Russell Harris QC explains how the delivery of housing association dwellings could be boosted at a stroke.
There’s a modern, planning “Catch 22” related to the way in which social housing is valued by lenders. It is resulting in many fewer affordable units being built by Housing Associations (HAs) than is appropriate. Its removal by Central Government would, at a stroke, result in the ability of HAs to build tens of thousands more social units across the UK.
This article explains how.
Back to the Catch 22. It’s a technical valuation issue. Stick with me!
In modern times, no Housing Association has defaulted on a loan in a way which has led to a mortgagee taking possession of premises which has secured that loan. Not one. Ever. The sector is very well regulated and Housing Associations assisted by Government tend to “watch each others backs.”. In short, the prospect of a mortgagee having to step into possession of a Housing Association property as a result of default to recover its loan is and has been shown to be vanishingly small.
But, notwithstanding these facts, a significant number of s 106 agreements are still structured in a way which pre-supposes, contrary to the evidence, that there is a real risk of default. As a result, and often I fear as a matter of political purity and to ensure that there properties remain and can be shown to remain in the social housing sector “in perpetuity”, many MiP clauses are drafted in a way which seeks to restrict rights of MiP to sell the premises on the open market in order to recover the value of their loan and costs.
This practice has the immediate effect of reducing the value of the relevant property as a Housing Association accounting asset. An unnecessarily restrictive mortgagee in possession clause as a result reduces significantly the amount that lender will/can lend against the asset.
Most Housing Association dwellings are built with the benefit of loan finance, with the amount that can be borrowed being driven by the value of the stock being provided as security. The most usual RICS basis for valuing affordable housing which is the subject of a restrictive MiP clause is to ascribe to it an “Existing Use Value as Social Housing”. (EUV-SH). Over recent years, the continued use of this valuation method, necessitated by over-restrictive and ideologically driven MiP clauses has resulted in HAs being less and less able to borrow sufficient sums of capital, meaning their ability to build more units has been reducing year on year.
There’s the Catch 22. In trying to secure MORE affordable housing and in removing or reducing the risk that it might not be secured IN PERPETUITY, some authorities are, in fact, undervaluing the stock HAs produce and are as a result producing many, many FEWER affordable units in the round.
The irony is that, if MiP clauses were made less restrictive, such that on any theoretical default, the MiP could sell wholly and entirely free of social housing requirements, then the value of all the assets charged would increase and as a matter of accounting principles could be valued at the much higher Existing Use Value -subject to tenancy (EUV-STT). This valuation would reflect the (notional) ability of a MiP to sell free of s 106 obligations beyond any existing tenancy. This position in turn would mean that HAs would be able to leverage much more capital out of its stock in development and in turn build very many more social units.
The equation is a simple one. The risk of losing units in perpetuity is ordinarily tiny, but the accounting benefit of potentially allowing for such a loss in theory results in a huge uplift in the numbers of social units that HAs can build. Put it another way, by seeking to ensure the political purity of “no risk” affordable housing in perpetuity, many, many fewer units of social housing are being built.
None of this is of course is rocket science and National Housing Federation set up a Securitisation Working Group in the mid 2010s made up of 12 representatives (including lenders, borrowers and valuers) to agree a consistent approach to the mortgagee protection clause within Section 106 Agreements to ensure that housing associations can achieve best possible funding value (EUV-STT) when securing loans against the assets.
In 2016 a “model clause” which sought to achieve these ends was produced for the sector.
Some enlightened authorities immediately understood the equation of “low-risk more units” and adopted the model clauses. But the roll out was not and is not substantial. Many authorities especially in London, in a misguided attempt to ensure that affordable housing stays affordable for ever are still insisting on MiP clauses that restrict and thus artificially undervalue HA stock.
In 2019, pre-pandemic, the GLA recognised the importance of this issue and also that its previous advice had resulted in the values being ascribed to HA product (and thus their ability to borrow) being artificially low. It issued (unusually for a strategic authority) very specific and detailed guidance on the drafting of s106 M-in-P clauses. Its urgent aim was to ensure that HA could in principle ensure that its newly delivered stock could be valued at the much higher EUV STT levels. See Mortgagee in Possession – Section 106 Standard Clauses Practice Note – 2019
In short, the guidance provides that in the event of a mortgagee taking possession of HA land, there should be a 3 month moratorium during which time the MIP cannot sell the property other than to another social housing provider (but at a rate which allows for the full or fullest recovery of its loan and costs). Once the moratorium is over, the MiP can, if no sale to another HA or registered provider has been effected, in theory sell free of the s 106 obligations and, again in theory, at a market value ( as with all other market value assessments subject to tenancy). The document provides model wording (importantly agreed with lenders) which ensures that the enhanced valuation (EUV-STT) which flows from this ability will be achievable and will inevitably significantly increase the scale of borrowing and as a result the number and proportion of affordable housing units which are capable of being built in the Capital. The use of the model wording is not an absolute requirement and there may be circumstances where it is inappropriate. But there really ought to be good reason for not allowing the HA to be able to value its new stock at EUV-STT.
The present Mayor is not known for being “soft” on the provision of affordable housing. So his decision to allow the notional ability for MiPs to take land free of affordable housing obligations (and the consequent hike in its valuation) must be examined carefully. So too should the five reasons which the Mayor gives for adopting this less politically absolutist position. That’s because the Mayoral reasons for taking this pragmatic position are in truth applicable throughout much of the UK. They are:
- A significantly higher need/target for the provision of affordable housing which is not coming close to being met and therefore needs action.
- A known shortfall in affordable housing funding which the adoption of the Mayoral clauses have the clear potential to increase significantly via the EUV-STT valuation.
- The strong monitoring of HAs provided by the Social Housing Regulator and the ability to intervene in the event of a HA in financial distress.
- Few examples of HAs falling into financial difficulties and where this has been the case they have been taken over by other HAs, and importantly;
- No known cases of MiP clauses ever being triggered in relation to assets owned by HAs.
As a result the Mayor has taken the view that any risk associated with HA defaulting on a loan and affordable housing not being secured “in perpetuity” is in truth, limited and is now significantly outweighed by the benefits associated with the five factors set out above.
Notwithstanding this guidance, several of the more left leaning London Councils are (even this month) refusing to adopt the guidance or its clauses in very large cases where hundreds of affordable units are at stake, relying on the proposition that affordable housing should always and only be affordable in perpetuity (whatever the cost). A number have already indicated that they propose to issue their own spg to restrict the use of the standard clauses soon. That is, in my opinion, short-sighted, politically inept and counter-productive.
The Mayoral approach is sensible, pragmatic and proportionate. It should be adopted nationwide forthwith. Central Government advice in the NPPF or PPG should be altered to support the use of a similar model set of model clauses and identify that this is the position that will be adopted (unless there is good reason not to) on appeal and following call-in. Safeguards and exceptions can be catered for as in the Mayoral guidance. But, at a stroke, the financial ability of most regulated HA to produce hundreds of thousands more affordable dwellings will be created.
At a time of national emergency and when there is a pressing need for recovery and more social housing such an easy win should be irresistible.