The way to fair rents

Social housing currently stands at the cross-roads in terms of how and at what level rents should be set. Behind lies a legacy where housing association rents were allowed to increase in a haphazard manner, based more on the size of a landlords development programme than on what tenants were getting for their money. An implicit compact over the last decade saw the government steadily decreasing "bricks and mortar" subsidy whilst allowing landlords to increase rents to compensate.

The result is a housing association sector with markedly different rents for similar types of homes in similar locations. These rents have become increasingly unaffordable to many on low incomes, locking tenants into housing benefit dependency, and contributing towards a tripling of the housing benefit bill over the last ten years. Meanwhile the Housing Corporation's wholesale rent-capping around an Retail Price Index-based equation is a blunt instrument that only acts to lock-in this status quo.

Over the same period rents for local authority housing, with its own funding and regulatory regime, have increased significantly in read terms, but are still on average lower than housing association rents. Divergence between rents in the local authority and housing association homes has increased.

So where do we go from here? The government has a number of different roads it could choose to walk down. Their preferred route is expected to be made clear in the long-awaited housing policy Green Paper.

One route the government has expressed interest in is to structure rents to reflect those charged in the private housing market - a market or capital values approach to rent setting. It is argued that this would make social housing rents more consistent with those charged in the private market and give better incentives for tenants to seek value for money in their housing and for landlords to provide it.

Another route would be to structure rents to reflect the incomes of social housing tenants - an earnings approach to rent setting. This approach would match the ability of social housing tenants to pay, with the type of social housing stock they occupy.

The National Housing Federation, Chartered Institute of Housing and Local Government Association have jointly commissioned research by Cambridge University and the London School of Economics to examine these approaches, specifically in terms of the affordability implications for tenants. The report, entitled Evaluating housing affordability: policy options and new directions suggests a common approach for measuring affordability in the social housing sector and examines the affordability and government expenditure consequences of the rent reform options being considered.

So how would rents change under each of these two options? The report illustrates a rent structure based on house prices or capital values. As in the private market, the different rents paid for different sized properties under this option are much greater than exist currently in social housing. If social housing rents were to move to such an approach the difference between social housing rents for a 2 and for a 3 bedroom flat, for example, would rise from around 7.5 per cent at present, to around 32 per cent.

Under an earnings approach to rent setting based on the incomes of new lettings housing association tenants, the report shows that the difference between rents for different sized properties would also be greater than at present but nowhere near as great as that charged under capital values. The difference between rents for 2 and 3 bedroom flats, for example, would be around 12 per cent.

So how would these two approaches affect the pockets of tenants? Of fundamental importance to any rent reform is its impact on the financial circumstances of tenants. For working households on low incomes, housing makes up such a significant proportion of household spending that even very small changes in rents have a significant impact on disposable income.

Unlike in many countries, the government to date has been reluctant to offer a measure or means for assessing housing affordability. The report suggests that it is crucial that a widely-accepted set of measures for housing affordability emerges from the rent and welfare reforms if the affordability consequences of these policy changes are to be assessed and monitored over time. Such a measure should take into account the proportion of rent paid to income, the amount of income left over after paying for rent, and the level at which the household becomes free of benefit. This would allow social housing rents, in terms of affordability, to become more transparent and for welfare to work incentives for tenants to become much more apparent.

A capital values approach that ensured an adequate return on the value of properties for landlords (lower than, but similar to that received in the private market) was found to generate rents of around £70 per week for one bedroom homes and up to £220 for four or more bedroom homes. Rents at these levels would be ...well beyond the means of social housing tenants', and would push large numbers of working households into benefit dependency, undermining the government's welfare to work agenda. Such an approach has no place in a social housing sector.

A capital values approach, however, that held rental income for the sector the same, would see rents fall for those in smaller units - normally single people and couples without children. To compensate, rents for those in larger units - normally those with children, would have to rise. This increase would be substantial for the largest properties (four bedroom properties and above) requiring weekly incomes of around £360 to be free of housing benefit. The difference between housing association and local authority rents would continue to be the same as they are now.

Alternatively, an earnings approach that was affordable to working households (in this case that ensured tenants were free of partial housing benefit) would see significantly lower rents on average in both the housing association and local authority sectors. Average rents for the very largest properties would rise slightly, but because of the current benefit and tax credit regime, the report argues that there is room for such increases given the larger "residual" incomes of these types of households.

This earnings-based approach would also go the furthest to complementing the government's welfare to work agenda. Because of the savings in housing benefit, the report estimates that the net government expenditure for this more affordable option would be as low as £350 million per year, including additional subsidy to compensate landlords for any loss in rental income as a result.

Finally, if the government chose to use a "mix and match" approach to rent setting, another option could mix the benefits of a capital values approach that reflects the characteristics and value of the property, with the earnings approach that reflects the income of tenants. This "third way" may well be attractive to government, a commitment to such an approach would need serious research to determine what the likely outcomes would be for tenants and landlords alike.

The roads to rent reform are clearly laid out. It is now up to the government to choose between walking down a route that complements its welfare to work agenda, building on the already successful Working Families Tax Credit, turn to a regime where social housing rents begin to mimic those of the private sector, or take the middle ground with some combination of the two.