House Funding Model

Why the current funding model for house building is failing to provide enough affordable or social housing or housing in general

In theory, this should be a fairly simple question. With house prices rising and a lack of supply surely developers and house builders should be falling over themselves to build more homes and so increase their profits. The market should see the shortage in new homes being built as an opportunity to meet this demand by increasing the supply.

To try and understand why this does not happen and why we have this severe imbalance between supply and demand. We first need to identify the primary builders of new homes and their motivations and funding model.

We are facing a severe housing shortage due to several factors the following of which a just some of them:

  • Longer life expectancy and better health has led to people living longer and so remaining in their homes longer
  • Greater immigration has led to a more rapid expansion in the overall population at an accelerated rate
  • A lack of suitable housing for the increased retired population
  • The increase in the number of single person households
  • After 2008 the increased difficulty in young people (25-35) being able to get a mortgage due to the more stringent rules
  • Due to a long period of low interest rates and poor investment returns an increase in domestic buy to let

As identified above, the main builder of new homes in the UK are primarily private developers and the big housebuilders (i.e. Barratts, Berkley Homes, Redrow etc) they account for 70% of new homes built in the period 2010 - 2015. Housing associations then account for 30 % of new homes built in the period 2010 - 2015. However, due to the changes in the way housing associations are now funded they should be seen in all but name as private developers. This is because, to be able to provide any social or affordable housing they need to cross subsidise any development by selling at market rate a large percentage of any housing they build. Therefore, before a housing association begins any development they need to assess its’ viability and profitability in the same way as a commercial housebuilder.

This means, that the vast majority of all house building in the UK is based on the same financial model of short term profitability and viability rather housing need and affordability. There is nothing wrong with this for the private sector, as these companies are commercial organisations and need to make returns on capital and profits to survive. This goes a long way to explaining why so few homes are being built when demand is so high. It shows that in excess of 85 % of homes being built are subject to these commercial realities.

The other major problem leading to homes being in short supply especially in urban and metropolitan areas is who is buying the homes which are being built. As a direct result of the way in which most developers and developments are funded, before work can begin a developer needs to attain a certain level of off-plan pre-sales. This can be anything from 20-50% of the whole development. It is only when a certain level of pre-sales has been achieved that the construction funding becomes available for the development to go ahead. The chief executives of all the major housebuilders have confirmed this and it is no secret.

This brings us on to the question of who are these advance buyers. Traditionally, these off plan buyers fall into two main categories, domestic buy to let purchasers and overseas investors. Whilst the domestic buy to let investor will make the property available to rent commercially, the overseas investor rarely does. This is because they have a very different reason for investing in UK property.

Due to increasing global instability both financial and political UK property is seen as a safe haven asset class with the added benefit of capital appreciation. This coupled with a long period of low interest rates and poor investment returns globally has led to the increase of domestic buy to let and foreign investment in UK urban and metropolitan housing. This has helped exacerbate the housing shortage.

For this reason, many new housing developments are marketed overseas to foreign investors on roadshows and conferences and in this way almost 50% are pre sold overseas. In most instances, these homes will never be available to rent domestically but will be held as an asset class. Once again, there is nothing wrong in this way of doing business for a commercial developer, it is in fact a prudent way of doing business. The problem is it does not help add to the UK housing stock.

This may be all about to change with the new tax changes announced by the Chancellor in his last two mini budgets. The rise in stamp duty for second homes will hit the buy to let investor, this coupled with the abolition of tax relief for interest payments will make most buy to let unviable. The tax penalties for corporate entities buying residential property and the way in which capital gains tax of overseas owners of UK property is to be treated will make property a less attractive investment for overseas buyers.

In theory, this should be good news as it will mean more property made being available to the domestic market. However, this may not be the effect that actually happens which is what the government was hoping for. Once again, as posited by many of the chief executives of the major housebuilders and other industry leaders, these measures could lead to a decrease in the number of new homes being built due to the way housebuilding is funded. The reason behind this is that the funding model of the house builders and developers, without pre sales the developments cannot go ahead. This will be an unintended consequence and could lead to less development of in particular lower value schemes as high values schemes will always find investors willing to invest.

In many ways, all the government schemes to date, such as help to buy and rent to buy whilst they have allowed people to buy their own home have also helped developers to use these schemes to pre fund and pre sell the homes they haven’t already done so to investors.  With a severe drop in the number of investors advance buying plots on proposed new developments, it is unlikely that owner occupiers will be able to bridge this gap and so they are less likely to go ahead. Owner occupiers are still finding it very difficult to access mortgage finance, this is in part due to the new more stringent lending rules, but also due to the need for a much larger deposit.

These factors combined, will inevitably lead to a decrease in new house building due to the way in which developers and house builders are funded and in particular how construction finance is structured.

A new financial model

It is clear, that to provide a sufficient number of new homes for both sale and rent at an affordable level means we need a new financial model. This is where the Community Trust Partnership is just such a model. It is based on using institutional long term funding (25-35 years) to provide multi tenure housing in urban and metropolitan areas and is ideal for urban extensions, local authority regeneration projects and estate refurbishment and regeneration.

The Community Trust Partnership model brings in funding and the expertise to provide mass housing for first time buyers and renters. It allows for affordable rents for key workers such as, nurses, care workers, police, fire and ambulance staff, junior civil servants and local authority employees, trainees and apprentices.

There is little point in building new infrastructure such as schools, hospitals and other social infrastructure if the people needed to run these services cannot afford to live nearby or within a reasonable commute. One of the key factors behind an inability to retain key personnel such as nurses and care workers in the health sector and teachers in the education sector is that there is no affordable housing within a reasonable commute. Imagine how much easier schools and hospitals would find it to recruit and retain junior staff if they were guaranteed affordable housing in the area.  

This model opens up a whole new way for local authorities to look at regeneration schemes and projects. As an example where there is a major estate regeneration to be undertaken this is an ideal way to implement it. The Community Trust Partnership (CTP) does not need to allocate the majority of the housing for private sale or for property investors. Instead in consultation with the local authority and local interest groups the mix of tenures can be tailored to the specific needs of the region. In this way, the stock of housing can accommodate what is required so there can be a balance between homes for rent of all tenures and sale in proportion to needs of the community and not the financial imperative of the developer. This allows for housing for first time renters and also for retirement housing to be provided in conjunction with starter and family homes for sale and rent.

The CTP also allows for the provision of the relevant social infrastructure such as leisure, education, employment and medical facilities as part of the overall regeneration plan and not as an afterthought. This allows the CTP to work with the local community and the local authority in partnership. In this way, facilities can be provided for the whole demographic from primary schools for young families to care and extra care facilities for the elderly.

The alternative is what has happened on the Heygate Estate in Southwark where the old estate has been sold off to a private consortium. Whilst the whole area is being regenerated, of the 2,000 homes being built none will be for the local community. Of the houses being built only around 2% will be genuinely affordable the rest will be shared ownership and market rent. With prices for a one-bedroom flat being in excess of £600,000 even under the shared ownership scheme these are not affordable.  This is what happens under a developer led financial model and it is fine for providing homes for the open market, but it does not provide homes for the community. This way leads to social and financial cleansing of areas but there is an alternative and it is the CTP.