Housing and Subsidy Control

The current government intends to increase the housing supply by virtue of a well-defined programme of development of brownfield and lesser quality greenfield sites. The idea is to capitalise funds along with local authorities which would invite both public and private sector investment. The funds will then finance developers to create or upgrade residential accommodation with a focus on social and affordable housing.

In addition the government intends to develop new towns in conjunction with local authorities and contribute public funds for the development of residential accommodation at these locations.

Where public funds are involved in the development of residential accommodation, whether for commercial sale or let, or sub-commercial (social or affordable) provision, there is a risk of subsidy as those public funds may be deemed to be distorting the housing and real estate management market. Whether or not a subsidy indeed arises depends on how the public funds are deployed.

Housing projects and subsidy

A commercial housing project financed from the commercial markets does not involve subsidy. Neither would a commercial housing project financed by the State on commercial terms, for instance a local authority providing a developer with a loan on terms comparable to what a bank would provide to it.

Where subsidies can arise are where State funds are given to developers on less than commercial terms. This could be direct by way of sub-commercial loans or grants to construct the residences. Or it could be indirect by guaranteeing the deposits of first time buyers without extracting a commercial fee for the guarantee. The indirect beneficiary is the developer since the guarantee would increase demand for its housing.

There may also be a subsidy involved in capitalising a local or National fund for the delivery of housing projects. The subsidy could arise to private sector co-investors like institutional investors, developers, property management enterprises or even registered providers. This would be the case where the State investor in the fund does not obtain a return commensurate with the risk it takes to engage in the fund, for instance where it’s return is subordinated to the private sector co-investor in any way.

Once the risk of a subsidy is identified, then it must be ascertained who the actual recipient is.

Recipient of housing subsidy

There are several potential recipients of subsidy in a housing development project. Using a case study, a local authority may invest in a fund together with a private sector institutional investor. The fund would then loan to or invest in a number of developers to build housing on brownfield sites. The housing would typically constitute a mixture of commercial and sub-commercial (social and affordable) residences.

If the local authority invests in the fund on terms subordinate to the institutional investor, for instance where it takes less return or delayed return on the otherwise same level of investment, then there may be a subsidy to the institutional investor. Again if the local authority lends money at less than commercial terms to the fund, there may be subsidy to the fund itself as well as to the institutional investor.

If the fund then provides sub-commercial investments or loans in the developer, this may be a further subsidy to the developer. Where substantial social and affordable housing are involved, this is often likely to be a given unless the commercial housing returns are good enough to bridge the viability gap caused by the sub-commercial housing. It follows that where grants or other gratuities (such as guarantees for less than commercial fee, waiver of debts owed to the fund or transfer of land at undervalue) are provided to a developer a subsidy is likely to arise to it.

What does one do when a subsidy arises

Once it is ascertained a subsidy arises and to whom, then the awarding body should check that it is not prohibited outright (for instance by way of unlimited guarantees towards deposits). It should then check that the subsidy is not subject to restrictions in any way, for instance by provision to an ailing or insolvent enterprise like a developer with an unsatisfactory balance sheet. The restriction is that the subsidy may need to be referred to the Competition and Markets Authority for approval in such cases before it is given. Finally it should check whether the subsidy is exempt from the detailed provisions of the Subsidy Control provisions, for instance where it is designated a Service of Public Economic Interest (SPEI) and other conditions apply (see below).

Once a subsidy is acknowledged as not being prohibited, restricted or exempt, then the awarding authority should self-assess its reasonableness under the Subsidy Control Principles, and in some cases the Energy and Environment Principles. This involves three steps to consider:

1. Is there an acceptable specific objective;

2. Does the project meet, or contribute to meeting, this objective; and

3. Is the subsidy the only or best way to implement the project?

In the case of housing projects, 1 and 2 are self-evident given the chronic lack of supply and seeming insatiable demand for the subsidised product. 3 needs a little more application, particularly in assessing a viability gap between the initial capital cost and the projected development value of the completed estate (or if ownership is to be retained by the developer, the present value of operating surpluses over the estimated economic useful life of the houses built).

Given the need for developers to include a certain element of social and affordable housing in the project to secure planning permission, this would contribute to the viability gap. Additionally such developments often include costs of a site-abnormal such as remediation or conservation deficit, the provision of public realm and other infrastructure, the location and also the delivery of community facilities which would contribute to a viability gap as they provide little or no revenues against the construction and maintenance costs.

The strange case of Social Housing and Affordable Housing

As noted in the previous paragraph, a viability gap would explain why a subsidy is necessary, but also that it has minimal distortive effect as a result. The provision of social and affordable housing would naturally contribute to the size of the viability gap, given these would be construction costs which simply would not be covered by future revenue surpluses (which are unlikely to arise).

One would therefore sympathise with the view that such developments, whether standalone or associated with larger commercial developments, should be exempted from the Subsidy Control provisions. This is indeed the case to a limited extent where a subsidy is categorised by the awarding authority as an SPEI (these particularly include social housing and social and community services) and the subsidy itself is less than £725,000 over a period of time. The limit looks substantial until one realises that it must include certain other subsidies received by the recipient in the recent past.

This means that for other SPEIs the Subsidy Control provisions apply as normal even where significant social and affordable housing is involved, which is odd to say the least, and therefore considerably more conservative than the parallel State aid regime practised in Europe (these would be block exempted from further consideration if certain conditions were met).

Until an equivalent exemption is developer in the UK, the awarding authority must consider the Subsidy Control Principles for non-exempt social and affordable housing subsidies. There is a let off for when the application of these principles prevent the implementation of the project, but there are no further explanations as to when such circumstances may arise. However given that a viability gap must be ascertained at the outset to satisfy the classification as an SPEI to start with, assessment of the Subsidy Control Principles should then follow relatively easily from there.

Conclusion

The current government has two well-defined agendas, the development of more housing and increasing the co-operation between the UK and the EU. Adherence to Subsidy Control is important to meet both these objectives. This is because State funds are expected to be co-invested with the private sector in the development of the housing which will in turn have a significant social and affordable housing provision. Given this aspect the likelihood is that at some stage during delivery a subsidy may well arise as the sub-commercial housing provision may reduce the project’s return on investment to a level that would not interest a commercial property developer.

The subsidy may arise from applying State resources into a housing fund, as well as where the fund itself passes on the capital to a developer. Potential recipients of subsidy would primarily be a developer, but could also include the fund itself or co-investors in that fund.

This article covers an area which is complex and hence not a substitute for detailed legal and accountancy advice. For further information or guidance please contact Jay Mehta.