New money, new ideas: Part 3 – pay it forward
Could institutional forward funding be part of the answer to financing the development pipelines of Registered Providers at a time of capital constraint?
As traditional Registered Providers (RPs) continue to face a challenging financial landscape – including the prospect of a two-pronged squeeze on their business plans arising from the proposed rent cap on the one hand alongside increasing cash demands from building safety and energy efficiency works on the other – the search for additional sources of capital to fund their development pipeline has rarely been more pressing.
Some RPs have already sought to plug this funding gap by undertaking sales of tenanted stock portfolios, notably comprising shared ownership reversions, to for-profit RPs owned by institutional investors. This has released significant amounts of capital which can be immediately recycled into funding new developments alongside other expenditure priorities.
Yet, where tenanted stock disposals are not appropriate or desirable, there are other ways of more directly channelling such institutional funding into the development pipeline to enable traditional RPs to fulfil or even expand their development ambitions, even in a climate of financial uncertainty.
The easiest method is to secure a back-to-back forward purchase of the new affordable homes from the prospective investor (i.e. a "turnkey sale" arrangement), on the condition that the selling RP will take back a long term management agreement or management lease of the homes simultaneously with completion of the sale.
Here, the RP manages and funds the development itself, but has the contractual comfort of knowing that all costs will be immediately reimbursed upon practical completion of the scheme, which is when the homes are transferred to the investor for a pre-agreed price. The sales risk in relation to the shared ownership element can also be transferred to the investor, further delivering an immediate cash injection into the RP's business. No consultation is required as there are no tenants at the point of the sale completion.
This is most easily done where the RP already owns the site and is directly procuring the construction of the scheme, so that the full range of collateral warranties can be offered to the investor (as is customarily required in the context of institutional funding). Moreover, the investor's preferred specification and any other bespoke requirements could be worked into the procurement of the construction supply chain.
But even where the RP is itself acquiring the homes from a housebuilder or developer on a turnkey basis (for example, as part of a Section 106 package), if adequate terms can be negotiated with the housebuilder, then a similar warranty and handover package could be offered to the investor as part of the onward forward sale.
If the scheme is particularly large or if cash reserves are particularly constrained, it may be possible for the RP to structure such onward sales on a forward-funded basis, where the investor acquires and pays for the land at an early stage (typically at "Golden Brick" level) and then also pays for the construction costs throughout the remainder of the build programme. This would effectively mirror the familiar Golden Brick acquisitions which RPs have been entering into for many years, as RPs have sought to leverage their relatively lower cost of capital to secure better pricing terms with housebuilders.
Such forward-funded sales would have the dual benefit of securing the investment at an early stage, whilst also requiring the investor to cashflow the development costs – something which may become increasingly attractive to RPs facing a sudden tightening of surpluses.
Meanwhile, the RP performs the development management role (albeit on behalf of the investor rather than for itself) which would enable the RP to maintain its working relationships with key housebuilder or developer partners, leverage the expertise of its existing development team, and also potentially charge a development management fee to the investor. Since the RP would likely retain some repairs and maintenance risk as part of the future management arrangements, its interests in ensuring that the homes are built to the right quality would be aligned with the interests of the investor.
Whilst RPs have in the past shied away from alternative approaches to financing their development pipeline, now might be the time for them to start considering institutional forward funding as a way of securing their development pipelines and ensuring that new affordable homes continue to be delivered in line with programmes in spite of the reduction in available reserves.