Lime Legal

What lies beneath

Published 24 July 2023

Housing associations’ global accounts may look rosy, but analysis reveals some worrying trends. By David Montague

At first glance, the headline figures in the 2017 global accounts of housing associations owning more than 1,000 properties appear to show a strong and viable sector.

Key highlights include an increase of 115,000 in properties owned or managed to 2.2 million, and a surplus before tax up 9 per cent to £270 million. The accounts also show an operating margin up by 0.3 per cent to 15.5 per cent, while gross interest cover (the surplus generated from lettings available to meet interest payments) is unchanged at 109 per cent. Gearing (the volume of borrowings compared with assets) has fallen one percentage point to 83 per cent.

But underneath the headlines, performance varies across regions, between traditional and stock transfer associations and by size of association.

A number of worrying trends are emerging: the surplus for traditional associations is down by 30 per cent in three years while the pressure on large associations is increasing. Their interest cover (excluding surplus on sales) is down from 107 to 92 per cent and gearing up from 51 to 59 per cent.

There is a mismatch between capacity and growth with 23 per cent of the sector’s surplus produced by associations of fewer than 2,500 homes. These associations delivered just 2 per cent of new dwellings. And while capacity exists in the south, there is none in the north. In the south, a surplus of £335 million contrasts with the north’s £64 million deficit.

Capitalisation of repairs expenditure is on the rise – more than £800 million repairs were treated as additions to fixed assets in the balance sheet rather than charged to the revenue account. And there is an increasing reliance on property sales, the surplus exceeding £500 million.

After adjusting for capitalising repairs and sales, the sector’s annual surplus of £270 million becomes a deficit of £1.1 billion. Overall capacity of the sector is negative – 53 per cent of associations report negative capacity.

Housing Corporation assessments (HCAs), suggest that many associations are making aggressive assumptions in their business plans to deliver continued growth and investment.

Taking the 2017 global accounts and HCAs as a starting point, we will need to keep a close eye on the dials in what is an uncertain economic environment.

It is true that some associations have unused financial capacity and it is their responsibility to use it wisely. But many don’t have extra capacity, and if we all set off in the same direction, some will come unstuck.

We all want to embrace the challenges of investing in growth and existing homes, services and communities. But the combination of reducing grant rates, capped rents and an uncertain environment is not the best incentive.

The easy way out might be to keep on pushing, capitalising more expenditure and selling more homes. But this inevitably leads to over-trading and normally ends in tears.

Many of the recent HCAs on viability refer to exposures that make the association liable to future deterioration. The most common reasons for qualified assessments are the result of ambitious development programmes, substantial future debt funding, or a reliance on high levels of shared-ownership sales to part-finance new development programmes.

Qualified assessments are also caused by a reliance on property disposals and capitalised repairs to meet loan covenants for many years into the future. Or they can be the result of optimistic assumptions regarding future efficiency savings, interest rates and maintenance cost inflation. The 2017 global accounts are not a sound basis upon which to build such risky assumptions. So, what’s the answer for those associations looking to invest in both growth and existing communities, but faced with fewer incentives to do so in an uncertain economic environment?

Some might call for greater regulatory intervention – and there is a case for immediate action for those living on borrowed time. But it is our responsibility to ensure that we adopt a sustainable approach to growth and service improvement. And that responsibility starts with a close look at viability.

Dependence on capitalisation and sales is not a sustainable answer to our investment needs. Instead, housing associations should set a target of eliminating capitalisation and sales dependence over a five-year period, moving back into core business viability and using the value created to deliver more homes and better communities.

There is much we can do ourselves. The big question all housing associations should be asking is: should we continue to act as independent associations or could we deliver more for by joining larger organisations?

Mergers may not yet be delivering the economies of scale they set out to deliver. But the potential is considerable and deliverable.

We should be prepared for more risk taking and risk sharing. Associations are perfectly poised to benefit from changes in housing markets. We have the potential to become both long-term property investors and short-term developers for sale. This means that we should be capable of adapting to changing market conditions, switching between tenures and locations to maintain viability and increase supply.

Along the way, we could use a little help from our friends. One move would be greater flexibility on rents. The differential between the rent on a one-bedroom and a five-bedroom home is as little as 25 per cent. This does not incentivise development of more family homes. A small increase in rents could lead to a large increase in housing supply of the right kind.

But we must retain discretion over our financial plans. Setting of new quality standards and direction of investment through new traffic lights may influence housing association boards and place at risk the value of our long-term income streams which are vital to raising new loans.

David Montague is chief executive of London & Quadrant Group