Labour’s promise of delivering 1.5m homes necessitates using housing associations. Credit analyst Richard Taylor and portfolio manager James Briggs from Janus Henderson’s Global Credit Team discuss how this has changed the prospects for the sector.
An undersupplied market
The UK housing market has been undersupplied for decades. A decline in housing starts has been driven almost exclusively by subdued social housing activity – which now makes up 20% of housing starts. Housing associations, rather than local councils are the primary delivery mechanism.. From the 1950s to 1980s, this was around 50%,[1] although this must be viewed against a different economic climate characterised by lower home ownership (versus renting).
Housing associations were public bodies at that time, but they are now privatised. The government is core to the financial and credit profile of housing associations as well as their operational risk. What has changed is the funding supplied by central government (Figure 1).
Figure 1: Housing association gross investment expenditure, including private finance, in England
Source: Chartered Institute of Housing, 2024 UK Housing Review, DLUHC local authority level capital expenditure and receipts, Homes England annual report, National Audit Office (2022) Affordable Homes Programme since 2015 and authors’ estimates of private finance, indicative only, 2024.
Labour’s promise
Given this reliance on social housing, political infrastructure is a key determinant in meeting housing targets. While the Conservative government has had much to contend, it is hard to argue that housing was a top priority despite the launch of the Affordable Housing programme in 2016. The UK has had 16 housing ministers since 2013, which has been an obstacle to long-term housing policies and funding. The new Labour government has made housing a priority, targeting 1.5 million new homes over the next five years.
Doing more with less
So how has punchy housing targets and the absence of sufficient funding impacted housing associations? They have increased balance sheet debt (resulting in higher loan-to-value – LTV – rates and lower interest coverage (ICR ratios), plus public debt issuance. This materially eroded their financial and credit metrics as margins have been squeezed, affecting free cashflow (FCF) and culminating in credit rating downgrades.
Additionally, business risk has increased as they cross-subsidise funding social housing starts with proceeds from market-facing activity, such as housing development. There has been an accompanying reduction in SHL (social housing lettings) income, with the sector average on a downward trajectory over 2019 to 2023, according to Janus Henderson estimates.
Nevertheless, lower rental income has also depressed housing budgets and the ability to buy sites for development. This pressure has coupled with costs to meet higher building standards from a safety and decarbonisation standpoint. We have seen the cost of fire remediation work result in rating downgrades for housing association credits.
Changing fundamentals
A government that has prioritises housing and more generous funding should reduce pressure on housing associations’ business risk profiles, balance sheets and FCF margins. LTV and ICR metrics are set to improve from additional funding and as development sales roll in. Such ‘generous’ funding does not necessarily translate into more funds, rather subsidising more of the new build cost.
Instead, money earmarked for social housing has actually been returned to government as housing association grant applications have declined due to them covering so little of the total building costs – and therefore risk.
More than a social factor
We believe that providing affordable and sustainable housing is a core function of a western government. Outsourcing funding for house buildingcreates moral hazard and is arguably not practical. The interest rate environment and progressive cuts in government funding discussed earlier have raised legitimate concerns around the ability of housing associations to meet demands for greater, greener supply. We believe supporting housing associations in their engagement with the government is important. Their role goes beyond providing affordable accommodation to other functions such as helping to reskill unemployed people and debt management.
Dispersion to increase
Housing associations can play a pivotal role in solving the UK housing crisis in our view, offering investors the opportunity to benefit from improving credit fundamentals alongside a positive ESG story. Housing associations typically haven’t defaulted in the past as the government has stepped in to encourage the takeover of distressed entities. But as we have seen with local councils, implied support is not an explicit guarantee. With Labour’s new homes target in focus, this could pressure business models and separate stronger companies from the weaker companies. This is why taking an active investment approach, with focused credit research, makes sense. Given the better prospects, we are dialling up our risk within the HA sector in the investment grade space. We are focused on names with high social housing lettings (SHL) exposure, solid ICR, operating surplus and FCF, as dispersion in the sector is set to increase.
[1] Source: Berenberg, 4 June 2024.