Chris Buss: 151s and the sliding scale of development risk
0Risk aversion in the public sector is shifting. But each model of housing development presents it own particular kind of challenge. Chris Buss runs through the options.
Building capital
How much of a risk taker are you? By nature I’m naturally cautious, particularly with money – even more so when it’s not mine. Thus, I’m not one that would by nature follow the maxim of you need to “speculate to accumulate”.
That’s not to say that I don’t believe you need to invest to make a return, it’s just at what point does the nature of the investment become too risky, even if the promised, or supposed, reward is superficially attractive.
For much of my career in local government the public sector has become risk averse, largely to avoid, in part, public opprobrium when things go wrong, as it does spectacularly on occasion. However, I sense that this risk aversion is now changing.
In part this is due to the need to seek greater returns to balance reductions in direct government funding, or the indirect impact of government actions such as rent reductions.
But in part it’s also a reaction to the greater commercialisation of the public sector, with the sector taking the view: “Why should the private sector get all the upside (or profit)?” One area in particular this is happening is in the provision of new housing.
Downturns and reform
Since the early 1980s the traditional housing delivery model has been that a local authority might assist a developer by selling land to them or, on occasion, assist them to acquire land. But the risk of development, and conversely the reward, for selling was a matter for the private sector not a council.
For those of us of mature years we can think back to the early 1990s when a number of large developers were financially burnt by the collapse in the property market. This reaffirmed in our consciousness that, whilst the property market may look like a one-way bet, and despite the trend of ever rising prices, it’s a fact that prices do go down as well as up in the short and medium term.
And it’s a fact that no one can predict the next down turn. In addition, there’s the risk of reforms imposed by government such as recent rule changes on stamp duty which might impact returns.
Sliding scale
So what’s a reasonable level of risk with regard to housing for a council to take?
At one end of the scale we can have a council as the deliverer of council homes – a phrase that most people understand rather than the Orwellian nonsense of what is an affordable home.
A council would normally own the site, demolish what’s there at present (often if it’s a small scale development which involves converting redundant store sheds, garages or drying areas), get a scheme designed and then get a builder to build it with a council keeping ownership of the new housing.
Relatively risk-free you might think, until you find that the site surveys didn’t pick up on some contaminated ground, or sewer, which increases build costs to such an extent that viability becomes an issue – and that’s before the government changes the sums further by forcing a rent cut leaving such a scheme with a funding shortfall. Even the simplest of schemes is not risk free.
As we move up the scale, in terms of both size and diversity of scheme, life becomes riskier, but potentially more rewarding for those willing to take the risk, as we come to the more typical development model.
In exchange for additional or reprovided social housing – often vested with a registered social landlord rather than a council – a developer builds out the private housing and keeps the sales proceeds. In this scenario (which I’ve over simplified for reasons of space) the risk rests with the developer, but then so does the reward. The primary risk the council faces is the scheme not being built due to market conditions, and a potentially blighted site in a down turn.
Traditionally, local authorities sold land with a “light touch” in terms of planning, allowing the developer to negotiate a consent with the planning department and capturing all the value that crystallises when planning is granted.
However, by investing in planning briefs or full planning permissions, councils can capture all the uplift created by planning permission for itself, thus increasing capital receipts.
Whilst this requires up front revenue costs to secure planning permission, this is more than covered by increased value and, in many cases, the costs can be recovered (as revenue) as a condition of sale.
Moving up the scale we come to the joint venture where both a council and the developer pool risk and reward.
The extent to which this happens will vary depending on the nature of the scheme, the level of investment being pooled and a wide range of other factors.
Clearly a council is taking more risk in this scenario, but hopes to take some of the reward that would otherwise go to the private sector. The joint venture option will often require up front investment from a council which can be at risk.
The far end of the scale is where a council provides both the new council housing and, often through an owned vehicle, funds the council housing through building for sale private units.
This is effectively taking the developers on at their own game, hoping the council can read the market as well as the developers and be able to sell at the right price to cover the build, marketing and finance risks involved in the overall project.
Thresholds
I’m aware of local authorities being involved in housing development at various stages along this sliding scale of risk, and it’s clearly for each authority to decide its own risk appetite, almost on a project by project basis.
There’s no right or wrong answer as each of us will have our own risk threshold and level of expertise available to justify that risk threshold.
However, for those tempted to go for the higher risk thresholds, and at the risk of teaching you to suck eggs, make sure you do the due diligence and don’t assume that housing is a one way bet in terms of values. Remember, at the end of the day no one loves a section 151 officer who loses the investment capital.
Remember, If it goes wrong it won’t be councillors who will be looking to carry the can. It will land fairly, or otherwise, on your desk.
Chris Buss is finance director and deputy chief executive at Wandsworth Borough Council.
