by Martin Angel
The 1988 Housing Act is a radical piece of legislation creating wide opportunities for the transfer of local authority and other public-sector housing to approved private-sector landlords. Although transfers were possible before the 1988 Act, as “voluntary transfers”, this new legislation enables tenants to change landlords, even though the public-sector landlord may be opposed to the move (“tenants choice”).
“Public-sector landlords” in this context include local housing authorities, new town corporations, a housing action trust and the Development Board for Rural Wales.
“Approved landlords” are parties who have been approved by the Housing Corporation on the basis of various published criteria, including independence of local authority control. In practice, the majority of approved landlords are likely to be registered housing associations and tenant co-operatives.
An important element of both voluntary and tenant’s choice transfers is that loan funding for the purchase of the stock comes from banks, building societies and the institutions; Government subsidies and guarantees are not a feature.
In circumstances of voluntary transfers, valuations of the housing stock to be transferred may be required for a number of reasons.
(1) By the public-sector landlord prior to serving a notice on the approved landlord stating the price required for the properties.
(2) By an approved landlord prior to proceeding with a proposed acquisition.
(3) By the lender to an approved landlord wanting to assess the loan security offered by the housing stock.
Valuation principles
One might be forgiven for assuming that these valuations would be no different from valuations of tenanted residential property in the private sector — continuing occupation and low net income are still very much in evidence. However, there are additional factors which significantly alter the approach to be adopted.
(a) Continuing right to buy
Any existing rights of the tenants of the public-sector landlord to purchase their dwellings at discounts are preserved after transfer to the new landlord. Similarly, the existing basis of “secure” tenancy and associated rent also remain.
(b) Restrictions on future disposal
An approved landlord may not subsequently dispose of acquired properties except with the consent of the Secretary of State. The indications are that this will only be given in very limited circumstances, such as extreme financial difficulty. However, this consent is not required for exempt disposals such as via tenants’ “right to buy” or the granting of a new assured tenancy.
A transferred dwelling is therefore subject to several possible alternatives (see below).
Following transfer a dwelling will continue to be let on the same basis until the current tenant exercises the preserved right to buy, or vacates the property. If the tenant leaves, the property will then be relet on an assured tenancy at an affordable rent — in theory, in perpetuity. If the tenant exercises his preserved right to buy, the new landlord receives the proceeds of sale and the property is transferred to the former tenant.
Valuation method
The valuation model consists of a discounted cashflow forecast, incorporating both income and capital receipts on one side, and outgoings including management and repair costs, on the other. Research has to be carried out into the historic rates of variables such as voids, bad debts, right-to-buy sales, management costs etc, and value judgments made as to the way in which the change in landlord may affect these variables in the future.
As the new landlord may be assumed to be borrowing to fund the purchase, a view must be taken as to the market for such lending to establish a suitable discount rate to be used in the valuation model.
Elements of the cashflow forecast
(a) Net rental income
On the income side, information regarding existing rental levels and the rate at which properties become vacant and are relet at higher rent levels form the basis of maximum gross rental income. Account then has to be taken of voids and bad debts. Outgoings include general management costs, day-to-day maintenance, warden charges (sheltered accommodation), landscaping costs (if applicable), a contingency fund and the costs of major repairs and renewals, together with the costs of any outstanding works which are required to comply with the landlord’s repairing obligations etc. Income and cost inflation must be taken into account for future years.
These elements are incorporated into a computer spreadsheet to establish the anticipated net income (positive or negative) from the housing stock for the period under consideration — typically 25 to 35 years depending upon the sources of funding available at the date of valuation.
Estimation of some of the elements of the cashflow are highly complex. For example, the size of the liability for future repairs and renewals will obviously be dependent upon the location, age, condition and construction of the dwellings. Considerable resources are required to assess this future liability accurately.
Initial net cashflows excluding right-to-buy receipts may be positive or negative, but in the best situation are very unlikely to exceed £1,000 per dwelling per annum. Where works are required to restore the stock to acceptable condition, the net cashflows will frequently be negative, at least for the early years.
(b) Right-to-buy sales receipts
Right-to-buy capital receipts are based on open market vacant possession values less discount, but even so they will typically be much more valuable than the net rental income stream. The size and incidence of right-to-buy sales receipts will therefore have a significant influence on the overall valuation.
The rate of sale is dependent upon a host of factors, for example recent trends in residential values; expectations as to future values; the cost and availability of mortgage finance; local wage rates; the degree of saturation of sales already transacted; and possible changes in government policy and/or fiscal policy.
In some cases reasonable assumptions can be made, but the valuer has to bear in mind that the assumptions must be similar to those which the funding market would be likely to adopt. If in doubt, the funders are most likely to err on the side of caution, since to do otherwise could well affect the underlying security of any advance.
Where such assumptions cannot be relied upon, it may be better for the approved landlord to inform the public-sector landlord in his section 103 notice (notice of intention to proceed with the purchase) that he wishes to enter into a prescribed covenant to make payments to the public-sector landlord following any prescribed disposal.
The value of this covenant has to be taken into account by reducing the transfer price for the stock.
This is effectively a mechanism for reducing the transfer price while agreeing to share the future proceeds from right-to-buy sales. From an approved landlord’s point of view this has several advantages including reducing capital employed, reducing borrowings and reducing risk (where, for example, the anticipated rate of RTB receipts does not materialise through factors outside their control).
From a public-sector landlord’s point of view, the initial receipts will clearly be reduced, although ultimately the overall receipts may be higher.
A further effect of the properties’ being sold via right to buy is that costs and income may well not reduce in similar proportions. Sheltered housing will always remain within the stock since it is not subject to the right to buy. The net income per dwelling from these units may be very different from the rest of the general housing stock. Similarly, it is likely to be the best housing where right to buy is exercised, leaving the most disadvantaged remaining within the stock; the latter often being more management intensive. It may also be the better-off tenants who buy, resulting in proportionately higher levels of arrears, bad debts and management costs.
(c) Funding
The funding of transfers is still evolving. Many approved landlords are likely to be new and/or comparatively small, with no significant security to offer other than the properties themselves. The larger approved landlords are likely to be unwilling to pledge other assets which they may have. Approved landlords are therefore likely to wish to obtain as close to 100% funding as possible. As a result it is the funding which transforms the demand for the properties into effective demand.
Accurate current information will be required as at the valuation date regarding the cost and availability of finance, and the flexibility available to tailor interest and capital repayments to the net cashflow profiles. The net cashflows may alter very significantly over the period — initial surpluses can be eroded where, for example, widespread refurbishment will be required over a significant proportion of the stock in a comparatively short time-scale, at some later date.
Having established a net cashflow forecast for the period under consideration, it is then necessary to align this with the most advantageous funding terms which are generally available to the class of landlord who would be likely to “bid” for the stock, if a competitive situation could arise.
There are housing stocks where values in this market are very definitely negative and reverse premiums or transfer dowries are required by a transferee landlord to enable them to manage and maintain the stock into the future.
Conclusion
The market in these transfers is still very much in its infancy, and as it evolves the detailed methods of valuation may well have to change. However, the challenge of the new opportunity created by the Housing Act 1988 is being increasingly considered by local authorities, tenant groups and by banks and other lenders. Transfer valuations with their complex issues and sophisticated computer models could become a major feature of valuation work in the 1990s.
