Shamez Alibhai, head of community housing and managing director at Man Group, explains how to maximise affordable housing investment as more capital flows into the sector.
Recent years have seen more institutional investment flow into the UK affordable housing market. It’s not hard to see why: the sector is characterised by its potential for stable, long-dated income streams, alignment with inflation rates, and robust demand that has not waned even amid economic turmoil.
Notably, affordable housing has maintained its outperformance through the two last major economic shocks – the global financial crisis and the period marked by Covid-19 and rising inflation.
In addition to the financial merits, affordable housing investment can deliver on investors’ ESG ambitions and offers a genuine opportunity to make a positive contribution to society.
That said, while it’s an attractive prospect and as more capital is ready to flow into the sector, investors need to be aware of a number of key issues which should allow them to address the key failings in the UK housing market whilst delivering a better return profile.
1. The complexities of additionality
The UK planning system currently requires developers to build a number of affordable homes in addition to market sale homes, colloquially referred to as s106 homes. The number and tenures of s106 homes (e.g., social rent, affordable rent, shared ownership) are heavily negotiated, with developers incentivised to reduce the number of s106 homes and skew the mix towards shared ownership.
On average, 25,000 s106 homes are delivered annually – a long way short of the 150,000 affordable homes that are needed every year. Historically, these s106 homes have been sold by developers to local not-for-profit housing associations.
The entry of private investors into this space has introduced new dynamics. They have begun to compete with housing associations for s106 homes, which naturally drives up prices and benefits developers at the expense of housing associations.
A more impactful strategy to increase the net supply of affordable housing is to focus on converting new-build private market housing into new build affordable homes, thereby increasing the net supply of affordable homes.
This approach necessitates more active asset management but leads to a more meaningful contribution to addressing the shortage of affordable housing. For investors, asking what percentage of a portfolio is truly additional, i.e., not s106 homes, informs how much impact your capital is delivering.
In the long term, we believe investors will benefit from better asset valuations for holding assets with a lower carbon footprint
Shamez Alibhai, Man Group
2. The imperative of energy efficiency
The UK housing market has failed to deliver improvements in operational and embedded carbon efficiency. Existing progress has most often been driven by regulatory changes versus a proactive approach.
We believe this approach has a negative effect on both residents and investors. The lower cost of maintaining a more energy-efficient home is a clear benefit to tenants, reducing bills, financial stresses, and promoting a longer tenancy.
For investors, the improved position for tenants translates into reduced losses due to lower tenant arrears and higher incomes as void rates fall. In the long term, we believe investors will also benefit from better asset valuations for holding assets with a lower carbon footprint.
According to our calculations, investing in EPC A housing requires an additional £10,000-15,000 of investment. This is equivalent to a 5% increase in build costs. Ignoring the potential for higher long term cash flows, capital values would need to increase by approximately 2-3% to offset the higher upfront capital costs. This investment in energy efficiency, although presently a small premium, should future-proof properties against regulatory changes and shifting market preferences whilst improving the quality of returns.
3. The value of quality
The quality of a home matters equally for residents and investors. When acquiring new build stock, involvement at the earliest stages is critical. For example, following the heightened focus on fire safety, it is exceptionally difficult to ensure proper fire safety control measures have been enacted once the walls have been plastered.
For example, on issues of fire safety, best practice is to ensure that there is an external independent fire inspector who has taken a digital record (including pictures) of all fire stopping measures and has a record of identified issues and remedies.
For residents, build quality (e.g., soundproofing of walls, fewer defects, better thermal insulation) translates into a better lived experience, and fewer tenancy management issues. These observations should translate to greater income, all things being equal, over the long term.
For investors, understanding when and how managers get involved in the build process will provide better insight into the quality of the development. This will also make divestment of the portfolio easier and mitigates the risk of stranded assets.
Conclusion
While the investment case for affordable housing is compelling, it is important for investors to engage deeply with the intricacies of the sector. By considering additionality, energy efficiency, and quality, investors can ensure their contributions have a positive social impact while also securing financial returns.
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