Investors heavily backed the launches of trusts that offered juicy yields through investment in social housing projects – but performance has not lived up to expectations. We explain why.
Social housing investment trusts seemed like a promising investment opportunity when they began courting investors three years ago. With the aim of improving the supply of desperately needed housing for society’s most vulnerable people, the trusts gave investors the feel-good factor along with juicy inflation-linked yields of 5% to 6%.
But these specialist real estate investment trusts (REITs) haven’t proved as safe as houses, as discounts have ballooned and share prices have fallen in 2019. The reason for this was a series of damning statements from the sector’s watchdog, the Regulator for Social Housing.
In April, it flagged a number of serious issues about the providers of supported social housing, including low-quality standards and concerns about their lease-based business model. This involves funds leasing properties to housing providers on a long-term basis, even though the providers typically only have short-term funding contracts with local authorities.
The regulator also warned that narrow margins mean providers may struggle to cover any void periods, plus they are dependent on housing benefit to cover their lease liabilities. All of which could threaten their solvency.
While the regulator plans to work with housing associations to resolve these issues, it has warned that it could look at other solutions, which could lead to losses for creditors and their investors, including REITs, says Thomas McMahon, senior analyst at Kepler Partners. The two largest, Civitas Social Housing (CSH) and Triple Point Social Housing REIT (SOHO), in particular have struggled to perform since the announcement, as the accompanying table shows.
Discounts are widening
|Civitas Social Housing||-19.6||4.8||-20.3|
|Residential Secure Income||-13.6||5||2.3|
|Triple Point Social Housing REIT||-13.4||4.9||-11.5|
Source: FE Analytics. Data to 17 September 2019
Broken business model?
At the time of writing (mid-September) McMahon suggests that the discounts on these trusts make sense, given the pressures they are under and the fact the regulator sees the whole business model as flawed. “Both Civitas and Triple Point have exposure to specialist supported housing. The regulator has declared some providers uncompliant and that they need to resolve issues to continue to function, and coverage has frequently focused on the REITs’ exposures to the providers in question. It should be clear, however, that the regulator takes issue with the entire business model,” he says.
“Clearly the regulator would prefer to resolve this without imposing losses on investors, and without causing any turmoil in the provision of housing that might follow from it effectively banning this business model. However, there is little clarity on the route it will take, and its objections are clearly fundamental and serious, which seem at least likely to be expensive to fix.”
Tarred with the same brush
Other trusts in the peer group have also fallen out of favour even though they do not invest in the same types of property, suggesting many specialist REITs have been unfairly tarred with the same brush. The Residential Secure Income REIT (RESI), for example, invests in retirement housing and shared ownership properties, and has publicly tried to distance itself from the lease-based supported social housing sector. “It doesn’t invest at all in the sub-sector which has been the subject of the regulator’s judgments,” says McMahon. “In our view, the widening of the discount earlier this year along with the other two was unwarranted.”
Although they may not be involved in the same type of housing, RESI and other specialist REITs come with their own issues that investors should not ignore, according to James Carthew, head of investment company research at research consultancy Marten & Co. “RESI has a completely different set of risks,” he says. “I’m not sure I completely understand the business model and where the flaws might be, but the shared ownership market has come in for criticism from some quarters.” He also points to The PRS REIT (PRSR), which invests in new-build housing for the private rented sector and is also trading on a wide discount. “PRS is probably doing a great job, although I have questioned the size of the gearing involved. If, post-Brexit, residential prices take a tumble, that gearing might look a bit stretched.”
The trusts themselves remain upbeat: in its interim results released at the end of June, Triple Point’s chairman Christopher Phillips said that “despite movements in the company’s share price”, the trust is looking to the future with optimism. In June its portfolio of 2,306 specialist social housing units was valued at £386 million. The trust stood on a discount of 13.4% in mid-September.
Triple Point says housing associations have been slowing the speed at which they sign new leases, to appease the regulator and improve their financial strength. It has been working with housing association counterparties to invest in new staff and reporting software, and diversifying into freehold stock rather than leasing all its properties. “To date, the regulatory announcements have not impacted valuations, which the manager comments ‘have continued to appreciate, reflecting market dynamics’,” said analyst Numis in a September note to investors.
Civitas, meanwhile, says it is in ongoing dialogue with the regulator as it works with its housing association partners to improve governance. The sector’s largest trust with a market capitalisation of £537 million, it is trading on a 19.6% discount.
Numis analysts sound cautiously optimistic on the two trusts. “We are encouraged by the progress housing associations (HAs) are making in terms of improving governance processes and strengthening balance sheets by acquiring freehold assets. In the absence of more negative newsflow, we do not see the discounts on Civitas or Triple Point widening materially. However, we require greater reassurance on the regulator’s stance, and its views on the improvements in HAs’ governance and strength of HA balance sheets before recommending either of the specialist supported social housing investment companies. On a more positive note, we understand that both Civitas and Triple Point have received all of their rents due to date, and do not expect any of the housing associations to default in the near term.”
The long and short of it
Carthew flags a few potential problems the sector could face in future but says that on balance, he thinks the discounts these trusts are trading on are unfair and they have been oversold. He says it is true the sector is thinly capitalised, and there is a “time mismatch” between the long-term leases and the short-term local authority contracts they are backed by. However, there is also an “acute shortage of this type of housing, and a growing need for it”.
Given this dynamic, he thinks it unlikely that local authorities would stop renewing their contracts, unless a future government decided it could no longer afford to fund supported housing. “Civitas says it knows this is an issue so has tried to keep its rents average for wherever they are,” Carthew said. Providers are also now putting clauses into their contracts so that, in the event local authority funding dried up, there would be a no-fault end to their leases so they wouldn’t go bust.
Bargain buy or not worth the risk?
Marten’s James Carthew points out that these trusts’ net asset values have not taken much of a hit despite their tribulations so far.
“If they keep on collecting the rent and paying out the dividends and nothing goes wrong, then eventually people will say this was all a storm in a teacup.”
So, at temptingly wide discounts, could these trusts be a buying opportunity if the regulators’ concerns prove unfounded? Miton’s Nick Greenwood says he has looked at the sector because these trusts fit the type of special situation-type investment ideas he favours. However, he has found better options in other property trusts which pay high dividends without the issues that have dogged the social housing sector, such as Real Estate Investors (RLE).
“There are out-of-favour funds out there that don’t have the same structural risks. Civitas may be fine, the housing societies that are taking out these long-term contracts may be fine, but they may not be. I wouldn’t be sounding the alarm, but we looked at it and chose not to buy,” he says.