21 April 2015

Stephen Williams, Equity Analyst at Brewin Dolphin

We believe that the problem is not one of demand but of supply. We would like to see the new Government post the May General Election take the following to help boost supply:

  1. Speed up the planning process by repopulating the planning departments that have been decimated due to local authority austerity measures.
  2. Require local authorities to list all the brownfield sites within their boundaries and to provide a five-year action plan to develop them.
  3. Encourage local builders to develop these brownfield sites by not requiring them to pay for the land until the development is sold.
  4. Develop diverse private sector financing initiatives.
  5. Encourage the private rental sector including local housing companies.
  6. Restore the funding programme of the Homes & Communities Agency (HCA).
  7. Leave housing associations alone to manage their businesses and allow them to charge an economic rent.
  8. Waive stamp duty for older people looking to downsize to retirement homes as a way of bringing more properties to the market.
  9. Increase rates and council taxes for second homes and introduce incentives for second homes to be sold to local citizens (e.g. a CGT amnesty or reduction to 10% if property owned more than 10 years).

All major political parties agree that the UK needs around 240,000 new homes per annum to avert an "emerging housing nightmare". This is seen as an acceptable level of annual supply required to tackle the "chronic" housing shortage as social concerns rise up their list of priorities.

There are now 1.7m households on the waiting lists for affordable homes across England. In addition, the Confederation Of British industry (CBI) and the British Chambers of Commerce (BCC) are also concerned about the implications for the competitiveness of British industry as the high cost of moving home and the lack of affordable housing are barriers to attracting and retaining employees.

The Problem
Despite a spate of initiatives, the pace of housebuilding remains constrained with only 150,000 homes started in the past 12 months, of which the private sector is currently building around 100,000 per annum - and that was a post credit-crunch high. There is a significant gap to be bridged as the rate of housebuilding has significantly lagged the rate of household formation in the UK.



Building more homes for social rent is vital if the crisis is to be tackled but the real problem lies in the lack of public housing being built. For the last 30 years there has been over-reliance on the private sector to meet the UK's housing needs. Council house building has been in decline since Right-to-Buy and since 1993 there have been virtually no public homes built. Compare this with 1955 when around 300,000 homes were built in England, of which two-thirds were public housing. In 2013 42,800 affordable homes (including shared ownership) were supplied, a reduction of 26% over the previous year partly due to the funding programme of the Homes & Communities Agency (HCA) that is tapering off. The programme is currently £4.5bn per annum (having been £8.4bn).

Demand and Supply
Demand for homes has been accelerating not only due to the increase in household formation but also due to government initiatives (Funding for Lending and Help-to-Buy) and historically low interest rates. With supply constrained, the cost of buying a home is still rising. House prices are rising faster than salaries and are now too high for the average buyer - the IMF says UK house price to income ratio is 30% above the long-term average. Relative to rents, the margin is even wider at 40%. What started in London, driven by inward investment, has now rippled out to the regions.

The supply of new homes should be coming from local authorities. The government has vowed to sell enough land to build 100,000 homes but its efforts have been slow. Local authorities cannot afford to build them as they are subject to budgetary and other constraints. Not-for-profit housing associations are trying to make up some of the shortfall in affordable housing but their output is also limited by government-imposed constraints in local authority borrowing capacity.

There has been an over-reliance to date on the private sector to meet the UK's housing needs. But, on current volume expectations, the top 8 housebuilders are expected to supply only around 65,500 units in 2015, rising to perhaps 72,500 by 2018. In order to meet the forecast requirements for housing by this date, double this number would be required to be supplied by smaller private housebuilders. However this is not happening for the following reasons:

How the gap can be filled?
In aggregate, the private sector is set to increase the supply of new homes to 167,000 per annum by 2018 (+8% per annum over the next five years). This is good but the total still falls far short of the number needed to meet government targets. The shortfall in supply is expected to be between 60,000 and 120,000 between 2014 and 2018 with the majority of the underbuild is expected to be in the South East and London.

The government currently underpins around 35% of private housebuilding through the Help-to-Buy (H2B) initiative and the affordable homes purchase programme. Not-for-profit housing associations strive to make up the shortfall in affordable, especially rented, accommodation but their output is limited by government-imposed constraints in local authority borrowing capacity. Councils have proved in the past that, if they are given the powers, then they can build at scale.

There is a strong case for municipalities to take the lead in encouraging residential development including acquiring land and making it available to developers. At the beginning of June 2014 the Chancellor announced that councils would be required to create pre-approved planning permissions (Local Development Orders) on derelict sites in towns and cities. This could provide up to 200,000 permissions by 2020. In addition, 20 new housing zones on this brownfield land in London will benefit from £400m of funding from the government and the Greater London Authority. There will be £200m of additional government funding available for 10 zones outside London.

Who are the potential providers?
The Housing Revenue Account reforms in April 2012 allow local authorities to use revenue streams to invest in social housing and borrow on top. Historically there was 100% grant funding from the government whereas now it is only 15% with 85% to come from the private sector and their own resources.

Housebuilding public/private partnerships

These would seem to be an answer to the housing shortfall. These are far less capital intensive than the private housing model and should be less sensitive to the housing cycle. Given that the next downturn in the private housebuilding cycle is still very much in the forefront of management thinking such partnerships can produce a return on capital employed of more than 15%, which is in line with the returns that can be enjoyed by the private housebuilders.

The Private Rental Sector (PRS)

New and existing housing that is let at full-market, unsubsidised rent by specialist providers, e.g. Essential Living, Fizzy Living and Hub Residential. Rather than building and selling homes on the market, these companies acquire sites, design and develop the properties and manage them for the long term as part of an income-focused rental business. The PRS in the UK is highly fragmented and currently dominated by small scale buy-to-let investors (78% of landlords own only a single property for rent). This is changing as the government's policy measures attempt to leverage institutional capital. First, the changes to the REIT regime in 2012 support the establishment of residential REITs, including abolition of the 2% entry charge and relaxing the diverse ownership requirement. Second, the Montague Review of 2012 led to the establishment of the PRS taskforce, the £1bn build-to-rent fund and a £10bn housing debt guarantee for developers of PRS stock.

Build-to Rent Funds/Investors

These are now beginning to appear. The residential property sector has not only delivered superior returns to the commercial property sectors, it has done so with materially lower volatility. The balance of risk and reward is attractive and it appeals to pension funds, life assurance companies and other investors.

Registered Providers (RP)

These include not-for-profit Housing Associations, Arms-Length Management Organisations (ALMOs) and specialist housing providers that are regulated by the HCA. There are 1,500 RPs with 2.7m homes (the largest 130 have 2.2m homes).

What are the problems facing housebuilders at present?


Planning consent

For more than three decades the UK has been building fewer new homes (per 10,000 inhabitants) than any other country in Europe. This is due to its having some of the most extreme land-use planning restrictions in the world. The shortage of land with planning consent remains the biggest obstacle to building the extra homes needed, especially in the South East.

The length of time and difficulty of getting planning permission is a massive brake on construction of new homes. This makes it very difficult for small housebuilders to thrive and for new companies to enter the industry as well as making small sites less viable. In addition, while banks are in principle more willing to lend to small housebuilders, in practice planning delays and construction times means that it can take two years from land purchase to the sale of the first homes, compared with loans of 12 months.

Public sector land supply

Last year the government reaffirmed Green Belt protection designed to limit the spread of cities, but pledged to facilitate consents to convert retail properties into homes. The idea of 'garden cities' should be dropped in favour of allowing new town extensions to be built steadily by taking "confident and well-planned bites out of protected greenbelt land" according to David Rudlin, the winner of the Wolfson Economics Prize in 2104.
The Community Infrastructure Levy enables local authorities to impose charges on new buildings to finance community infrastructure projects but this effectively imposes an extra tax on buyers of new homes. New towns such as Ebbsfleet (a former limestone quarry) require expensive transport links which we believe has hampered the development of the site to date.

Mortgage lending and funding

While the H2B mortgage guarantees have been extended to 2020 a change of government in 2015 could cause these to be revised. Given the long lead times on sites, housebuilders may be wary of scaling up production due to the political risk. Other political risk includes some of the Labour Party's housing policy proposals such as introducing three-year leases as standard (rather than six months), market-linking rent with a cap; and a ban on letting agents' fees.


-ENDS-

The value of investments can fall and you may get back less than you invested.
No investment is suitable in all cases and if you have any doubts as to an investment's suitability then you should contact us.
Past performance is not a guide to future performance.
The opinions expressed in this article are not necessarily the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd accepts liability for any direct or consequential loss arising from the use of this document or its contents.

For further information please contact the press office on 020 3201 3330

distributed by