Pension funds are seen as a vital source of patient capital to tackle the UK’s housing crisis. But are there pitfalls to consider?
The housing crisis is tangible for residents of Oldham Council, with thousands of families on the waiting list for social housing. By the end of last year, nearly 500 families lived in temporary accommodation; this number has doubled in the last two years. In the private rental space, affordable homes are also in short supply. This prompted members of Oldham Council last year to vote on a motion declaring that the council was facing a housing crisis.
While Oldham is by no means isolated, stories like these would have been at the forefront of assistant director Paddy Dowdall’s mind when the Greater Manchester Pension Fund (GMPF) committed nearly 5% of its £29.4bn in assets to local impact investments. While GMPF has been investing in real estate for decades, it has recently ramped up its real estate investments with a special focus on providing affordable homes.
Roughly a quarter of GMPF’s £13.6bn Impact Investment Portfolio has been allocated to housing investments, funding close to 4,400 new homes which have either been completed, planned or are in development.
At Room151’s Housing Summit, Dowdall argued that efforts to attract more investment in local housing have at times been “missionary work”.
The rise of patient capital in Build to Rent
The interplay between social housing and finance is by no means a new one. Indeed, many modern housing associations, including Peabody, one of the sponsors of the Room151 Housing Summit, date back to Victorian times.
However, the role of private finance in UK housing has played an increasingly dominant role in the period of austerity that followed the 2008 global financial crisis. With the introduction of the self-financing regime in 2012, councils were incentivised to borrow against their rental revenue to build new homes. At the same time, local authorities faced the impact of devolved austerity measures, which led to the increased creation of housing companies in a bid to attract private capital.
While these housing companies have targeted a broad range of institutional investors, including Dutch, Canadian, Swedish, Indonesian and Korean pension funds, the link between now chronically underfunded local authorities and the LGPS pension funds who invest on behalf of their members remains close.
Speaking at a Housing151 panel, Eamonn Hughes, CFO at Peabody, emphasised that local authorities and housing associations now face a common set of challenges, and that private capital can play a vital role in tackling them.
“We’ve got close to £2bn in publicly listed homes and that funding comes from institutional investors who provide the patient capital and invest for, say, 30 years. That funding sits alongside grant funding we are able to generate and is really important in delivering new homes,” he explains.
Growing demand
Many LGPS investors seem willing to heed his call. Improved funding ratios combined with a desire for income are driving growing demand for housing strategies. In recent months, Border to Coast, ACCESS and LGPS Central have all confirmed significant expansions of their real estate offering.
Meanwhile, LPPI and London CIV have joined forces this year to launch the London Fund, which alongside infrastructure also invests in affordable housing. Aoifinn Devitt, recently appointed CIO at London CIV, joined Dowdall and Hughes on the Housing151 panel to discuss the opportunities for investing in local housing. London CIV, the pool for 32 local authority funds in London, is also currently on the lookout for managers for a new real estate strategy to meet growing demand from partner funds.
But the case for local impact investment is often easier to make in the capital than in other parts of the country, argues Matthew Trebilcock, head of pensions at Gloucestershire Pension Fund.
Outside of the UK’s property investment hot spots, it can sometimes take quite a bit of effort to make the case for local impact projects. “One of the biggest challenges we had is that conflict of interest with the manager around the localism aspect, it wasn’t in the eyes of many managers that Gloucestershire exists. Once we put the spotlight on that, a lot of very positive noises were coming out,” he stresses.
Another potential challenge is sourcing affordable homes, emphasises Dowdall. “The key issue that we face is this massive market failure where it is actually impossible to buy existing stock or buy new stock at rates that people can afford,” he argues.
One measure of affordability which GMPF uses is the salary of 1.5 ambulance drivers, who would rent a three bedroom semi around £1,200 a month. But in the greater Manchester area, only eight properties meet these criteria and all of these offer sub-standard housing, Dowdall explains.
Navigating demand shocks: lessons from Covid
While this acute shortage of affordable housing should mean that there is in theory unlimited supply, institutional investors should be mindful of unforeseen demand shocks impacting liquidity, as the Covid crisis illustrated.
Academic research on the role of patient capital in the provision in housing points out that the increased role of private finance in this provision means that the private rental sector has flourished.
While most risk assessments consider house prices to be stable due to the gap in housing supply, relatively little attention has been paid to demand crises, as Frances Brill, research fellow in geography at the University of Cambridge; Mike Raco, professor of urban governance and development at UCL; and Callum Ward, post-doctoral fellow at UCL, point out in a recent paper for European Urban and Regional Studies.
Having reviewed some 100 asset owners invested in PRC in London, they highlight how many pension funds were suddenly met with liquidity problems when rental incomes in London collapsed by more than 18% within just a few months due to the Covid pandemic.
Research shows that institutional investors were able to navigate these challenges by adjusting payment plans and increasingly focus on the provision of housing to key workers. Nevertheless, the researchers argue that in order for patient capital to remain patient in the face of economic certainty, more long-term oriented policy guidance and regulation is required.
An (almost) perfect match?
Despite these challenges, pension fund investors like Dowdall continue to see housing as a suitable match to their liabilities. But with bond markets offering above inflation returns, why should pension funds be allocating to highly illiquid assets such as bricks and mortar?
While many corporate defined benefit schemes have turned to UK Index Linked Gilts, Dowdall argues that real estate in fact offers a far better match to meet LGPS liabilities. “Index linked gilts are an excellent matching asset class for pension funds. Investment in residential property can, subject to successful execution, provide cashflows with a similar profile to index linked gilts, giving long term inflation linked cashflows,” he explains.
While real estate does not match inflation as precisely as Linkers, it offers better risk-adjusted returns, a crucial factor for open DB schemes whose liabilities are linked to inflation, he argues.
Indeed, the yield on Linkers is still too low to make them a suitable liability hedge for the LGPS, he says: “The low yield on index linked gilts means that if an LGPS pension fund were to use them exclusively to fund future liabilities the employer contributions would have to be in excess of 40%. Clearly a diversified portfolio is more appropriate for an open defined benefit pension scheme and therefore residential housing can play a part in that.”
This article was first published in the Q2 2024 edition of the Private Markets Profile, which you can read in full here.
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