Funding retrofit: guaranteeing a way forward
Retrofit, the full benefit of which goes to the tenant in the form of energy bill savings, is now regularly top of the agenda in the discussions I have with executives and directors in our sector.
How should associations approach paying for these huge, no-return investments in stock?
Together with the bright minds at BuroHappold, we set ourselves the task of answering this question, producing a report released in December 2021.
Given that available grants are, at most, 40-60% of capital spend, the answer inevitably involves long-term debt funding, and the cheaper the better.
The cheapest debt funding is that which has been guaranteed by the UK Government. The new Affordable Homes Guarantee Scheme has recently priced its first, long awaited issuance at just 38bps over the cost of Government borrowing, producing an all-in rate of around 1.5%.
When we ran the first version of this scheme through our subsidiary Affordable Housing Finance Plc we plumbed similar depths. For Livewest we achieved a rate of 1.2% on a £20m loan fixed for 10 years to 2027; for Merlin we secured 1.393% on £25m not due to mature until 2047. This year Silva was able to revise the rate on its AHF loan, financed by the European Investment Bank, to 1.04% fixed to maturity in 2047. In January 2021 we even secured 1.74% for Leeds & Yorkshire Housing Association in THFC without any guarantee at all.
The obvious problem is that the new guarantee scheme, like its predecessor, is limited strictly to using proceeds for new development.
Development remains a hugely important means by which housing associations can increase their provision of affordable homes. And if we are to reach net zero carbon by 2050, each one of these must be energy efficient from the start.
New build is also a vital source of income, for despite recent pressures, the cross-subsidy model endures. And this income is part of the equation, what with the plethora of reports released recently forecasting the costs of decarbonising UK housing association stock at anywhere between £35bn and £55bn.
Our own research argues that the viability of funding retrofit relies not just on the grant funding that is starting to be distributed through BEIS’ Social Housing Decarbonisation Fund, nor on the economies of scale achieved by building up the retrofit industry, but crucially on the ability of housing associations to access cheap funding on a long-term basis.
While sustainability bonds like bLEND’s are necessary to attract the right investors, the much vaunted 2-5bp benefit of sustainable-labelled debt isn’t enough for retrofit finance.
Assuming 50% grant funding, the impact of a guarantee which reduced the interest rate from 2.5% to 1.0% is to almost double the equity IRR of a retrofit project, from around 2% to around 4%. Without cheap debt or match funding the same project would not achieve a return at all.
For those of us who have been in the sector a long time, it is clear that social housing has come a huge way in a very short space of time, with ESG reporting and sustainability strategies now more de rigour than à la mode.
But retrofit remains a thorny issue with few associations having actually commenced works on scale.
Funding is one of the biggest remaining challenges, but it is becoming increasingly clear what works and what is most needed.
The rates achieved by AHF and Saltaire represent fantastic value for associations looking to develop, but where is the same value for those looking to decarbonise?