Private Equity Is Finding Ways To Help Solve The U.K.’s Housing Crisis And Make A Profit Too

Too heavily regulated. The returns are too low. Dealing with vulnerable groups on an emotive topic is too risky or just too much hassle.

For a long time there were a lot of reasons for private equity firms to steer clear of investing in the U.K. affordable and social housing sector. But that has started to change.

Hedge fund Cheyne Capital blazed a trail in 2013, setting up a vehicle that is now halfway toward a target of investing £700M in housing projects that provide a social as well as financial return. But for a long time it was on its own.

Then in June Starwood Capital bought into regeneration firm Pinnacle, which develops housing across different tenures, including affordable and social housing for rent and shared equity properties.

And earlier in January Estates Gazette reported that Blackstone was backing affordable housing company Sage in a major push into the sector.

Private equity has well and truly embraced sub-market housing in the U.K. and is set to invest billions of pounds in a sector that has radically changed in the past five years.

The opportunity for private equity is a result of changes in policy in 2012, which reduced government funding for social and affordable housing. This has limited the ability of the traditional providers of this housing, local authorities and housing associations, to meet the needs of a growing population in a country where house prices and rents are growing much faster than wages.

“The country’s housing needs are greater that the capacity of the government and housing associations to address alone, and there’s a clear investment opportunity here,” housing association Hyde Finance Director and former Starwood partner Peter Denton said.

“For a long time there has perhaps been a communication challenge,” Denton said. “Investors can achieve lower but solid returns from below-average risk whilst contributing massively to social good. An investor should be able to achieve an inflation-linked income and solid single-digit returns on very stable assets with full occupancy and little risk.”

The private equity firms that have moved into the sector have all gone about investing in different ways.

Starwood teamed up with fellow private investment firm Tunstall to buy Pinnacle, essentially giving itself a platform with the ability to bid to build major regeneration schemes around the country but with a particular focus on London and the South East. It bid to be the developer and investor in Haringey council’s controversial Haringey Development Vehicle, where the assets will have an expected end value of £2B.

For Blackstone, the joint venture with Sage is likely to be all about scale. The world’s largest property investor has been looking for some time for a way of investing in the U.K. housing sector and mirror investments it has made in multifamily housing in countries like the U.S., Spain, Germany, Sweden and Finland.

In the U.S. it also teamed up with Starwood to create a $20B REIT called Invitation Homes which owns single family homes.

With Sage it will provide finance for the group to buy and manage the affordable housing which private developers are required to built as a result of section 106 agreements. It is likely to try to buy these in bulk from house builders to create a very large portfolio of hundreds of millions of pounds or more.

That portfolio could then be sold to a pension fund or listed through an initial public offering, selling at a profit to investors with a lower cost of capital and boosting its returns. The investment is being made through its opportunity fund, which typically targets returns of 12-15% or more.

Cheyne, the trailblazer, is doing things differently again. It set up the Social Impact Property Fund in 2014, and undertakes developments and deals itself, in joint venture with local authorities and private sector partners. It has invested in social and affordable housing as well as housing for the elderly and people with learning disabilities.

The fund is different than a traditional private equity vehicle in both its financial structure and in its ethical stance.

As a social impact fund it has to make investments that provide a social good as part of its mandate. For example when undertaking new housing developments it has to add net new housing to an area rather than just replacing existing stock.

“When you are dealing with disadvantaged groups we wanted to make sure that the investments we made protected the interests of these groups,” Cheyne Social Property partner Shamez Alibhai said. “When you look at investment globally in areas where private capital has gone into low income housing you come across instances where the financial imperative has overwhelmed the social imperative.”

Alibhai said that when structured correctly, investment of this sort proves making money and providing a social good do not have to be mutually exclusive. The fund is structured as a private REIT with long-term pension fund investors, and has a very long-term outlook. The theory is that you make a higher return than a typical private equity fund but that return is spread over a longer time period, something with which pension funds with long-term liabilities are perfectly happy.

“When people think about impact investing they often think that social returns compromise financial returns,” he said. “But when you extend the time horizon you find they are actually complementary. You can work with the local community in a less adversarial way to create developments that add to an area and so are more successful.”

Alibhai said that when structured correctly, investment of this sort proves making money and providing a social good do not have to be mutually exclusive. The fund is structured as a private REIT with long-term pension fund investors, and has a very long-term outlook. The theory is that you make a higher return than a typical private equity fund but that return is spread over a longer time period, something with which pension funds with long-term liabilities are perfectly happy.

“When people think about impact investing they often think that social returns compromise financial returns,” he said. “But when you extend the time horizon you find they are actually complementary. You can work with the local community in a less adversarial way to create developments that add to an area and so are more successful.”

Cheyne has built 165 mixed-tenure homes in Bristol with architects AHMM and housing in Luton where tenants pay 60% of the market rate. Luton council has taken a 21-year lease on the 80-apartment scheme which saves it money, as it is paying less for short-term accommodation like hostels and hotels for vulnerable residents.

Cheyne has also undertaken a partnership with charity Thera where it will buy up to £15M of houses across the country and adapt them to the needs of adults with learning disabilities. Thera pays the rent to Cheyne, and there are benefits beyond the immediate provision of housing — people with learning disabilities are found to be happier and therefore have a better quality of life and better health when living in the housing that is specifically tailored to their needs.

Cheyne will probably look to float the fund at some point, Alibhai said, and there is recent evidence that public markets as well as private equity are becoming more amenable to social housing. Civitas raised £350M for a social housing REIT in 2016 and last year Triple Point raised £200M.

The flow of investment from private equity into the sector may not become a flood. As Alibhai points out, the problem for private equity is finding the ability to deploy a significant amount of capital in social and affordable housing.

But that arbitrage remains, with very little sign that the government has the ability to commit more funds to providing social housing. As long as it does, that will be an opportunity for private equity to fill some, if not all, of the gap.