Although its detonation may have been brought forward by the present costs of remediating substandard construction and the prospective costs of decarbonisation, the incapacity of housing associations to build more is accurately described as a time bomb by Paul Hackett, chief executive of Southern Housing (“Housing groups warn they ‘can’t build’ homes”, Report, April 4).
The components of detonation are simple. The initial yield from sub-market letting is lower than the level of nominal interest rates. Funding this investment at a nominal interest rate, as housing associations mostly do, produces an initial deficit which must be covered by surpluses from older lettings. Since there is a finite supply of these, the coverage, and consequently new investment, will eventually cease.
Mitigation has been sought in profits from other activities, so importing other risks. Most common is the development of housing for open market sale, even if abating the social effects of excessive land values by resort to those values may look like Alcoholics Anonymous supporting itself from the profits of a pub. Wider diversification has occasionally ended in disaster.
Decades ago the problem was appropriately named the “front-end problem” because rents, being closely correlated to the general price level, might eventually rise. Government intervened. Local authorities received a revenue grant, reducing as rents rose. Housing associations received a capital grant, recovered out of 100 per cent of inflationary surpluses.
From the late 1980s housing associations were allowed to retain inflationary surpluses. Recognising the front-end problem, the 1987 housing white paper recommended the use of index-linked borrowings to maximise development by better matching anticipated rental flows. In the event housing associations have mostly chosen fixed interest rates to fund their variable flows, so creating an uncapped basis risk, which, as is now implicitly acknowledged, was “laid off” on the unhoused.
Someone must take the risk in exchange for the reward of future rental growth. It could be the government, as under the old arrangements.
It could be investors with an appetite for index-linked investments. It could be a mixture.
The solution should not be an infusion of grants into the current structure, which would be unfair to the generality of taxpayers. Defusing the “time bomb” requires non-trivial interventions.
May the travails of some water companies be a warning.
George Lemos
Capital Finance Strategies
London EC1, UK
