The King is Dead

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17 February 2010

The King is Dead...

Prediction has long been a staple of the human condition and whether it is how many medals Team GB will score in Vancouver or an ancient Mayan apocalypse forecast for 2012, attempts to divine the future are all pervasive in any area of life which people find important. So with housing market and economic forecasting in overdrive - my current favourite forecast being the Sports Illustrated Indicator - it is definitely worth considering some of the fundamentals of the market in more detail and participating with some of our own future-casting. This week, in light of the SNP's recent revision of the right to buy policy, it seems a good time to consider the market fundamentals of New Home Supply.

New Build Supply

Since the 1950s there has been a stark shift in the way in which housing has been delivered, moving from the public to the private sector (see graph). This reliance has meant that since 2007 the supply of new homes being completed by the private sector in Scotland has fallen by almost half (46%) in 2009. This has also meant that the proportion of supply being provided by the private sector fell from 84% in 2007 to 71% in 2009.

The specifics of this supply drought can be seen in the downward moderation of council forecasts for residential supply in the Lothian's by almost 60% this year and 25% for 2010/11 and the equally stark constriction of Glasgow supply, down from peak by over 50%. The recent announcement of the Scottish Government's budget cut for Housing and Regeneration in 2010/11 by £178m from the previous year's allocation has raised understandable concern from the likes of the Scottish Federation of Housing Association. SFHA deputy chief executive Andrew Field warned that, "there is a danger that affordable house building, which has been bridging some of the gap created by the slump in private developments, will fall significantly - at a time when demand for homes, especially affordable homes, is extremely high."

This decline in delivery is unsurprising given the challenges being faced by the house building industry which has been exemplified by the number of high profile administrations that have hit the headlines in recent months, with Thomas Mitchell Homes sadly the latest in a long line this week. While only time will tell as to how and when these assets re-emerge into market circulation it is clear that if current circumstances and delivery models persist there is going to be a wider constraint on developable assets as land banks are managed, planning gains remain obstructive and funding issues for residential development all restrict the viability of development under the traditional model.

These new constraints therefore dictate a new approach - necessity being the mother of invention. With the traditional model of speculative development for sale and upfront payments for land & infrastructure no longer feasible there has been a spate of potential models being touted as viable replacements. The rise of proposals such as Tax Increment Financing (TIF) and the acknowledgement that many Section 75 agreements are currently making sites unviable are symptoms of the change in approach.

William Scarlett (0131 624 9041), Director of Land & Development at Rettie & Co. comments that, "in Edinburgh real progress has been made by the Housing Department to recognise that a more commercial interpretation of the Affordable Housing regulations is required. This has resulted in the refreshing approach to off-site affordable housing provided certain criteria are met."

Heir Apparent

So if the king is dead, who will be the victor in this succession struggle? In all reality rather than a new autocrat it is likely that a form of devolution will emerge with differing models winning success in different areas and sectors of the market depending on circumstances.

Currently battling to be first past the post (or will that be proportionally represented?) are deal structures which manage the release of value from the scheme over the duration of the process. Towards the peak of the market residential property was increasingly being viewed as a  liquid asset than traditionally perceived. It was also seen as an asset class in which short term gains were possible with capital growth being the raison d'etre often ignoring the ongoing income as yields were low in the broader investment context. Now however, this has shifted and with rental demand bolstered by sales constraints there is a revisiting of residential property as a mid to long term investment where rental incomes are as important as eventual capital growth as in many cases they are now providing a comparatively attractive yield. From an institutional investment perspective, there is an argument that housing has many of the characteristics of infrastructure investment.  Built well, their utility lasts a long time and if maintained it can last almost indefinitely - the Edinburgh New Town as an example has maintained it utility going from townhouse, to office, via brothel, to flats and back to townhouse again in an impressive recycling story compared with your average 70's office block.

While many of the new development models are yet to be tested there is growing discussion regarding build to rent models and an appetite to embrace schemes which extract the value in a phased or conditional way from the development process. It is hardly surprising that at a time where individual buyers are increasingly drawn to rent-to-buy and shared equity models similar theme are being considered for the delivery of housing. The success of these models will be reliant on satisfying the land owners - be they the banks, pension funds, investors, developers or individuals with all their differing ambitions - that unlocking the limited resources of land for development is financially prudent in the current climate and preferable to a longer term hold which would further constrain supply.

As Matthew Benson (0131 624 9031), Director of Land and New Homes at Rettie & Co. points out,

"The stop / start nature of land release and the see-sawing capital values this engenders, is the major factor in the housing cycle.  It increases the risk of delivery for house builders - risk demands a return, so forcing prices up even further or stopping production altogether if those prices cannot be paid - which is where we are now.

This is the flip side of the argument against long term residential leases - a shibboleth in Scotland. If land for housing could achieve a long-term economic rent - exactly what pension funds need - rather than an inflated one off capital payment, how many more, better quality, larger, more liveable-in houses could be built without having to rack up unsustainable short term debt to the Banks"

Given the reliance on the private sector for new home delivery, the role of Government and Legislature will be essential in enabling the private sector to embrace delivery through new channels. Government involvement will also be crucial in ensuring that an appropriate and mixed stock is delivered and that supply is not solely concentrated to narrow niches such as family housing, on a moderate scale on greenfield sites at the avoidance of urban, flatted brownfield regeneration sites.

While the models for the delivery of new homes are still a work in progress and will require a far greater degree of co-operation between government, institutions, agencies and companies the future still requires new housing to meet population and household growth. While there are many heirs apparent it will be those that address this supply issue that stand the best chance of claiming the empty throne.

A tale of borrowing currently doing the rounds

It was a slow day in town, snow was on the ground....the streets were deserted. Times are tough, everybody is in debt, and everybody lives on credit.

On this particular day a rich tourist from the east is driving through town. He stops at a hotel and lays a £100 note on the desk saying he wants to inspect the rooms upstairs in order to pick one to spend the night.

As soon as the man walks upstairs, the owner grabs the bill and runs next door to pay his debt to the butcher.
 
The butcher takes the £100 and runs down the street to retire his debt at the local public house - it has been tough times.

The publican takes the £100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her services on credit.

She, in a flash rushes to the hotel and pays off her room bill with the hotel owner. The hotel proprietor now places the £100 back on the counter so the rich traveler will not suspect anything.
 
At that moment the traveler comes down the stairs, picks up the £100, states that the rooms are not satisfactory, pockets the money & leaves.

NOW, no one produced anything...and no one earned anything...however the whole town is out of debt and is looking to the future with much optimism. And that, ladies and gentlemen is precisely how the British, U.S. and Canadian Governments are conducting business today.

The Herald - Scotlands Homes Column

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Andrew Meehan
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e: andrew@rettie.co.uk

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