A worsening cost-of-living crisis is adding urgency to the UK’s burgeoning market for social-impact housing investments. Maha Khan Phillips reports

The average energy performance certificate rating for a house in the UK is D

The average energy performance certificate rating for a house in the UK is D

Even before factoring in the impact of the cost-of-living crisis, the need for social and affordable housing in the UK was substantial. There were 1.2m households on social waiting lists in March 2022 in England alone, according to analysis conducted by Legal & General and the British Property Federation. The National Housing Federation and Crisis estimates that 145,000 affordable homes are needed each year – compared with the 52,000 delivered in 2020-21 in England – requiring an additional £34bn (€39bn) in capital funding per year. In 2022 there were nearly 100,000 households in temporary accommodation, twice the number from the previous decade. 

“There’s a housing crisis in the UK,” says Gemma Bourne, managing director at Big Society Capital, the impact investor. “You’ve got this huge demand for social and affordable housing, and the cost-of-living crisis is going to make demand increase even more. The latest figures suggest that 8.5m people need decent and affordable homes.”

Macroeconomic factors are exacerbating the situation. “High levels of inflation will add additional pressures to an affordable housing sector which is already strained,” says Mike Adefuye, research manager at LGIM Real Assets. “Inflation will lead to increased costs for many housing associations at a time when income through rental growth cannot fully compensate for the rise – both due to the government’s rent cap and also considerations from housing associations with regards to their tenants’ welfare from other cost-of-living concerns.”

In November, the UK government confirmed it would introduce a one-year 7% rent ceiling in 2023-24. This sets an upper limit on the maximum amount that providers of social housing can increase rents by and has been brought forward in response to the inflation-driven cost-of-living crisis that is severely impacting residents, according to the government.

“It’s been good to have some guidance on social housing rent caps,” says Nikki Howard, associate, private markets at Bfinance. “Not only is there pressure to put rents up, but it’s happening at the same time when tenants are being squeezed on energy.”

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Andrew Davey: “the investor set has grown exponentially off the back of institutional demand for solutions in this area, but there is a recognition that companies want to be seen as offering solutions that could add impact”

Rising energy bills and the need to meet net-zero decarbonisation targets are also significant issues, say industry participants. “The assets in the home need to be energy efficient and [we] need to think about net-zero energy efficiency,” says Bourne. “The time has passed when homes could either be socially affordable housing, or energy efficient. They need to be both because there is real pressure on individuals and tenants.”

The scope of the challenge is significant; the average energy performance certificate (EPC) rating for a house in the UK – including social, private-rented and owner-occupied – is D. “The UK, as a whole, has fairly inefficient housing,” says Ben Fry, head of housing at Gresham House. “But what you see in newer accommodation is that the EPC average is a B or potentially higher.” 

The government requires all affordable housing to be upgraded to a minimum EPC level of band C by 2030. This means that 44% of the sector needs to be improved over the next decade, according to the Legal & General/BPF study. Elsewhere, Savills estimates that an additional long-term capital requirement of £50bn will be needed for retrofitting existing stock for decarbonisation. 

“Reaching net zero is a big challenge for the sector, with housing associations grappling with a wide range of property types, including pre-fabricated, post-WW2 concrete homes which need to be knocked down and rebuilt, to homes which require alternative heating solutions and renewable-energy technology to meet new standards,” says Jack Burnham, head of affordable housing at Octopus Real Estate.

Howard points out that asset managers can play a critical role. “When we talk about energy efficiency, what we are seeing is that managers that have more expertise in terms of real estate development and energy-efficient standards can really help housing associations. Energy efficiency is at the top of asset managers’ agendas. They are very passionate about trying to get their EPC down to [C or better],” she says.

Adefuye agrees: “Given a more constrained financial and macroeconomic environment, and relatively limited funding from central government, more partnership between the private and public sector will be required to meet our enduring affordable housing needs. Take the need for retrofitting in the sector, for instance. Estimates suggest it would cost £104bn to bring social housing homes to the EPC C standard required by 2030. This surpasses available government funding for retrofitting,” he says. 

Decarbonisation challenges are not putting institutional investors off the asset class, however. Data from Big Society Capital’s annual study of market size of the sector found that equity investment had risen from £350m in 2016 to £3.8bn in 2021. Social and affordable housing now accounts for the largest segment of the £7.9bn social-impact market, standing at 48%.

Michael Adefuye

Michael Adefuye: “inflation will lead to increased costs for many housing associations at a time when income through rental growth cannot fully compensate for the rise”

In fact, institutional investor interest in the asset class has never been higher, nor has manager attention. “There has been quite a quick evolution of institutional capital over the last 12 to 18 months,” says Andrew Davey, head of liability-aware strategies at CBRE Investment Management. “When we were pitching for opportunities to invest institutional capital, we were probably up against three parties last year or the year before. Now we’re up against 30.”

For investors, affordable housing holds clear attractions, offering both long-term income and capital growth. Investors typically target a net internal rate of return of between 5% and 10% over a fund’s life, with target distributions of 3.5% to 5% per year, according to Big Society Capital. Returns are long-dated, stable, inflation-linked and lowly correlated with other real estate income, because rents are set by government policy, which typically tracks the Consumer Price index (CPI). Moreover, annualised growth and volatility from 1998 to 2019 show that social housing rents experienced growth and much lower levels of volatility than other real estate sectors, according to Big Society Capital. 

Investors also want to do the right thing and asset managers are keen to oblige. “The investor set has grown exponentially off the back of institutional demand for solutions in this area, but there is a recognition that companies want to be seen as offering solutions that could add impact,” says Davey.

Burnham believes that investor interest has the potential to change the sector in a few ways. “The actual methods used by institutions to assess whether or not to invest in an asset, compared to those of housing associations, are different. Unlike some investors, there are some housing associations who may not look for capital payback for many decades and can justify this approach, given their social and charitable purpose,” he says.

Burnham points out that there is a “real compatibility between long-dated patient capital and the traditional operators in the sector, because many of their objectives are aligned”.

Still, affordable housing is a complicated asset class with a myriad of operational, development, and other risks, such as counterparty, void, policy and resale. It also encompasses a range of different types of assets – for example, across the discounted/affordable private-rental sector, multi-tenure social and affordable housing, and supported housing areas. 

“There are definitely a lot of definitions of what constitutes an affordable housing product,” says Davey. “When an investor decides to invest they need to be clear about what solution the investment manager is trying to solve, but also whether their requirements are aligned, and whether the manager will be able to solve it.” 

The cost-of-living crisis and rising inflation has particularly put development risk in stark view. “At the moment, development risk is a big challenge for the sector,” says Burnham. “Both material inflation and labour shortages are impacting the sector’s ability to build new homes. And whilst we are seeing a good volume of suitable deals on the market, rising construction costs make developing new homes in the medium term a challenge, particularly when combined with the rising cost of finance.”

Howard argues that asset managers can play a critical role here. “A key expertise that asset managers can bring, as opposed to housing associations, right now is understanding what materials cost. Even if a manager isn’t doing a development strategy, just having a couple of individuals who have deep expertise just to understand what the costs are is important,” she says.

Fry points out that investors have a duty of care if they allocate to affordable housing. “Investors need to understand the regulatory position, and what exactly they are investing in,” he says.

“If you are investing in people’s homes, you are having the biggest single impact in terms of their wellbeing and mental and physical health. People have to be mindful of that and get things right from the start, in terms of finding the right types of investments, the right types of managers with the right types of checks and balances, to make sure things are being picked up.”