Proposals for a social housing REIT overestimate appetite for UK residential, says Shayla Walmsley.
Even before the fine print of the residential REIT regime has been worked out, the UK government has launched a consultation on social housing REITs aimed at attracting private sector capital to take over when public subsidies disappear in 2015.
Its consultation document makes a pretty strong case for REITs as an alternative to public bonds and bilateral agreements. Leases tend to be longer than in the private rental sector, which means voids are lower - fewer than 2% in England in 2010-11. Moreover, the government claims to have mitigated significantly lower rents than those available in the private rented sector with the introduction of 'affordable housing'. Recently introduced provisions include shared ownership, shared equity and a mid-way option between social and market housing that will allow landlords to charge tenants as much as 80% of local market rents.
Yet this blurring of the lines makes moot the point of a social housing REIT in the first place. "I don't know how easy or sensible it is to draw very clear lines between social housing, affordable housing and private rented housing," says British Property Federation (BPF) director of policy Peter Cosmetatos. "The UK housing market is a continuum."
Assuming investor appetite for social housing REITs, housing associations will have to go for it, too. The BPF, though broadly supportive of the residential REIT idea, pointed out in a recent submission that, so far, these regulated housing bodies have shown little interest.
There are a couple of outriders. SAF Housing Solutions, which has created the first social housing REIT (SAF REIT) ready for launch later this year, is targeting £500m (€611m) of institutional investment for 4,000 new social housing units. It is offering a return of 4%.
Although the firm vigorously opposed the REIT consultation exercise - which it described in a letter to members of parliament as "a U-turn on something that is already happening" - it has welcomed what it sees as a market-changing aggregated model for UK social housing.
"We need access to low-cost finance, and pension funds need access to a reliable source of income," says partner Phil Shanks. "It's a beautiful synergy."
The firm's objective is to pass on cost-savings to tenants in lower rents - effectively, to bring down the cost of housing. "We don't intend to be the only REIT in town," Shanks says. "We want others to copy us. I hope we get undercut. If someone else can do it better and cheaper, bring it on."
If existing housing associations convert into REITs, the advantage would be large portfolios with pricing that is not driven by the owner/occupier market. The problem is the potential for mismatch between the objectives of social housing landlords - to reinvest the surplus generated by rent in building more assets - and the commercial objectives of the REIT structure, which requires 90% of profits to be distributed as dividends.
A return would require sales - problematic because it is in housing associations' interests to keep and augment their portfolios and because the structure places a 30% cap on churn.
"My one concern is that these great financial minds might lose sight of the delivery side - that they'll get in the way of us operating a social housing provider," says Shanks.
One more structure
Even if the social housing REIT comes off, it will be just "another approach to investment - another structure", as Cosmetatos put it. "All this does is create another vehicle - a closed-end, tax-efficient structure with strong governance and liquidity via public listing."
But listing could be one of the problems for investors looking to avoid volatility. In the US, REITs are available both as listed and unlisted structures, with unlisted REITs making up 80-90% of the total.
"There is no reason it needs to be listed," says Winckworth Sherwood partner James Duncan. "For a social housing REIT involving registered social housing providers, the extra degree of oversight that listing provides is not necessary. The important thing here is that the returns are so low that any costs they can take out make it more worthwhile."
In any case, if the government proves amenable to industry submissions on listing requirements or any of the other issues raised, a residential REIT is unlikely to solve the fundamental market - rather than regulatory - problem. To focus on a REIT - social or otherwise - is to miss the point, says CBRE EMEA chief economist Peter Damesick.
"The market constraints won't be altered by the proposed changes to REIT rules," he says. "There are benefits to residential REITs - the removal of the confusion and flexibility over who can own them, for example. But whether they'll change the character of residential as an investment is a different question."
He adds: "The government will be disappointed if it thinks REIT legislation will change the character of the UK residential market. The problem is residential, rather than REITS."