Ahead of next week’s general election, the main political parties have all stated their commitment to the delivery of more housing. Few commentators would deny that there is a pressing need and that, in particular, there is a short supply of affordable homes.
Liberalising national planning policies and opening up permitted development rights further are tools that are being considered, and such measures will encourage developers to build more private homes. But the key to delivering more affordable homes lies in making more funding available to registered providers of social housing (RPs) so that they can invest in much-needed affordable housing schemes.
RPs are increasingly reliant on private finance to fund the development of new housing stock. By leveraging their assets, RPs are able to use the monies raised on existing stock to deliver more affordable housing.
The mortgagee exclusion clause solution
When negotiating finance packages, lenders require detailed due diligence to be carried out on the affordable housing assets being offered as security for the loan. This includes a review of the section 106 agreements imposed by local planning authorities (LPAs) that control how the affordable housing units must be used and occupied.
While lenders will expect to see restrictions on the use and occupation of the affordable units, they will also expect to see a “mortgagee exclusion clause” (MEC) that will allow them to realise their security quickly in the event of default by the RP.
How such MECs are drafted can have a substantial effect on the value attributable to the particular asset. In the absence of an effectively drafted MEC, affordable housing is valued at up to 40% less than it would otherwise be. The differential is at its widest in the South East, where the housing crisis is most acute.
An effective MEC will enable properties to be valued at market value subject to existing tenancies (MV-T) – on the assumption that the lender will be able to sell the affordable units free from the affordable housing restrictions but subject to any existing tenancies granted – rather than the reduced existing use value for social housing (EUV-SH) – the value calculated on the assumption that the units will always be bound by the affordable housing restrictions. Both are defined in the RICS “Red Book”.
Of course, the LPA’s desire and duty is to ensure the provision of affordable housing in its area and, to satisfy this, it will wish to ensure that these properties remain affordable in perpetuity. It might be argued that affordable housing units should be valued on the assumption that they will remain as such, with no “get-out” clauses.
However, most LPAs recognise that, by potentially allowing lenders to dispose free from affordable housing restrictions, they are trading the very small risk of losing affordable housing stock in their area for the more definite gain of increasing the supply of funding to affordable housing providers.
To date, there have been no instances where an RP’s mortgagee has exercised their rights to sell affordable housing free from affordable housing restrictions. It is difficult to envisage a scenario where the Homes and Communities Agency (HCA) would not play a key part as regulator to facilitate the rescue of a failing RP.
So the downside risks of accepting MECs would seem to be outweighed by the upside benefits of increasing the supply of affordable housing.
How to achieve it
In order to give assets an MV-T valuation for lending purposes, lenders need to be satisfied that they will be permitted to sell the units on the open market, free from the affordable housing restrictions, at a price that is not less than all sums secured by the charge.
This can be achieved in two ways:
- The complete exclusion: this simply enables a mortgagee to sell completely free of any on-going restrictions and, provided it is drafted correctly, will enable MV-T.
- The “hooped” mortgagee exclusion: such a clause requires a mortgagee to jump through a series of “hoops” before it can sell free of the ongoing restrictions; the aim being to try first to dispose to another RP (or back to the local authority) in order to preserve the stock as affordable, before being able to dispose free of ongoing affordable housing restrictions. Again, if drafted correctly, this will also enable MV-T.
As always, the devil is in the detailed drafting and there is no consistent approach to the wording of these clauses among LPAs. MECs are frequently found in other property documents that might similarly restrict use in new development, including land transfers, leases or nomination agreements.
For a mortgagee to lend at MV-T, all of these documents must have a consistent MEC so that the mortgagee only has to follow one procedure.
Who is really excluded?
All too often MECs contain references to “mortgagee in possession”. The reality is that a mortgagee is unlikely to actually
go into possession when enforcing its security. Such a reference means that the exclusion simply will not work.
A mortgagee will want to be able to employ the widest range of enforcement options available to it to exercise its security. If it cannot exercise appropriate options, then the mortgagee is likely to restrict the value to EUV-SH.
Therefore, the exclusion must be drafted to cover all options and, critically, must also exclude any purchaser from the restrictions; a purchaser will not pay the full MV-T if it is then bound by the restrictions to use the property as affordable housing.
The drafting must also consider the now-common use of security trust deeds in which the chargee is not itself a lender but is the holder of a charge over the property on behalf of one or more lenders.
What is needed
The key ingredients for a successful hooped MEC are threefold:
- Speed – the accepted “norm” for achieving an MV-T value is that the mortgagee must not be restricted to a sale to an RP for more than three months. If the procedure takes longer than three months, the property will only attain EUV-SH.
- Price – the provisions may not work if, for example, there are price controls imposed. If the lender is not comfortable it will recover its costs as well as the principal debt and interest it may choose either not to lend or will reduce the lending (by a reduced valuation) to a level it is comfortable it can recover.
- Certainty – if the MEC contains obligations that are subjective, there is no certainty that they can be complied with, or they are otherwise onerous, the property may be unchargeable or may only attain EUV-SH.
The difference an MEC makes
In extreme cases, lenders may be unprepared to lend at all, but in most cases, the issue will be whether the lender values the asset on EUV-SH or on MV-T.
Often this decision is made some years after the section 106 agreement is signed and dated, when the properties are constructed and occupied by the RP’s tenants.
By getting the MECs right in the first place, RPs, developers and LPAs can avoid the time delay and cost involved in obtaining subsequent variations to section 106 agreements, and can ensure that RPs are able to fully exploit their assets when it comes to raising finance for new affordable housing projects.
It is critical that the drafting of these clauses enables the highest possible value to be available as security. Trowers & Hamlins is involved in a joint initiative aiming to raise awareness of the impact of the drafting of these clauses with funders, RPs and LPAs. Key players including the National Federation of Housing, the Council of Mortgage Lenders, valuers, RPs and other law firms are working together in this ambitious venture.
The aims are to save costs and time in negotiations and, importantly, to realise increased sums of money to create additional and much-needed affordable housing.
Top tips for developers
1. Engage your RP in the section 106 negotiation process, wherever possible
2. Avoid references to:
- “Mortgagee in possession” (a mortgagee will not go into possession of affordable housing)
- “Lender” or person “providing loan facilities” (these will exclude a security trustee)
- “Best endeavours” (this is too onerous and can require a sale at an undervalue or otherwise on onerous terms)
- The moratorium period under the Housing and Regeneration Act 2008 or other references to the Act (this can cause a conflict between duties and a mortgagee is bound by the Act anyway)
3. Include:
- Chargees and receivers (mortgagees will usually want to appoint a receiver to dispose)
- Successors in title (so the restrictions do not bite against future purchasers)
- Ensure the price that the mortgagee is obliged to sell at is not less than the sum outstanding under the mortgage including interest and costs (the mortgagee must be entitled to seek full recovery)
- Exclusions for shared owners who staircase to 100% (ie buy their property outright) and tenants who purchase a property under the Right to Buy or Right to Acquire schemes (and their mortgagees and successors)
Jacqueline Backhaus is head of planning and Jennie Chilton is real estate senior associate at Trowers & Hamlins
