In recent years, social housing has become an increasingly important component of our sustainable funds. However, it is crucial to find the right way to invest in the sector, in a manner which respects the strong social benefits that it provides.
Even if you get this ‘right’, there is no free lunch in buying social housing corporate bonds as not all housing associations are equal. With increased focus on the sector, and despite significant issuance, we are seeing early signs that some investors are buying indiscriminately due to the high ratings and social label status, while ignoring latent balance sheet risks due to some issuers’ overemphasis on property sales. This highlights why we believe that a thorough and well-resourced bottom-up approach to active sustainable investing will ultimately deliver the best returns for clients.
Laying the groundwork
Social housing is often used as a catch-all term for housing offered at a discount to market rent, including council-owned properties. This includes general purpose properties that are let at a discount to provide a more affordable home and more secure tenancy to individuals and families, as well as more specialist accommodation for senior citizens or those with particular care requirements. As housing charity Shelter England puts it, social housing “gives social renters better rights, more control over their homes, and the chance to put down roots.”
The provision of affordable homes is a clear social benefit, and one which makes the sector attractive for our funds. The sector’s approach to its own environmental, social and governance (ESG) obligations has also been maturing. Royal London Asset Management fed into the consultation for, and became an early adopter of, the first set of industry-wide standards on sustainability reporting and we are encouraged by the numbers of social housing associations that are taking them up.
More than window dressing
The production of standard data should help investors to better compare the relative ESG performance of different social housing borrowers. Increasingly, however, our analysis is driven by more than an assessment of operational policies and practices (such as how they treat tenant complaints, appropriate and fair management of any rental arrears, and building safety), preferring to make a more holistic assessment of what each association offers.
For example, we aim to scrutinise the future development pipelines that our bonds are funding to assess how much is being put towards badly needed general purpose social housing, as opposed to homes for market rent or shared ownership. In time, we would expect leading associations to be providing investors with more information on how their developments are helping to meet genuine local need in their areas.
There are two major ways in which investors can get exposure to the social housing sector. The first, and our preferred method for our sustainable funds, is to buy bonds issued by registered not-for-profit housing associations. This is one of the most ‘impactful’ elements of our portfolio as, while many businesses we invest in have a positive impact, here much of the lending we provide is going directly into the construction of new social housing properties.
In addition, the social benefit is not just on a ‘use of proceeds’ basis as is the case with most labelled green, social or sustainable bonds. The income paid on the bonds comes from social rents, thereby ensuring that our lending remains focused on social provision rather than general income from a wider business that may have other activities, as is the case with most labelled bonds.
Elizabeth Froude, CEO of Platform Housing Group, suggested in a 2020 essay that 80-90% of the costs of building new social housing need to be raised from investors. When we buy newly issued bonds, both those issued directly by associations and through ‘aggregators’ such as The Housing Finance Corporation who lend on to smaller associations with less access to external funding, that lending helps associations to build the homes which their regions need. In addition, although less directly impactful (as the funds have already been raised), we will also purchase bonds in the secondary market from these associations.
Lending in this way also fits neatly into our longstanding credit philosophy, which targets inefficiencies in markets, including the undervaluation of secured debt. Our exposure to the sector is largely secured on pools of social housing, with most deals offering security over housing collateral that is at least 1.05 times the amount lent at debt issue, but there are also some older deals that offer as much as 3 to 5 times the collateral. Spreads remain attractive for a sector that has a zero historical default and provides good downside protection.
A more recent trend is for investors to take equity stakes in social housing properties through a real estate investment trust (REIT), although this is an option that we’ve chosen to avoid in recent years.
Having previously held one REIT (Civitas) in our sustainable funds, we rescreened the company at the end of 2018 and chose to exclude it, after assessing several similar REITs and deeming those unsuitable. In our view, this sort of investing can undermine the sustainability case associated with social housing.
First, when the investment trusts acquire the properties, there is limited evidence that the funding this provides is then used to finance the construction of new social housing. Secondly, when we carried out our analysis, our assessment of the underlying tenants at Civitas and other REITs raised further red flags.
At the time, nearly a third of its tenant base (as measured by net asset value) could be linked to housing association community interest companies controlled by two individuals. They also separately controlled the providers of the underlying care services at those properties, along with property sourcing firms. Another large tenant was separately judged poorly by the Regulator of Social Housing due to conflict-of-interest arrangements and poor evidence of health and safety compliance. And, at another REIT, we found evidence that care operators were not giving patients proper nutritional care at some properties.
Finally, analysis of other companies in the sector uncovered a range of controversial related-party transactions, where the investment adviser to the trust was acquiring properties from businesses owned by the adviser themselves, effectively sitting on both sides of the transaction. The care group would then lease the properties back from the trust, with the advisers continuing to have an interest in the care group. In our view, these transactions raise the risks of conflicts of interest and suggest poor corporate governance practices. As reporting by The Sunday Times has highlighted, similar conflicts of interest were also recently uncovered at Civitas.
While we’re open to diverse methods of financing to help to boost the quantity and quality of social housing, our analysis suggested a clear gap between lending to well-governed, high quality institutions in the corporate bond market and the weaker sustainability case associated with equity-based REITS focused on social housing assets. Although the whole sector looks superficially attractive for sustainability focused funds, in our view, how and where you invest can make a real difference.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the authors at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.
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