The banking crisis and government cuts have left some housing associations short of long-term finance. Pension funds might be able to fill the gap
Inflation is very much the watchword at the moment. The Consumer Prices Index is running uncomfortably high and commodity prices are on a charge. For pension funds and insurance companies, this is increasingly worrying; it just isn’t that easy to get hold of simple assets that provide inflation protection. The conventional route is through the index-linked gilt market, but the 30-year gilt now pays a real yield of just 0.8%, prompting investors to look elsewhere.
And while some are struggling to find suitable investments, others are struggling to find suitable investors. The financial crisis has not been kind to the UK’s social housing sector. Last month’s Public Finance interview with Waqar Ahmed, the group finance director of L&Q housing association, outlined a number of challenges the sector now faces. Borrowing has become harder and the government cuts are only adding insult to injury.
However, pension funds and social housing providers could help solve each other’s problems.
Housing associations are the directly regulated not-for-profit entities that provide and manage social housing. Almost 10% of all the UK’s housing is social housing and the largest providers manage and own tens of thousands of properties, which they offer for rent at below market rates.
In the past decade or so, 85% of all housing association funding came from just five banks. However, as the regulatory framework has changed, it has become less attractive for banks to offer and hold long-term loans. Consequently, they are far less willing to offer the 30–40 year borrowing terms required by housing providers.
By contrast, pension funds are natural providers of just such long-term finance, and so their interests align very conveniently with these social housing builders. What’s more, the lending is low risk. Housing associations have long-term tenants providing strong and predictable rental income, much of which is provided directly to the landlord from housing benefit. Furthermore, almost all lending to the sector is secured, so an investor essentially has a first mortgage over particular residential properties.
It is also beneficial that the sector is regulated very effectively, with particular focus on financial stability. If a housing association has had any difficulties, the regulator has acted quickly and decisively to protect tenants and stakeholders. To date, no lender has ever made a loss.
Having said all this, the safety and long-term aspects of investing in social housing are only part of the story. To go back to where I started, the social housing sector has a natural link to inflation. The rents on the properties rise, in general, by a little more than inflation. For pension funds looking for inflation protection, then what better match than the inflation-linked rents of housing associations, which also happen to offer significantly higher returns than the gilt market?
But will government cuts harm the attractiveness of the investment? Ministers have stressed that the focus on the economic stability of social housing providers will remain and the cuts in grants will take funding back to 2006/08 levels, when a significant amount of building still took place. There is a clear political consensus that we need new houses and landlords will still need to borrow.
So, ultimately, while the news is significant, it does not change the fact that housing is looking for a new source of finance and offers predictable, secure cash flows with a natural link to inflation. Housing providers and pension funds make a pretty good team.
Bernard Abrahamsen is head of institutional sales and distribution for M&G Investments’ Fixed-Income business.
