Safe as houses?

Last year, I wrote about the risks for investors in housing association (HA) debt of the significant increase in housing development for outright sale that many HAs are undertaking.

This risk has recently come in to focus following the latest trading update from London & Quadrant (L&Q), one of the largest HAs in the UK with one of the most ambitious development plans. They are also one of the most prolific issuers of corporate bonds, with £2.3bn of public bonds outstanding, and maturities out to 2057. In what amounted to a profit warning, L&Q announced at the end of January that their expected surplus for the year ending March 2019 would be £150m lower than they had originally budgeted for (£190m vs £340m).

The majority of the blame was placed on weakness in the London housing market: “…the ongoing political and economic uncertainty continues to weigh on consumer sentiment, particularly in the London sales market where confidence remains a constraint and is contributing to downward pressure on pricing.” In simple terms, they are making less money from selling homes (both outright and via shared ownership schemes) than they thought they would. Indeed, L&Q’s net margin on all sales fell to 7% in the 3rd quarter, down from 16% in the same quarter of 2017.

It may well be that this is a short-lived phenomenon, and that post-Brexit consumer confidence returns with a bounce in sales and operating surplus. However, for us, these results re-affirm our view that the outlook for much of the sector is more uncertain than is reflected in current bond pricing. In general, we will continue to avoid those HA bond issuers with development plans that expose them to excessive outright sale risk.

That’s not to say that funding social housing isn’t a key focus for our Ethical range of funds. Indeed, we recently purchased a newly issued bond from Futures Housing Group, a smaller sized association (<10,000 homes) based in the East Midlands. Although it is increasing its development pipeline, the proportion earmarked for outright sale is very limited, with most of the development still focused on affordable housing. At a spread of close to 170bps over similar maturity gilts, the 2044 dated bond (rated A+ by S&P) offered a much more attractive risk/reward profile than many of the alternatives in the sector.

About the author

Iain Buckle is Head of Credit in the Fixed Income team. He has responsibility for credit analysis, particularly securitised and structured finance assets. Iain is the co-manager of several funds with a primary focus on sterling credit mandates. His funds include pooled and segregated mandates and included in our ethical bond franchise. As an experienced investment manager Iain is responsible for overseeing the institutional pooled and buy-and-hold portfolios managed across the team. Iain joined us in 2000 from Baillie Gifford where he was a fixed income analyst, and has 21 years’ industry experience. He studied Economics at Heriot Watt University*. 
*As at 30 November 2018.

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The affordable housing conundrum

The UK needs more affordable housing

Development of new council housing has fallen off a cliff over the last half century. Last year there were 1,155,285 households on local authorities’ housing waiting lists in England alone. Local authorities no longer have the resources to be significant developers of social housing and the burden now falls to private house builders, and, particularly for social housing, the Housing Association (HA) sector.

New homes built by private and social sectors in England

Source – Ministry of Housing, Communities and Local Government

HA’s have been somewhat reluctant participants in the development game; happy to cautiously grow their housing stock, but not picking up the slack from the dearth of council housing. In addition, government policy has, at times, not exactly been favourable towards the sector. However Theresa May seems to be more predisposed to the social housing sector. Recent proposals indicate rent levels will return to being linked to inflation in the coming years, and there has even been a return of government grants, albeit relatively small, to fund new social housing development. The quid-pro-quo for this friendlier relationship is that housing associations have to get out and build new affordable homes.

Many in the sector, especially the larger associations, have heard the call. They have responded with a spate of mergers designed to pool resources and flex balance sheets to launch ambitious development programmes. Some of this will be funded by government grants, but much of will come from debt raised by HA’s in the corporate bond market. Indeed, they have become some of the most prolific issuers of corporate bonds in the UK market in recent months. It’s rare if a week goes by that my colleagues and I don’t have a meeting with an HA looking to raise fresh bond market finance.

New development programmes often consist of a mix of “tenures”. Some new homes will be for traditional social housing, some will be for shared ownership schemes, and some will be for outright sale on the open market. The latter subsidises the former and is all very sensible and commendable. However, from a creditor’s point of view it introduces more risk. Developing homes for outright sale exposes them to potentially adverse movements in house prices, especially in volatile markets like London. This increase in risk has been reflected in a downward drift in the credit ratings of some of the larger corporate bond issuers in the sector. When I first started analysing the sector over a decade ago, the small number of issuers generally had very strong credit ratings – usually in the broad AA range. Today, there are still a few who can boast an AA rating but they are the exception rather than the rule, as the table below shows.

Part of these moves reflect the downgrade of the UK’s sovereign rating (to which HA ratings are linked) in recent years, but the increase in development risk has taken its toll on the credit rating of many an HA.

We have long been providers of finance to the housing association sector, often through our ethical fund range, where it will continue to be an area of focus. However, now, more than ever, we are being increasingly selective about where we invest in this sector. We see most value in those HA’s with a proven track record of development through different property cycles, and on those whose focus is on developing primarily social housing, without taking outright sale risk.

HA’s have a tricky path to navigate: developing new housing stock to keep policymakers happy whilst simultaneously maintaining good relations with bondholders on whom they rely for finance. The two aren’t mutually exclusive, but will provide a difficult challenge for management teams in the coming years.

About the author

Iain Buckle is an investment manager in the Fixed Income team with responsibility for credit analysis, particularly securitised and structured finance assets. Iain is the co-manager of several funds with a primary focus on sterling credit mandates. His funds include pooled and segregated mandates and included in our ethical bond franchise. As an experienced investment manager Iain is responsible for overseeing the institutional pooled and buy-and-hold portfolios managed across the team. Iain joined us in 2000 from Baillie Gifford where he was a fixed income analyst, and has 21 years’ industry experience*. He studied Economics at Heriot Watt University.

*As at 30 September 2018.

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Higher education, higher quality accommodation

Recent figures from the Office of National Statistics showed demand for UK goods and services continues to grow, with exports rising to £637bn in the year to August. A rise of 5.5% compared to the same time last year. One industry leading that charge is Higher Education. The UK is the second most popular location, behind the United States, for international students. We have some world class higher education institutions in the UK, which offer highly desirable courses to international students.  Of the more than 1.8 million full time student population in this country, 23% are from abroad. It is a key export sector for the UK economy. That’s not to say there isn’t strong demand from within the UK as well. Overall, demand for applications continues to outstrip available course places. On average over the last 6 years, demand for course places has outstripped available supply by over 35%. We expect demand for places to remain strong over the longer term with demographic trends implying a significant growth in the student age population from 2022 onwards.

Full time student applications continue to outstrip available places


Sources: UCAS, HESA, Unite estimates

Place of study for 4.5 million international students

Source: HESA,UNESCO, QS World University Rankings, NUS, Education at a Glance 2016, OECD

Providing good quality, affordable accommodation to students is vital to the ongoing success of the Higher Education sector. UK universities frequently cite their guarantee of accommodation to first year and international students as a key competitive point of differentiation. Moreover, students are increasingly opting for purpose built accommodation, which offers dedicated facilities like study rooms, high speed Wi-Fi, and 24/7 customer care. This has the benefit of freeing up the existing stock of housing for more general needs. However, financial constraints on many universities mean that they are building very little new accommodation themselves, preferring to spend their money on upgrading campus facilities like lecture halls, libraries, and laboratories.  The gap has been filled by the independent providers of student housing like Unite, who are the biggest in the UK with just under 50,000 beds. They let out accommodation both directly to individual students, but increasingly through “nomination” agreements with various universities. These agreements see the universities guarantee Unite, to a greater or lesser extent, that they will fill the rooms in their properties. For the universities this allows them to continue to attract students, and for Unite it provides a highly visible and recurring income stream, usually linked to the level of inflation.

Unite and Liberty Living, a privately held provider of student accommodation in UK with over 20,000 beds, are prime examples of companies which help provide long-term, sustainable solutions in an important industry, whilst also potentially offering attractive returns for investors.

About the author

Iain Buckle is an investment manager in the Fixed Income team with responsibility for credit analysis, particularly securitised and structured finance assets. Iain is the co-manager of several funds with a primary focus on sterling credit mandates. His funds include pooled and segregated mandates and included in our ethical bond franchise. As an experienced investment manager Iain is responsible for overseeing the institutional pooled and buy-and-hold portfolios managed across the team. Iain joined us in 2000 from Baillie Gifford where he was a fixed income analyst, and has 21 years’ industry experience (as at 30 September 2018). He studied Economics at Heriot Watt University.

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