As one of the leading institutional backers of UK housing, Legal & General has been an enthusiastic investor in everything from housebuilding to student accommodation. Now, the insurer is steadily plugging one important gap in its portfolio: social housing.
With little fanfare, over the past 18 months L&G has invested £500m in social and affordable housing, through five loans and one equity deal. The latest is a £25m, 40-year loan to Adactus Housing Group, to help fund that association’s developments.
A housing association and City institution may seem an unlikely pairing. The apparent incongruity is even more pronounced with Adactus as it is based in the North West – still off limits for many fund managers attracted to residential investment, but only in the prosperous South.
However, as Alex Gipson, lending manager at L&G, points out, housing associations should offer reliable income regardless of location and it is long-term, regulated and inflation-linked income. It may not grab the headlines but it is a good match for the liabilities of an insurance company.
“The robustness of the cash flow comes down to are they offering a product where there is demand? And 99% of the time if you deliver decent property across the UK you will have demand,” he says. “So the revenue stream, income-wise, is fairly secure.
“You can quite quickly pick up whether or not an organisation can deliver this efficiently. It isn’t about capital value but sustainability of income.”
L&G is not alone in coveting such income. Last month M&G Investments also ventured north when it provided £40m to One Vision Housing in a 30-year private placement that will allow the Merseyside association to refinance its existing bank debt and fulfill its development ambitions.
In July, Aviva Commercial Finance announced its first social housing deal with a 25-year, £67m loan to fund the Sapphire Extra Care consortium’s construction and maintenance of 390 homes in Stoke. This hybrid social housing and healthcare deal, part of Aviva’s £4bn PFI loan book, offers a “fantastic match for our long-term annuities,” says new business origination manager Zoe Slater.
Aviva is expected to confirm a similar deal in Hull this autumn and is considering funding pure social housing, following approaches from several associations.
City institutions are no strangers to social housing, but their exposure has been largely indirect, via the bond markets, as housing associations have sought new funding to compensate for a sharp fall in grants and bank debt in the past five years.
With the advent of direct lending to social housing by alternative debt providers such as L&G, M&G and Aviva, the sector’s financial backdrop is changing significantly.
According to the Homes and Communities Agency (HCA), which regulates housing associations – or RPs (registered providers) – traditional bank funding still represents 78% of total agreed facilities. The main bank lenders here are Barclays, Lloyds, Nationwide, Royal Bank of Scotland and Santander.
The capital markets, including private placements, contributed 41% of the new funding in Q1 2014 and 52% of the £5.6bn of new facilities in the year to March 2014. M&G alone has invested a total of £4bn in UK social housing through property deals, public bonds and private placements.
Places for People, which with more than 140,000 social and affordable properties owned or under management is the UK’s largest housing association, issued the sector’s first bond in the early 1990s. Today, says Finance director Simran Soin, bondholders account for most of the association’s £1.8bn debt. Barely a third of it lies with banks.
Shift to bond market financing
Soin says: “Increased activity in the bond markets from the sector in the past few years is largely on the back of refinancing. As lines of bank debt come up for refinancing the overall balance of debt is slowly moving into the bond markets.
“Banks are definitely no longer giving 20-to 30-year debt to the sector, but they are happy to give shorter, three-to five-year facilities.”
He adds: “Our preferred model, which we’ve had for 10 years, is that the banks fund the shorter end of the curve between three and five years, which we use to build the assets. Once they are built we use them as collateral to move into the bond markets at both the medium and longer end of the curve. That system works extremely well and will continue, certainly for us and, I suspect through a lack of choice, the rest of the sector will have to move to this as well.”
Even small RPs are benefiting from the bond markets by banding together through Housing Finance Corporation subsidiary Affordable Housing Finance (AHF), which makes loans to RPs. These are funded by issuing government-guaranteed bonds and borrowing from the European Investment Bank. AHF’s latest bond, issued in May, was three times over-subscribed and included investors new to the sector.
The £208m raised will be distributed among 13 housing association borrowers.
Equally significant is the credit spread for the 28-year bond: at 0.37% over gilts it is believed to be the tightest priced public bond transaction in the sector’s 26-year history of accessing private finance.
This is just another example of how the sector’s capital structure “is changing quite dramatically”, says Michael Leslie, a director of consultant JC Rathbone Associates (JCRA), which advises associations.
“The sector remains attractive to senior debt and institutional investors. But what’s really changed is that you see the volume of institutional money come in to plug some of this legacy, long-dated senior debt, and to plug the reduction in grant,” he says.
“There is serious competition and very attractive pricing from senior debt providers if you look for a five-year facility. When you push that senior debt facility beyond 10 years there is less appetite, less capability.
“But the problem is that the sector is not starting with a clean slate. Going from longdated senior debt and grants to institutional money, shorter-term senior debt and grants can be a painful process, as much long-dated senior debt was at historically cheap margins and often is subject to long-dated interest rate hedging in the form of fixed rates.”
Leslie adds: “I see the sector evolving whereby every five years or so you submit your development plan, bid to the HCA and fund it through your revolving bank facility, then you flip those assets to an institutional structure.”
Dangers in diversification
There have been other sources of pain. Successive governments have encouraged RPs to expand beyond social housing, notably into the private rented sector or developing homes for open-market rent or sale, to compensate for reduced grants.
Two big RPs suffered as a result. The first big post-financial crisis casualty was Genesis Housing Association, which required a cash injection from the HCA after construction ground to a halt on a development site in Straford, East London.
More recently Cosmopolitan Housing Group came close to insolvency following rapid expansion of its core business, allied to diversification into student housing.
Genesis’ development was eventually finished and subject to a £125m, groundbreaking public rented sector sale-andleaseback deal with M&G in January last year. Two months later, Cosmopolitan averted catastrophe by being taken over by another RP, Sanctuary Group.
Fitch and Moody’s both believe the regulator can safeguard RPs’ assets while protecting the interests of tenants and taxpayers, following recommended regulatory improvements in a recent HCA-commissioned report on Cosmopolitan.
However, the two ratings agencies remain cautious about the sector, given the potential impact on income from the government’s introduction of welfare reform and universal credit, as well as the increased business risks from expanding beyond social housing.
None of these issues appears to trouble investors unduly, although L&G’s Alex Gipson points out: “Mistakes get made when associations move into new areas … we do kick the tyres quite a bit more than would be typical in a public [bond] issue.”
One of L&G’s borrowers is Thames Valley Housing (TVH), which has enjoyed conspicuous success from diversification with Fizzy Living, its private rented sector offshoot. Earlier this year TVH secured a remarkable £200m of equity for Fizzy from Abu Dhabi Investment Authority and the duo are in the final stages of negotiating a similar amount of debt. TVH finance director Jack Stephen says the shortlist of prospective lenders includes two US institutions and two German banks.
Big hitters show interest
Stephen suggests that such big hitters demonstrate “real interest in the private rented sector”, but he adds that the fledgling Fizzy helped raise TVH’s profile in the City with government, and among its peers, leading to commercial joint ventures in social and affordable housing development.
Stephen also argues that this broader income base has softened the impact of welfare reform on RPs: “The worry has always been that your rent arrears would go up. But the [financial] year just finished was the best year we’ve had for rent arrears for about eight years – they have gone down.”
Fizzy was conceived as a way to generate new revenues to plough back into social housing, which remains the priority. This year, L&G agreed a £40m, 25-year loan to TVH that will help it to develop 500 homes.
The need for capital is unlikely to ease up. Stephen says that over the next five years the group plans to build 500 new social housing units a year and a further 1,000 a year of other housing tenures. Such is the pace of development, Stephen says, that TVH aims to raise a further £200m – probably through a bond issue – to finance its programme.
Right now, TVH is odds on to secure its funding. As Stephen remarks: “How many quoted companies would you actually take a bet on for 25 years?With housing associations, the assets will always be there.” ■