Three innovators add a social flavour to recipe for resi REITs

Planned resi REITs aim to supply social housing and returns for investors, writes Doug Morrison

UK residential REITs have suffered many false dawns, but for their cheerleaders, the concept is still the Holy Grail for securing institutional funding into housing – and now social housing.

Places for People, law firm Winckworth Sherwood and new company Single Access Funding (SAF) are tempting fate (and government officials) by offering institutions something that private residential landlords have singularly failed to offer: large, attractive investment in housing via proposed REITs, without flouting REIT regulations that preclude boosting returns by trading assets.

This presents housing as a long-term income play at a time when, five years after REITs were introduced in the UK, the first residential REIT, whether public or private sector, has yet to materialise.

The impetus for the three groups’ housing REIT plans has only partly come from the  government’s recent consultation on social housing REITs, which ended in June, with the possibility of action this autumn.

The housing crisis and lengthening waiting lists for homes are heaping political pressure on the coalition, but a sharp drop in government grant is also forcing housing associations into an urgent quest to find new sources of funding.

“We need to fund new mechanisms for affordable and social housing to meet the unquestionable demand; the question is,  how do we go about doing it?” says Simran Soin, finance director at Places for People, one of the UK’s largest housing associations (see panel below).

Pragmatic approach required

He adds: “In the absence of grant funding,  as a sector, we need to take a very pragmatic approach and think of alternatives to how we can deliver new housing. We think this [REIT] is one of those alternatives.”

Winckworth Sherwood and SAF both claim they are pushing ahead with their REITs, which involve raising up to £500m each, regardless of the deliberations of the Treasury and Department for Communities and Local Government.

Those deliberations will be tough, not least in deciding how REIT reforms by the Treasury will treat the grants that currently sit on associations’ balance sheets.

Officials will also dwell on a bearish consultation submission from the British Property Federation, Investment Property Forum and RICS, which warns: “Govern-ment should not assume the additional capital REITs may attract into social housing will replace or make up for the expected reduction in grant funding.”

The industry bodies doubted that City investors would accept typical 4-5% social housing returns – and this is the central dilemma for the creation of social housing REITs. The stability of low-risk, low-return assets may have appealed to institutions in a series of bond issues over the past few years from the likes of Places for People, but would 4% be enough for equity investors?

“Institutions already achieve 4-5% on secured debt funding in the sector, but I’d be intrigued if they wanted to invest equity instead for a similar return,” says Soin. “Equity investors usually demand a higher rate of return than debt investors.”

The BPF submission says such REITs would be more palatable to investors if they held a mix of properties. Places for People has gone further by converting social housing to affordable housing in its proposed REIT, raising rents to promise a total 7% return. “Feedback from our merchant banks about what equity investors feel is an appropriate  return suggests around 7%,” says Soin.

He says this model would be limited to southern England, as there is little or no difference between social and affordable rents in many northern cities. Location aside, nothing prevents any of the association’s assets going into the REIT, including high- profile developments such as Brooklands in Milton Keynes.

Analogy with utility flotations

Winckworth Sherwood’s model (see panel below) is based on 4-5% returns and partner Keith Jenkins says it is more akin to the utility flotations of the 1990s, which pension funds regarded as safe, defensive invest-ments. The utility analogy, he claims, would help narrow the usual discount to net asset value afflicting commercial property REITs.

Barclays analyst James Martin believes the utility comparison is appropriate, since regulated water returns stand at 4.5%. He  also calculates that with rents being linked to inflation, at around 2.5%, and annual re-leveraging of the debt, prospective social housing returns could rise to 11%. This assumes acquisitions are at the properties’ book value, net of grants and depreciation.

“Will a massive sector emerge in the next 12 months? No, it’s not going to be that easy,” says Martin. “The government needs to encourage the [REIT] structure to take hold and to force some sort of amalgamation of  smaller housing associations.”

Meanwhile, Jenkins is convinced that the first social housing REIT will start trading before any private residential landlord gets its act together. He is optimistic about investor take-up for his January initial public offering. “We could probably find a home for £1bn-
£1.5bn,” he claims.

Places for People: housing giant takes AIM with 7% return target in its sights

Places for People is one of the UK’s biggest housing associations, with 62,000 properties. Financially it is one of the more innovative too, having tapped the bond markets for new sources of finance in the UK, US and Japan over the past two years.

The association has also been examining the pros and cons of the REIT structure, with the help of investment banks Rothschild and Morgan Stanley. The model it has devised involves transferring up to 5,000 properties, worth between £400m and £500m, into a REIT with the promise of total returns of 7%.

Such a REIT would not be so much social housing as affordable housing, rented out at 80% of market rents. That would be consistent with the coalition’s broader policy on affordable housing, says finance director Simran Soin, but would require a tweak of current REIT legislation.

“We need permission to increase rents on the properties we would transfer into the REIT, otherwise we’re not going to get the level of returns that would be attractive to investors,” he says.

If the government accepts Places for People’s affordable housing argument, Soin says the group would go for an initial public offering on AIM in two tranches, which would take at least a year to organise.

“You have to wait for properties to become empty and be transferred from one tenure type to another,” he adds. “I don’t think there is an ideal time [for an IPO]. Our point of view is that there is investor demand at the right level of return and a severe shortage of affordable and social housing. The quicker we move in this direction the better.”

SAF: a Housing Solution for tenants and investors?

SAF Housing Solutions is the REIT being planned by Huddersfield-based Single Access Funding, the company launched last year by social worker turned entrepreneur Phil Shanks.

SAF hopes to raise between £200m and £500m to invest in low-risk, social and extra care housing stock across the UK.

Shanks claims to have devised a blueprint for delivering “moderate and reliable” returns for investors while cutting rents to provide “affordable and sustainable housing for some of the UK’s most vulnerable citizens”. He adds: “It is not a tool for developers.”

Nor is it entirely in step with government thinking. Following the Budget, SAF Housing director Juliette Tarrant wrote to MPs to attack “the government’s U-turn on REIT support” and question the need “to consult on something that is already happening”. She wrote: “There is an urgent need to be met and further consultation will result in the injection of further unnecessary delays.”

SAF Housing appears to be pressing on regardless, although the REIT’s launch on AIM has slipped from July to autumn.

The group says it is already working with a number of local authorities and housing providers to build portfolios “with live stock and shovel-ready schemes, utilising interim finance in readiness for the REIT transfer”.

The bid to launch the first social housing REIT took a more credible turn this month with the appointment of accountancy firm Mazars. Leigh Wormald, Mazars’ head of real estate, says: “With a minimum 4% guaranteed return, SAF Housing REIT represents one of the most attractive and low-risk investment options in the market.”

This REIT, she adds, “demonstrates how institutions and entrepreneurs can actively contribute to broader society”.

 Winckworth Sherwood: aggregated REIT has a number of positive associations

Law firm Winckworth Sherwood is bringing together housing associations across south- east England with the aim of raising £500m through a listing on AIM.

The firm’s so-called aggregated REIT  will allow medium-sized and smaller associations to access new equity funding over a 40-year period, replacing traditional grant funding and long-term debt.

Returns will be indexed to social housing rents to keep landlord and investor liabilities matched. The associations will manage the homes for the 40 years, with ownership reverting to them at the end of the period.

Winckworth Sherwood partner Keith Jenkins says seven of his target of 10 associations have signed up so far, while prospective investors have shown interest in a REIT with suggested 4-5% returns.

The date for the AIM listing has slipped from October to next January, but Jenkins is confident that this will be the UK’s first social housing REIT. He says the flotation is, in effect, a private placing and describes the proposed REIT as an “equity-wrapped bond”. The REIT is being pitched to the City as a low-risk investment, more akin to a utility than a property company.

Jenkins adds: “We are getting associations to sell clean, 40-year income streams with upward-only rent reviews. The fundamentals of what we are doing are not essential to put into an equity wrapper, but we think it is better for the creation of that market, as it is better to have your eggs in several baskets, rather than dealing with one investor. You also stop it being treated as a property company, as it looks, talks and behaves like a utility.”