Learning from the land of opportunity: Could a US-style system of low income tax credits boost affordable housing in the UK?

What do you do if you have an ambitious pledge to build 1.5 million homes and constrained public finances?

Keir Starmer’s Labour party put the figure at the heart of its general election campaign and has moved with speed on measures to reform the planning system in a bid to get Britain building. Starmer’s hope is that removing planning red tape and delegating fewer schemes to local planning committees will help to speed up the supply of housing.

But, as the National Housing Federation points out, the target will not be met unless the government also significantly boosts affordable housing, which traditionally has been heavily reliant on grants. The trade body estimates that 90,000 social rented homes are needed each year to meet current levels of housing need.

The problem is that this would require billions in upfront grant funding if the government were to meet a significant proportion of the cost. The Centre for Economics and Business Research (CEBR) has estimated the cost of building these homes to be £35.4bn. If government grants cover just a third of it, this would be a cost of £11.8bn.

The CEBR points out that the investment would pay itself back within three years as the benefits to the economy would outweigh the cost.

However, the problem is that the government has set itself strict fiscal rules governing short-term spending and financial experts are warning that, as things stand, it may well breach these. Even if the imminent spending review includes a more generous than expected affordable housing settlement, the pressure on the Ministry for Housing, Communities and Local Government to come up with models that do not have a high up-front cost to the taxpayer will persist and officials are busy considering several alternative models to lever in more private finance into affordable housing.

The government’s dilemma is how to boost affordable housing, at a time when many housing associations are also constrained financially, without making the up-front fiscal position of the public balance sheet worse. The answer, according to an influential group of activists, could in part lie on the other side of the Atlantic Ocean.

Low-income housing tax credits (LIHTC) have been used as the primary funding tool for affordable rental housing in the US over the past few decades. The mechanism, under which the government foregoes future tax revenue to incentivise institutional investment to support sub-market housing, has funded more than four million homes stateside since 1986.

The model is being pushed by members of the pro-development Labour YIMBY group and the cross-party group YIMBY Initiative, which sees it as a complementary model that could be used to lever in finance for sub-market rental housing without upfront cost to the taxpayer. The latter has enlisted the support of Barack Obama’s housing secretary Shaun Donovan, who is in the UK this week promoting the model.

UK Treasury officials, as one may expect, are understood to be interested.

How the model works

In the US, the federal government allocates tax credits to state governments (in the UK, this could be councils or combined authorities).

The public authority sets criteria to determine the type of housing it requires to be delivered. This could relate to affordability (in the US, this is measured by the percentage of homes within developments set at lower rent levels for householders with below average local incomes), or energy efficiency requirements. Developers then bid for the tradeable credits. Once the credits are allocated, developers then sell them to an investor, via a syndicator, to lower the risk.

Once the homes are inhabited, the investor draws down tax relief over a period of time. The developer must maintain the affordability of the homes for a set period, such as 30 years. If compliance is not maintained, the government can withdraw the credits.

So what are the benefits?

“The main thing is that it doesn’t increase public sector borrowing,” says Chris Worrall, a member of the Yimby Initiative and executive committee member of the Labour housing group.

“We’re at about 95% to 100% debt to GDP ratio, the government has a plan for growth, but the issue with borrowing above that level – why we have such fiscal discipline at the minute – is that, for every 1% you go above 100%, you get 0.4% negative GDP growth. So capital investment programmes that involve grant are limited in scope [currently].”

Steve Partridge, director and head of housing consultancy at Savills, agrees. “In the run up to the spending review, the government line has very much been ‘give us ideas that don’t hit the public purse within the next five years’. Because that’s the crunch point for the fiscal challenge,” he says.

Under LIHTC, there would obviously be a cost to the Treasury in foregone tax revenue, but as it is a reduction in future income it does not affect short-term fiscal metrics. “It kind of drips out over time, doesn’t it? You never take into account the tax you never had, from that perspective it’s an interesting idea worthy of investigation,” says Partridge.

Worrall insists that the value for money of LIHTC is better than the current system for funding affordable housing, once you take into account the interest costs on the finance that goes in, although this is a bone of contention (more of which later).

A key part of the model is its “pay for success” nature. Worrall sees the model as sitting outside of the current social housing regulatory regime. Pay for success means money is only released when homes have been built and are inhabited.

To carry on receiving the tax credits, the development must continue to comply with the council’s requirements, with inspectors assessing the properties every couple of years to ensure they are being maintained to a standard. The Treasury would be able to claw the tax back from the investor in the event of non-compliance.

“They have very low levels of non-compliance [in the US] as opposed to the significant increases in [Housing Ombudsman] severe maladministration cases we are seeing in the current social housing sector,” claims Worrall.

“If there is a compliance issue or failure, the investor in the tax credit then sues the owner operator as a result of that tax being clawed back from them. So there’s a financial penalty to the owner operator. And funnily enough they comply.”

Partridge says Savills has conversations with American investors who have taken advantage of the LIHTC model in the US and are thinking about how it could work in the UK. “One of the challenges for them would be to make sure that the regime around it – the reporting, the regulation, the monitoring – is as friction-free as possible,” he adds.

Proponents of LIHTC argue that the longer payment timelines and compliance requirements could appeal to pension funds with varying liability timetables and needs.

Worrall suggests the backloaded nature of the payment means there is an incentive to get on and build homes. He says there are economic multipliers from getting homes built in this way and it could, for instance, be used to solve urgent supply issues such as the current crisis in temporary accommodation.

Another argument for a tax credits system via local authorities, as opposed to through Homes England, is that it improves local accountability while making it easier for SMEs to win work. Worrall says there is a perception among Labour members that Homes England often “favours the big boys”, meaning the large developing housing associations and housebuilders.

From the investor point of view, the YIMBY Initiative believes the model could help to attract finance from investors looking to hit their ESG metrics who might not otherwise be looking at funding affordable housing.

Worrall stresses that the LIHTC model is complementary to other funding models and could be used in a versatile way. “This LIHTC model could help us deliver 200,000 to 400,000 or more homes,” he says, “because it might be that it is deployed at a different tenure that doesn’t fall under the housing regulator.

“It could be that it’s care leaver homes or keyworker housing or goes directly to solve temporary accommodation crises across the United Kingdom.”

The case for LIHTC on many levels is compelling – but there is also a great deal of caution about the model.

Would it actually work in the UK?

The most obvious point to make is that this is a model that has demonstrably worked in the US, but the US is not the UK, with its mature social housing sector and a public/private model that has been successful since the 1980s in attracting finance into the sector, while the burgeoning for-profit registered provider sector looks set for rapid expansion.

John Perry, policy adviser for the Chartered Institute of Housing, points out that “there is practically no social housing” in the US. LIHTC is estimated to have delivered around 90% of affordable housing over the past few decades, and in a sense is the only serious game in town across the pond.

Perry says the only difference between a tax credit and a grant is the credit is spread across 10 years and doesn’t score against fiscal rules. “The question is whether tax credits have anything to offer here compared with the system already in place,” he adds.

“Would it be worthwhile setting up a whole system, involving local authorities, to administer what would be a pretty complicated scheme? Obviously, it is central to housing support in the US, but in a completely different context in which there is virtually no social housing in the form that exists in the UK or most of Europe.”

This sentiment is echoed by Rob Beiley, partner at law firm Trowers & Hamlins, who has looked extensively into the LIHTC model. “There is a risk that you massively overcomplicate how affordable housing is delivered in England,” he says. 

“We do have a very well-established and well-trodden path, and one that works in relation to the affordable homes programme, either delivered by Homes England or the Greater London Authority, and I think it worth asking whether or not there is any benefit in duplicating that regime under the LIHTC model?” he says.

Would it be worthwhile setting up a whole system, involving local authorities, to administer what would be a pretty complicated scheme?

John Perry, policy adviser, Chartered Institute of Housing

Whereas Worrall sees strength in the regulation by the investor in the US LIHTC model, Beiley is sceptical whether this would be as robust as that provided by the Regulator of Social Housing: “There is a compelling argument that, actually, if you are putting taxpayer resources into subsidising affordable housing [through foregoing tax], that should be properly regulated.

“And, again, we have got a very well established, well respected regulator. Why would you move away from that?”

Similarly, the established for-profit registered provider model has been successful in the past few years in attracting institutional investment, with Savills estimating the market could grow to 150,000 homes within five years. The consultant giant’s recent survey of FPRPs found that debt costs and regulatory burdens are the biggest barrier to investment.

Meanwhile, a group of FPRPs called the For Profit Provider Network has written to Angela Rayner calling for adjustments to rules that “disadvantage for-profits vs non-profits”, such as Stamp Duty Land Tax, grant repayment and access to exempt accommodation payments.

Rather than set up LIHTC to attract more institutional investment into housing, might it not be easier to simply tweak rules and regulations to make it easier for investors to turn on the taps via the FPRP route? This would have the advantage of being within the social housing regulatory framework.

An investment expert, who declined to be named, said this is where many institutional investors’ lobbying is focused, rather than for the LIHTC model.

Whereas setting up LIHTC would not be straightforward and risks duplicating aspects of other models, surely this can be overcome if there is a compelling argument that the model delivers better value for money for the taxpayer overall than the traditional grant funding route?

There’s no point introducing another model to the system if it offers comparable or worse value for money to the public purse 

Paul Hackett, chief executive, Southern Housing

 

Paul Hackett, chief executive of Southern Housing, says he has yet to see the figures or cost benefit analysis to suggest that LIHTC is better value for money than the current system: “That’s my first really big question. There’s no point introducing another model to the system if it offers comparable or worse value for money to the public purse.”

By contrast, Worrall appears to have no doubts that the model is cheaper in terms of the direct funding cost to the taxpayer in the longer term. He takes the example of a home that costs £400,000 to build.

If, for example, half the cost (£200,000) is financed by a housing association loan underpinned by taxpayer-funded housing benefit, and £200,000 through a grant from the government funded by Treasury borrowing, there is interest to pay on both elements.

“When you are looking at a period of more than 30 or 40 years, borrowing at 5% rate, the cost rises to something like £1.4bn,” Worrall says. LIHTC, by contrast, does not include interest costs, so the proportion funded through the tax credits is better value for money over the longer term.

The value for money debate

This may be true, but surely value for money should also take into account the long-term benefit of the product that is funded?  And the product funded through LIHTC, at least in the US version, is different to traditional social housing in the UK.

Under LIHTC, the home remains affordable only for a set period of time and then flips back to market rate. And this is probably the thing that is creating the biggest doubt about LIHTC, at least when it comes to funding general needs housing.

Hackett says: “There are a number of specific issues relating to it that make it less attractive than other forms of affordable housing investment. One is that, in the US, the model doesn’t provide affordable housing in perpetuity, that tax credits are granted for a period of time when the housing is let to people on low incomes, but at the end of that period, it then is flipped into the private sector.

“I believe there are separate funding pots available to something which they call preservation – which is, in effect, ensuring it remains as affordable housing for another period. But that requires another funding pot or funding mechanism to keep it going.”

Hackett points out that, by contrast in the UK, once the government funds social housing, it is “social housing forever”, and if a property is sold the grant gets recycled. He suggests this has to be considered when comparing the value for money of the two models.

Savills’ Partridge says this is the “equivalent of grant disappearing after 25 years and having to repay it […] That could be a pretty big constraint, to be honest,” he adds.

LIHTC is just one of many ideas being considered

The supporters of LIHTC are strongly pitching their model at a time when the cash-strapped Treasury is challenging the sector to come up with alternative ways of funding affordable housing, and people have not been shy to come forward.

Housing Today and the G15’s amortised grant model is being considered in Whitehall as a way of getting more public investment into affordable housing through the existing infrastructure without affecting the government’s balance sheet (as some or all of the funding is repaid, it can be classed as an investment).

Institutional investors are lobbying for deregulation to get more investment in to the sector via for-profit registered providers of social housing, and there are also believed to be discussions in Whitehall about ways to make it easier for housing associations to sell shared ownership properties into a vehicle to free up capital.

And, of course, the traditional social housing sector continues to lobby for higher grants, rent convergence and a long-term rent settlement.

An idea ‘worthy of further exploration’

It may be that the market place for funding solutions is simply too crowded. And, while most recognise the fact that the LIHTC model has the advantage of not requiring up-front borrowing, there are doubts as to how it can be used and what it adds that other models do not.

The Local Government Association, which represents councils in England, does not have an agreed position on low income tax credits, while investor body the British Property Federation (BPF) can at best be described as only cautiously supportive.

“This looks like an interesting idea and is worthy of further exploration,” a BPF spokesperson said. “However, we would not want it to distract from the urgent need for government to encourage greater investment into affordable, and especially social, housing.”

You could target this system at need which isn’t being met by the current grant system, and in that way, it genuinely becomes complementary

Rob Beiley, partner, Trowers & Hamlins

To be fair to Worrall and his fellow LIHTC supporters, they are pitching the model as a tool that complements the other funding models, rather than replacing them. Worrall suggests it could be used to tackle specific problems that are not being addreed sufficiently through the traditional routes.

“We don’t want to hypothecate and tell you this is exactly how it would work in the UK,” he says. “But there is a model there that could work really well in helping to solve a number of problems that the country is facing [such as] sales velocity, getting rid of section 106 properties that developers can’t get registered providers to buy for love or money and a lack of incentives for new entrants into the market.”

Beiley echoes this sentiment: “You can see that there might be some attraction in utilising this to address temporary accommodation [shortages]. Equally, there might be some merit in using the system for key worker or essential worker accommodation.

“In other words, you could target this system at a need which is not being met by the current grant system. And, in that way, it genuinely becomes complementary.”

The LIHTC model is certainly setting tongues wagging in the affordable housing sector and in Whitehall. However those expecting it to take off in the way it has in the US will almost certainly be disappointed.

There is scepticism that it offers the same real value as the traditional model once you consider that the homes are not affordable in perpetuity – and also a hesitancy about setting up a whole new infrastructure to deliver it.

But there may just be a role for LIHTC in providing funding for specific housing issues that are proving difficult for the current funding regime to tackle, all while not worsening short-term government borrowing – something which is rapidly becoming a priority as Rachel Reeves tries to boost growth and stay within her fiscal rules.