These stakeholders participate in their own ways in taking the crucial steps needed to increase the availability of affordable housing. Market players may even have several roles - a government can be a provider of support schemes as well as an off-taker of a development upon construction.
This almost provides a sense of comfort that through the cooperation and determination of these market participants, the housing shortage can be reduced; but there is one critical piece missing: the financing that allows developers to build these homes.
Within Europe, several models exist to enable affordable homes to be developed and constructed. In France for example, the provision of social housing is managed centrally, nationally or locally, by associations acting on the power of the government. The construction financing typically comes directly in the form of state subsidies, grants and/or loans from domestic commercial banks.
In jurisdictions where the banking system is very liquid, such as Scandinavia and Switzerland, the financing for development and construction projects is provided by the high-street banks. In Germany, although there is a market for alternative lenders as a substitute or complement to traditional bank financing, the loan-to-cost (LTC) and loan-to-value (LTV) ratios on typical development and construction projects are at such levels that potential lenders feel they would be taking an equity-like risk without obtaining the corresponding return.
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One might note that the models in place to finance affordable homes in the aforementioned markets all vary, but they have one noteworthy commonality: they restrict the existence of private debt actors financing the development and construction of affordable housing projects.
However, there are two countries in particular where the banking system alone is too constrained and simply cannot provide the sector with sufficient financing. The existence of alternative lenders such as private debt funds with the appropriate mandates is therefore imperative for increasing the housing stock.
The first country is Ireland.
The banking sector in Ireland has still not recovered from the aftermath of the global financial crisis. Consequently, house completions have fallen dramatically, leading to a severe undersupply of housing in the nation. In fact, the lack of housing is alarming and widespread to the extent that it has been quoted as the Irish government's "number one priority".
An undeniable result of the shortage both of affordable housing and of the financing for the development and construction thereof is the critical need for alternative lenders addressing this deficit.
England presents a similar picture.
In 2021, around 1.2 million households in the country were on local authority waiting lists for affordable housing.
Already in their 2019 election manifestos, all the main political parties included commitments to increase housing supply in England. The government's policy is currently to deliver an additional 300,000 homes per year with an increased focus on affordability.
Nevertheless, net housing supply is rather low compared to the government's ambitions and decreased in 2020-2021 compared to 2019-2020. Moreover, lending to the construction sector in the UK has been on a downward trend since 2011, and England shares the same problematic outlined in the case of Ireland: the lack of traditional financing calls for private debt funds and other lenders to fill this gap.
However, not all of them investing in this sector are suited to fill it; as the majority of construction financing opportunities are too small for larger players, they naturally present themselves to relatively smaller ones.
Investing in social and affordable housing through private debt in markets where key opportunities lie can provide an investor with a wide range of benefits. As outlined formerly, the lack of financing in the UK and Ireland means that private debt funds active in these markets face little price competition and can provide investors with attractive returns.
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These investments can currently produce double the annual yield of high-yield European listed corporate debt at similar maturities, all while financing a sector that has been accepted as the most defensive within real estate. Private debt generally also offers low volatility, and lower duration and shorter maturities than public markets.
The financing provided by private debt funds active in the social and affordable housing sector is key to delivering new houses.
Not only is this investment strategy defensive because of the widespread demand for the product it finances, but also because the off-takers on the development projects can be identified at the outset of the financing, before construction is initiated.
Increasing the stock of affordable housing and hence reducing the number of households on local authority waiting lists is the S in the acronym ESG. Private debt is not a homogenous asset class, nor is real estate.
Investors should try to identify defensive sectors that are more resilient to market shocks and experienced managers that have a prudent view on project LTC and LTV levels in their portfolio construction.
Colin Greene is head of private debt at Union Bancaire Privée (UBP)