial innovations but may find that some reconfigurations of the Ballantyne quadrants in figure 1 are still on the table and may offer one of more positive contributions to support the financing of affordable supply in Scotland.
• Part of the answer may lie with the devolved application of the ideas suggested by Lloyd and Grayston in changing the fiscal rules, increasing flexibility for councils, reducing the scope for HM Treasury to intervene in and interfere with conventions like the rent settlement that are so important to private investment, and, also to adopt international accounting rules regarding public corporations’ debt and borrowing with particular respect to council housing borrowing. A political decision (for that is what it is) applied at the UK level would also operate in the devolved administrations as well.
• We do however need to be careful when applying English evidence to Scotland – in particular the focus on for-profit registered providers, which do not operate in Scotland. The Scottish Housing Regulator would need to take on this additional role and there would be considerable resistance from within the housing sector, and politically too, if such a development were to proceed^[6]. At the same time, however, there is social investment operating in Scotland to provide homes e.g. for charities who are not for profits but not registered as housing associations. Social investment has a track record but not much scale yet in the UK housing system (though the UK is in general a major player in social investment). At the same time, debt finance and joint venture arrangements as well as different leasing models either already are present or could readily be possible in the Scottish environment.