A tangled web?
Leasehold ownership structures have become more common, especially in the supported housing field. Why? And is this a good thing?
Traditionally (and very generally), if a housing association wanted to acquire housing, it bought the freehold. It might buy newly completed stock from a developer, or it might buy land and develop itself. (Or, in the case of flats, it might take under very long leases for individual flats.) But freehold was what you wanted. Everyone understands it, it is safe, it is secure and it is simple.
There has been a trend over recent years, however, of housing associations taking shorter leases of dwellings, particularly in supported housing. Why?
Actually, let's pause for a second. Before we get into the whys and wherefores, let's take a moment to look at the way a typical transaction of this type might be set up.
Under a typical lease structure the housing association becomes the funder's tenant, entering leases generally of something like ten or fifteen year terms. Sometimes, a second "reversionary" lease is granted at the same time, but to come into effect only on expiry of the first. This gives a longer overall term, while preventing the housing association from exercising statutory enfranchisement rights and buying the freehold.
The housing association pays a rent, which will typically be indexed, and then lets to tenants in the usual way.
Why do things this way?
There can be sound reasons to adopt this structure:
- It is a quick and easy way to acquire new stock. Leasing property means you do not need a lump of capital up front, just the ability to meet the rent payments.
- Although owning freehold property is simple, it brings with it all the incidents of ownership. You are responsible for everything. A housing association tenant under a shorter term lease may have lesser repairing obligations and so on. This can be an advantage to a smaller housing association, or one moving into a new geographical area.
- It is an easy way to get access to funding. There are a variety of new funders in the market, offering this model. Especially for smaller housing associations, it might feel easier than more traditional routes to funding, such as charging. And the newer funders are perceived to be a bit lighter on their feet, too.
- Having part of your portfolio based on an index linked rent can be part of a considered treasury strategy.
What's the downside?
You will be aware that the Social Housing Regulator expressed concern about the potential implications of this model for some of the housing associations that pursue it. These concerns have been well publicised since the beginning of 2018, particularly in the context of the rapidly expanding specialist supported housing sector.
So then, there are clearly several risks to the model which need to be understood and which can include:
- The rent risk is the housing association's. The rent under the lease to the funder falls due every month, and increases with inflation every year. This is, therefore, a risk if dwellings become void, which can be for reasons completely outside the housing association's control. What if there are housing benefit delays? Similarly, housing association tenants' rents are subject to a large extent to government policy. The sector thought it had a long term rent settlement, until Government announced an unexpected cut. There may be parallel rent support agreements or similar, but these are all risks that need to be considered by an housing association.
- Closely tied to the first point, is the inflation risk. What if an economic shock prompts a spike in inflation? If that were to happen, can you be confident that housing benefit levels would increase correspondingly? Probably not; in fact, quite the opposite. You could be stuck with rents under the lease increasing substantially each year, with rents you can charge tenants flat or falling. Equally, are you confident the benefit arrangement will match the duration of your new obligations?
- These transactions are more complicated than a small housing association looking to grow may be used to doing. It is vital officers and board have a full, clear picture of what they're signing up to, and important to take professional advice early and throughout. In particular, it is clearly really important to appraise the various risks in the model.
- The skills to manage a transaction like this, and then the stock under it, are different. The housing association may not have all of the burdens of freehold ownership, but this can mean the various landlord responsibilities are spread across two or more parties. It is more important than ever that you are clear where responsibility lies for things like fire safety.
So – good thing or bad thing?
Ultimately, and like any other legal structure, it is not inherently right or wrong. There are certainly advantages and drawbacks. As long as the groundwork is done, the risks understood, and prudent steps taken to minimise them, this can be a good way to acquire stock relatively cheaply and quickly. But it is also a model to which the Regulator is paying very close attention. The long term success of the model will depend on well advised housing associations who understand (and can manage) the risks inherited in the model, and the evolution of the lease structure that better allocates rent risk between the funder and housing associations.