Smaller housing associations' capacity to develop new homes

Key points

• The research suggests that it is reasonable to expect that, on average, the associations in this study could sustain future organic growth at a rate of about 5 per cent a year.
• Effectively using the projected spare capacity of smaller associations would potentially increase the number of association homes built by around 2.5 per cent. To make use of that capacity requires sufficient organisational capability or/and suitable partnership arrangements combined with access to new debt finance and grant funding.
• Issues around access to the right skills and properly quantifying risk are potential barriers to smaller associations utilising their development capacity.
• Smaller associations have some potential advantages, with their focus mainly on a particular specialism or locality.
• The way forward may be to encourage organic growth among smaller associations and innovative approaches by larger associations and potential partner bodies to help them do this. This will not be easy at a time when the development environment for associations is particularly challenging.
• There are some advantages to smaller associations purchasing from – or managing stock for – larger associations (and others), rather than directly developing.
• It is vital that all associations ask themselves two questions: 1) if their mission is to provide homes for those in need, should the development of new homes be a key part of this? 2) do their current size, structure and costs enable them to effectively achieve their organisational purpose?

Background

The idea that the major unused capacity in the housing association sector is among smaller housing associations has attained the status of an urban myth. Yet there is a lack of hard evidence about the capacity of smaller associations and their ability to utilise it to grow and provide new homes.

This project is designed to consider this issue. The aim is not to come to definitive conclusions about the capacity of independent smaller associations (those with less than 1,400 units), but rather to develop some clearer indications of the range of any potential unused capacity and identify barriers to that capacity’s effective use.

The analysis

Key ratios

The key financial performance and strength ratios of the associations in this study compare favourably with the averages for all traditional registered providers as reported in the Homes and Communities Agency’s (HCA) 2013 Global Accounts of Housing Providers. It reports:

• gearing (debt-to-gross-cost of housing properties basis) of just 25 per cent, compared with a sector average of 35 per cent, with typical maximum covenant levels for this measure ranging from 60 to 70 per cent;
• interest cover (earnings before interest, taxes, depreciation and amortisation (EBITDA) basis – created by considering a company’s earnings before interest payments, tax, depreciation, and amortisation are subtracted for any final accounting of its income and expenses) averaging 250 per cent, compared with a sector average of 197 per cent and typical loan covenant minimum of 110 per cent;
• an average operating margin of 30 per cent (sector: 23 per cent), ranging from 14 to 50 per cent.

These strong ratios demonstrate that the associations are relatively well placed to undertake organic growth from the perspective of financial capacity alone.

Can using spare capacity make a major impact on new homes?

The research suggests that it is reasonable to expect that, on average, the associations in this study could sustain future organic growth at a rate of about 5 per cent a year.

A 5 per cent growth rate would produce an annual output for the sample associations of around 800 new homes. Given that the average figure for the growth of units by this group of associations over the last four years has been around 480 units a year, this suggests that there is scope for the development of around an extra 300 units per year.

If the projection is scaled up to the whole of the 400–1,399 group of associations, this would mean they could produce in the region of 1,230 extra homes a year. Overall associations developed around 50,000 new homes during 2011/12. Effectively using this projected spare capacity of smaller associations would potentially increase the number of homes built by associations by around 2.5 per cent.

This is significant and worth working for but is not as great as some commentators have suggested.

Barriers to smaller associations making use of their capacity

The finding that there is extra capacity to provide homes is important. To make it happen requires sufficient organisational capability or suitable partnership arrangements combined with access to new debt finance and grant funding.

This work identifies two potential barriers to smaller associations using their development capacity:

Properly quantifying risk

Some of the associations and a major lender to smaller associations interviewed for this study highlighted that boards of smaller associations may be less confident about embracing the risks of development.

Properly quantifying risk is important for an association. If a smaller association has one large development and it goes wrong it can have significant adverse effects on the association’s long-term prospects. Small associations therefore need to ensure that they are properly risk aware rather than risk averse. Having access to wider skills and understanding in terms of finance, development and risk management at both board and professional levels is a key issue here.

Skills

Some of the associations in the study have development and financial skills in-house. Others have ongoing relationships with larger associations who provide the skills for them, with varying degrees of satisfaction with these arrangements. There is, however, an important issue around how a smaller association without such skills can be an effective client when working with a larger body. This highlights the importance of good relationship management as much as technical skills.

Recognising strengths

It is important to recognise the diverse set of organisations covered by the term ‘small associations’, given the disparate range of geography, objectives, organisational history and needs they are addressing.

This means that:

• care has to be taken in terms of generalised statements about smaller associations;
• reasons why associations may be unable or choose not to maximise development will vary;
• in looking for ways forward to encourage development, ‘one size fits all’ approaches to unlocking capacity are unlikely to be appropriate.

Moreover their local or specialist knowledge should have advantages for them, not least in terms of their ability to assess local needs, develop focused management arrangements and have a strong network of relevant contacts. Most also still have a strong voluntary ethos and their boards tends to be much ‘closer to the ground’ than their larger counterparts

Not just about development?

In some ways the practice of smaller associations purchasing from or managing stock for larger associations (and others) – either as part of asset management strategies or as part of development activity – has some advantages over directly developing, particularly in terms of the reduction in risk for the smaller association. It is also an effective way of recycling their money into new provision, because larger developers have the resources and expertise that can then use those resources.

Associations can challenge themselves

Spare development capacity is not just an issue for smaller associations, but may also be relevant in relation to some medium sized and larger associations. Associations need to be clear about what their purpose and values are and identify their strengths. They then need to ask themselves some key questions:

• If the association’s mission is to provide homes for those in need, then should the development of new homes be a key part of this?
• If development is too risky, can the association’s mission be satisfied by just continuing to manage homes and/or demonstrating wider social value?
• Does the association’s current size, structure and costs enable it to effectively achieve its organisational purpose?
• Could the association’s resources be better utilised to meet its mission if combined with others?

It might be that the sector itself needs a mechanism to identify and challenge associations that are not utilising their capacity. This could take the form of a template for a ‘capacity audit’, which would allow an association to challenge itself on whether it is making the best use of its capacity.

The role of the HCA and local authorities

Local authorities, the Homes and Communities Agency (HCA) and Greater London Authority (GLA) could be more proactive in their use of the agreements they enter into with the big providers, which give access to land, planning and/or grant. These could open up access for smaller associations by, for instance, setting an expectation that where a provider develops in areas where they don’t have a significant local management presence, they should seek an active local player to buy or manage the built stock.

Conclusion

Smaller associations are part of a wider association sector. If the sector as a whole does not demonstrate its effectiveness in releasing capacity it will face continuing scrutiny from government

In seeking to use the spare capacity available to smaller associations perhaps the sector as a whole – not just the smaller associations themselves – needs to consider how to utilise that capacity.

It seems the way forward is to encourage organic growth among smaller associations and innovative approaches by larger associations and potential partner bodies to help them do this. This will not be easy at a time when the development environment for associations is particularly challenging.

About the project

This project was jointly funded by JRF and the National Housing Federation.

The sample used was based on independent associations owning and managing between 400 and 1,399 units of low-cost rented stock (based on 2012 statistical data return). Nineteen associations were chosen for the sample. They constitute 26 per cent of both the number of associations and the stock owned by associations with between 400 and 1,399 units. Analysis and financial modelling is based on the financial statements of the associations involved plus basic supplementary information on stock profiles, maintenance costs and recent development provided by the associations themselves.

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