Social Housing Development Costs

Kenneth Gibb & Tony O’Sullivan

Background to the Research

• The Firm Foundations argument and its implications

• Motivation for the study and the research brief

• Research methods• (Quantitative) secondary evidence 1• Secondary evidence from previous research• (Quantitative) secondary evidence 2• Key actor interviews and case studies• Conclusions and recommendations

Firm Foundations and its Implications

• According to Firm Foundations, over the past 5 years, the social housing sector has seen development costs rise significantly.

• In 2002 the average Housing Association Grant (HAG) subsidy per unit was £52,000 and in 2007 it stood at £79,000.

• This represents an increase of 35% above inflation.

• The Scottish Government considers such subsidy levels to be “unsustainable”.

Study Motivation

• The sector has assumed that this cost increase has been principally due to a combination of increased land prices caused by housing market growth and construction cost price inflation.

• The purpose of this paper is to establish whether these are in fact the main causes of the sharp rise in HAG levels, and to look at possible actions that could be taken to slow down or even arrest cost increases.

The Research Brief

• The research, funded by SFHA, was carried out with Tony O’Sullivan of Newhaven Research Ltd between December 2007 and January 2008.

• Main questions addressed:- Have costs risen as much as suggested? - Why have they increased?- Can the main drivers be identified?- What can be done to alter the trend?

Research Methods

• What does the policy and research literature tell us about development costs and the HAG system?

• What can available quantitative evidence say about development costs?

• What themes emerge from a wide-ranging set of key actor interviews?

• What lessons emerge from a small set of development case studies?

Unit costs and HAG per unit 1989-2007

Figure 1: Average New Build Social Rent Unit Cost and HAG per unit 1989-2007

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Unit cost

• Over the period 1989-2006 the unit cost rose from just under £43,000 to almost £115,000, or by 167%. This represents an annual nominal growth rate of 5.95% over 17 years.

• Over the same period, unit HAG grew from just over £33,000 to just under £77,000, or by 131%.

• Annual development cost increases after 2000 were significantly higher than they were prior to that year.

HAG Social Rent Unit Grant Rates 1989-2006

Figure 2: New Build Social Rent Unit Grant Rate (%) 1989-2006

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• Having been above 80% in the early 1990s, the rate fell significantly to 63% in 1999/2000, before rising subsequently to slightly under 70%.

Total Costs, Subsidy and Private Finance 1992-2006

Figure 3: Total Cost, Public Subsidy and Private Finance for New Social Rented Housing 1992-

2006

£0£100,000,000£200,000,000£300,000,000£400,000,000£500,000,000£600,000,000£700,000,000

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Private finance

• after dipping in mid 1990s the total annual expenditure on new social rented housing in Scotland for the most part increased strongly after 1998, achieving a total annual value of around £600 million in 2006/7, of which approaching one third was private finance.

New Build Social and Lower Quartile House Prices

Table 1: Price of New Social Renting Units Relative to New Build Generally

Year All New Build

Lower Quartile* RSL Average

Unit Cost RSL Unit Cost as a % Of All New Build Lower Quartile

1990 £39,670 £42,840 108.0 1991 £45,984 £47,253 102.8 1992 £49,000 £48,174 98.3 1993 £48,250 £51,270 106.3 1994 £49,356 £51,542 104.4 1995 £50,000 £55,241 110.5 1996 £49,995 £56,317 112.6 1997 £53,995 £56,612 104.8 1998 £58,995 £59,147 100.3 1999 £61,062 £61,154 100.2 2000 £62,995 £66,240 105.2 2001 £66,495 £70,932 106.7 2002 £76,950 £74,177 96.4 2003 £91,000 £80,457 88.4 2004 £108,700 £88,934 81.8 2005 £122,500 £101,932 83.2 2006 £129,950 £114,805 88.3

* Sasines data 1990-2006

• At the start of this period the unit cost of a social rented dwelling was, at £42,840, 8% more expensive than a lower quartile new build property in Scotland.

• In the mid 1990s the relative cost of a newly built property for social renting worsened relative to the lower quartile price of new properties as a whole.

• Since 2001 the relative cost of new social rented units has improved, and by 2006 it was the case that a newly built social rented dwelling cost 88% of the price of a lower quartile new built unit

• Over the period 2000-6, new build prices at the lower quartile more than doubled (+106%), while the cost of a new social rented unit increased by approximately 73%.

Scotland v England Comparisons

Table 2: Average HAG Per New Social Rented Unit, Scotland and England 1997-2007 Year Scotland England* Ratio Scotland/England

1997 £39,687 £22,642 175.3 1998 £39,030 £25,072 155.7 1999 £38,940 £29,209 133.3 2000 £42,567 £37,517 113.5 2001 £47,703 £48,638 98.1 2002 £50,986 £57,619 88.5 2003 £55,673 £63,456 87.7 2004 £58,203 £66,886 87.0 2005 £71,371 £66,886 106.7 2006 £76,917 £61,907 124.2 2007 £65,000 £61,907 105.0

* HC 47-II Table 4

• At the start of this period, average grant per unit was significantly higher in Scotland than in England – some 75% higher, at nearly £39,700.

• However, the per unit cash subsidy in England, rose more quickly than in Scotland between 1997 and 2004, and by 2004, the value of this subsidy in Scotland was only 87% that of in England.

• Subsequently it has again risen strongly in Scotland, although if Scottish and English projections for 2007 are accurate, there will now be very little difference in the subsidy in the two countries, in cash terms.

Why? Some Hypotheses

• A first point to note is the difficulty of accurate measurement of cost differences. Following on from this point, there needs to be recognition of the local dimension to development costs. We might expect local housing markets to present different inflation rates.

• Nonetheless, there are a number of possible reasons a) why development costs have risen so significantly since 2000 and b) in ways that differ to a degree between Scotland and England. These are that:

1. The cost of new housing generally has risen, due to rising land, construction, design or fee costs. Of these, land costs might be expected to play the most significant role in terms of different experiences in specific localities.

2. Differing policy frameworks in England and Scotland have caused unit development costs and/or unit HAG subsidy to differ.

3. Related to the last point, differences in the structure of the housing association sector in Scotland and England may have affected the relative efficiency of procurement, and the degree of competition faced by contractors in the procurement process.

Reviewing the Literature

• 2005 Scottish HAG Evaluation• Davis, Langdon and Everest, 2003• Calcutt Review, 2007• Barker, 2003

HAG Evaluation

• Over the period 1997-2002, real cost increases are largely explained by increases in house size, as measured by number of rooms and floor area.

• The quality of HA rented houses has improved in other ways over time, through the introduction of higher standards.

• interviewees attributed cost increases to increasing space and housing standards, while also pointing to increased land prices as an additional driver.

• However, adjusting for inflation and growth in floor area, the land costs met through HAG for rent fell by about 20 per cent over the period 1997/9-2002/3, while works costs, (either raw material or labour costs, or some combination of the two) rose strongly.

• Comparing change in construction cost indices with changes in HAG programme unit costs, “Scottish HA project development costs over the 1992-2002 period moved in exactly the same way as other construction costs across the country”.

• Overall, they concluded that, up to 2002/3 at least, HAG for rent investment had been highly effective. “Its key achievements have been in rental housing supply, neighbourhood stabilisation and improvement”.

HAG Evaluation (continued)

• Scottish system compares well with England in terms of lower rents, probably higher standards and more regeneration and rehabilitation work

• An English system would have generated procurement efficiencies and more private finance leverage but any such shift would put the CBHO movement (as a developer at risk)

• However, the Scottish HAG system is not conducive to procurement efficiency and encourages expensive bespoke design

Other Literature: Davis et al

• Analysis of cost and price movements in the Scottish construction industry 1985-2002 conducted by Davis Langdon & Everest (2003) found:

• Real capital costs increased by 5% for non-housing and 3% for housing.

• Material construction costs fell in real terms by around 10% and labour costs increased in real terms by around 28%.

• Real housing tender prices were fairly constant over the longer term, with productivity gains offsetting labour cost increases[2].

• However, tender prices showed evidence of cyclical behaviour over the short term, rising during periods of expansion and falling during periods of contraction.

• Construction prices within mainland Scotland can vary by up to +/- 9% around the Scottish average due to the “relative remoteness and/or nature of the construction sector in some areas”.

• Real tender prices for social housing projects in Scotland fell by 4% in real terms over the period as a whole, in contrast to England, where they rose by a similar amount.

Calcutt and Barker

• No evidence of materials costs driving up unit costs. Between 1995 and 2005, growth in the cost of building materials (24%) only slightly exceeded RPI growth of 22%.

• Evidence for labour and capital cost increases playing a role, with the cost of labour and plant nearly doubling over the period (+98%).

• However, there is little in the evidence presented by the review to suggest this source of pressure on unit cost increases has become significantly greater in recent years, compared to the pre 2002 period, or that it impacts differentially in different parts of the country.

• The reported widespread perception that land for housing development is in short supply. “It has been constantly emphasised in evidence submitted to us, not just by housebuilders but by a wide cross-section of stakeholders”.

• Barker (2003) concluded the underlying constraint on increasing housing supply to be land supply. Land supply is constrained by a range of factors, including:

• Increasing complexity of site development given increasing use of brownfield land where significant remediation may be required

• Difficulties of site assembly where ownership is fragmented • Operation of the planning system and its influence on available land• The extent to which development is seen in localities as politically

contentious

Secondary Evidence on Land Prices

• Evidence on land prices is difficult to find. The only plausible source is that published by the Valuation Office Agency. The Valuation Office Agency (VOA) publishes figures twice a year on a regional basis for the UK as a whole.

• These figures provide an estimate of the average price of bulk land (in excess of two hectares) with planning permission.

• A considerable advantage of the VOA land data is the time period it covers. Average values are reported as far back as 1983.

• In the following analysis the VOA land data has been combined with simple average new house price figures published by the Department of Communities and Local Government which are also available on a regional basis and for a long run of years.

• Looking at residential land prices (in £ per hectare) between 1988 and 2006. land prices rose from £200,000 in Scotland to £1,830,000, or roughly by a factor of 9. However, more than half of this increase occurred after 2002.

• Over the period 1988-2006, average new house prices (in nominal terms) rose from around £45,000 to over £190,000 in Scotland, but again the bulk of the increase occurred after 2002.

Land and House Prices

• the (correctly signed and statistically significant at 0.01 per cent) correlation coefficient between annual house and land price inflation in Scotland over the period 1988-2006 is 0.479.

• Scotland has seen a changing relationship between land and house prices recently , with an increase in land prices from £780,000 in 2001 to £1.8 million in 2006 being associated with an average new house price increase from £98,000 to £190,000 over the same period.

• The evidence supports the conclusion that the single most important factor in escalating social housing development costs in Scotland and indeed in the rest of the UK has been land price increases, particularly since around 2002.

Figure 11: Land and new house prices (1988=100) Scotland 1989-2006

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A Range of Interviewees

• Turning to key actors, we sought out a wide range of views from across the sector:

• Two major housing developers, • A leading housing construction firm,• A community-based housing association, • A national housing association, • A cost consultant, • A representative of Communities Scotland • A representative of a city council. • Case studies involved further interviews with two

national housing associations

Interviewee Findings

• The nature and extent of the problem• Scotland v England comparisons• Cost drivers:

1. The price and availability of land

2. A greater reliance on abnormal land

3. Construction contracting dynamics

4. Housing quality and standard types

5. Buoyant markets

6. Policy/regulatory unintended consequences

7. Infrastructure• We return to proposed responses in the conclusions

Case Studies and Their Lessons

• Shortroods, Paisley• Ardler, Dundee• West of Scotland Development Programme

Partnership• The Larach Alliance

Conclusions 1: The ‘Perfect Storm’

• Land cost increases on the back of an asset bubble in the private housing market (where land price is determined as a residual cost).

• Increasing land decontamination costs (due to the proportion of brownfield land within the development programme, a need to meet rising standards with respect to decontamination, and stricter controls on dealing with residual material post decontamination).

• (Possibly) a reduced willingness on the part of landowners to supply land to the market, due to S75 requirements, which has also acted to push up land prices.

• RSLs have not helped themselves to contain unit HAG levels, by keeping rent increases as low as possible, and (less laudably) by pursuing individual design standards on a scheme-by-scheme basis where a lower mass production specification seen as suitable for the private market would do

• There may be some scale economies in procurement, but not of a very significant nature in terms of lowering the unit HAG cost. This is not to deny possible wider efficiencies in construction

Conclusions 2: Recommendations for Further Action

• A land assembly agency, while not cheap raises possibilities of removing one important kind of risk and of opening up new development finance opportunities. This is worthy of further investigation

• The in-principle case for securing buyer economies of scale (and scope) through lead development and larger partnered construction programmes is sound but would have to learn lessons from previous procurement strategies and be both relatively large and multi-year in duration to be effective.

• Larger and stronger associations with low debt (and also good management and strong boards) should be able to use their asset base through refinancing to assist lowering subsidy costs. Equally, some associations will be able to use reserves creatively.

• Multi-year programmes which offer opportunities for partnering, incentives to share risks and savings, and if large enough, the scale to generate procurement efficiencies and other possible benefits.

• There is a strong case emanating from the industry to undertake further research to investigate the ways to promote innovation and incentivise contractual relationships more efficiently.

• Standardised house types and construction methods should also be more creatively promoted to reduce the excessive costs of bespoke design.

• There is less of a case (HB cost and affordability problems) associated with seeking higher rents. Equally, constraining allowances would only contribute in a modest way to reducing the subsidy cost of new social housing.