Creative financing – the answer to social housing development?

Whilst traditional financing models, such as capital market transactions and aggregator lending, are still possible and remain important, they are often undertaken out of necessity. To fill the gap in lending, it’s time for cash-strapped providers to consider alternative financing methods.

Barriers to better financing

Many privately run registered providers are already operating on wafer-thin margins in a climate of growing costs, high interest rates and mounting regulatory pressures. Many are struggling to undertake much-needed maintenance and sustainability improvements to their properties and recent caps on rent have reduced their capacity to boost revenue and slowed new development activity.

The situation has been compounded by the requirement that providers must retain a minimum of 18 months’ liquidity. To comply with this, some are entering into loan facilities they don’t require despite providers having to incur all related fees, including commitment fees. Bank loans are becoming less attractive generally, largely due to the use of strict interest cover covenants based on EBITDA-MRI.

Such covenants make it more difficult to invest in major repair work, disincentivising providers from going ahead with much-needed retrofit programmes to upgrade properties and improve their sustainability. Whilst covenants can be amended, this process can be time-consuming and costly.

Local authorities with social housing stock are also facing significant financial and regulatory pressures. Their funding has been decreasing over the last thirteen years or so amid the rising cost of temporary accommodation and lengthy housing lists. To worsen matters, raising finance from the Public Works Loan Board for capital projects is costly, and the Treasury is not encouraging councils to make use of the cross-subsidy financing model.

What alternative financing models are available to providers?

Among the alternative financing options available to providers are sustainability-linked or green loans. Both offer lower margins than traditional bank loans, with some providing a financial incentive for investing in low-carbon technologies, as long as specific KPIs are met. The caveat accompanying these loans is that the covenants applied can be complex to navigate and the incentives offered are typically small.

The cross-subsidy financial model is also available, however, the relatively slow housing market makes it less appealing than it was four or five years ago when it was easier to achieve a healthy profit margin from the sale of newly built properties.

Other sources of finance include Government grants, such as the Government’s Social Housing Decarbonisation Fund. However, the level of funding available is insufficient to fund the significant financial demands of decarbonising housing stock.

Solutions for the future

For providers to remain viable and secure the finance needed for social housing development, more Government input is required to incentivise investment and increase housing demand. For example, the Treasury might consider introducing new fiscal incentives for investors and consumers looking for affordable, sustainable housing.

A paper published by the UK Sustainable Investment and Finance Association proposes a number of ideas to encourage the delivery of low-carbon social housing, based on the following existing models:

• A model in the Netherlands where providers pay for energy-saving work on their properties through the savings they make after the improvements have been made.
• A US programme where the Federal Housing Administration incentivises lenders to offer cheaper mortgages for low-carbon homes.
• Certain US states and agencies offer tax incentives to investors to invest in housing to rent to lower-income housing.

Greater collaboration between providers, energy companies, investors and infrastructure contractors could prove transformational, offering providers an innovative financing model based on ‘payment-by-results’. This would involve restructuring how energy costs are paid for and developing energy performance contracts based on sustainability KPIs.

Contractors would install energy-saving improvements to save energy costs and pay the contractor once the savings have been made. With this model, providers would pay for retrofitting through savings made in their energy costs.

Key takeaways

Undoubtedly, a long-term solution is needed to resolve the financing challenges that many providers are facing. Whilst this will likely require Government intervention, here is a summary of actions providers can take to strengthen their position:

• Consider alternative financing models – could they alleviate current pressures?
• Increase collaboration with investors, energy companies and infrastructure contractors.
• Consider restructuring how energy costs are paid. Is there room for improvement?

For more information, contact Jon Coane.