View the article online at http://citywire.co.uk/money/article/a629833
Would you want your pension fund investing in housebuilding?
We desperately need more affordable homes, but plans to fund construction with local authority pension cash are built on shaky foundations, Lorna Bourke warns.
Recent proposals from the Future Homes Commission (FHC) to use local authority pension fund money to kick-start growth with a housebuilding initiative are well worth considering, and they are likely to win widespread support. But would you want your pension fund investing in residential housebuilding?
Nobody disputes that more homes are desperately needed, or that such a move would create thousands of new jobs. Households are being created at a rate of 250,000 a year, while new homes have been built at an average rate of just 150,000 a year over the past decade, and new starts are currently running at just 100,000 a year.
There is currently a requirement for over a million more homes to be built.
Are the returns high enough?
Research by the FHC showed that pension funds are desperate to increase the return on their investment portfolios. They have suffered declining contributions as a result of redundancies and increased payments to those retiring, along with stagnant investment returns over the past 10 years.
But there are problems with using pension money to fund housebuilding: the most important of which is the return required by the pension fund.
The FHC found that pension funds’ minimum is a return of between 7% and 10%. The current average return on buy-to-let in London and the South East is 6% at most – and this is the return on private sector, open-market rentals, not subsidised local authority housing or ‘affordable housing’ where the return is lower.
These are gross yields, too. Once management expenses, insurance, repairs and maintenance are taken into account the net yields are even lower.
Sector shunned by institutional funds
This is one of many reasons why investment in residential housing, as opposed to commercial property, represents just 1% of institutional funds’ investments, according to a recent report from the Investment Property Forum. This compares with as much as 47% in the Netherlands, 15% in France and 13% in Germany.
UK life-insurance companies and pension funds have for years been busy selling off what residential property they held.
The FHC proposals acknowledge that individual local authorities have neither the expertise nor the size to invest in residential properties. Therefore, the FHC’s proposed Local Housing Development Fund is envisaged as a pooled, independent mutual investment fund of £10 billion out of the £180 billion currently held in local authorities’ pension funds.
According to the FHC the London Pension Funds Authority (LPFA)’s requirements, if it were to put pension fund money into housing, would be a total return of 8% to 10% a year from income and capital growth, an initial return in line with the return on 10- to 15-year gilts (currently around 3%) increasing in line with inflation, and a clearly defined date for the fund to mature of not more than 10 years.
LPFA would be looking for ‘sustainable, high-quality investments, period tenancies within the life of the fund, market rents increasing in line with the retail prices index, and management and strategies to minimise voids and maintain the properties’. This is quite a tall order.
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