15    Home Investment by Partnership Rent

Bill Powell Tel: 01827-718945 <[email protected]> 20th February 2004.

1 Climbing on the Housing Ladder

Many are unable to ‘climb aboard the housing ladder’ because they do not qualify for a mortgage. They are not credit worthy. There are many reasons for this: Youth in Training; a Career Break; Old Age; Loss of Income; Ill Health; Marriage Breakdown, etc. Such people are forced to rent.

The sale of Council houses under ‘right to buy’ has depleted the supply of social rented accommodation. ‘Affordable Housing’ polices are attempting to provide a new supply of housing below open market rents or prices. Those who buy at these ‘affordable prices’ are in their turn bound to sell at below open market prices. In plain English ‘Affordable Housing’ means subsidised housing. It is subsidised in perpetuity (or until bought under ‘right to acquire)’. The subsidy may come from government via the Housing Corporation and / or from the purchase of land at below market price via the Planning process.

‘Shared Ownership’ is another at-tempted solution. The occupier takes out a mortgage for 50% of the property and rents the other 50%. This does lower the hurdle. But it is no answer for those who do not have a stable income. ‘Affordable Shared Ownership’ schemes are more common. In these the house is always valued below market price.

Those who rent find their payments increasing until the day they die, whereas those who build up an owner-ship stake have it to fall back on or pass on to their heirs. Many who rent would like to buy, as has been demonstrated by ‘right to buy’.

There is an alternative method for sharing ownership. The property is owned by a ‘Limited Liability Partner-ship’ between the occupier and an investor. Its rental value is revised every year. The occupier is himself a partner. He therefore receives some of his rent back as a discount.

The occupier may increase his share in the Partnership by buying from the share held by the investor. He could eventually buy the property. If he does not increase his share he is simply renting.

2 Purchase by Mortgage

The spreadsheet below shows the purchase of a house costing £110,000 by means of a mortgage repayable over 25 years at 5.5% interest. It assumes that the purchaser’s down payment is £10,000. He therefore starts with a debt of £100,000 that reduces year by year. His repayments of £621.24 p.m. pay off the loan and interest over 25 years.

Suppose Mr Smith lives there for five years. In that time his equity grows at £592.03 p.m. and reaches £44,742. In effect living there has cost him only £42.21 p.m.

Mr Smith then sells for £133,832, pays off his outstanding loan of £89,089 and moves to a better job. He now has a higher salary and with his down payment of £44,742 he buys the home of his dreams - on mortgage of course.

Mr Jones who lives next door is not so lucky. His employer goes bankrupt. Mr Jones finds himself out of work. He can’t pay his mortgage. His building society ‘repossesses’ his house and puts it up for auction at a reserve price of £89,089. (That’s what Mr Jones owes.) It sells for £90,000. He has no home and no income.

Over those five years Mr Jones’ equity £10,000 has shrunk to £911. His accommodation has cost him £772.72 p.m.

There are many who do not even get as near climbing the housing ladder as Mr Jones! They simply can’t get a mortgage in the first place.

Note 1: The spreadsheet is recalcu-lated on a yearly basis, which differs slightly from modern computerised monthly or even daily accounts.

Note 2: In the real world the mortgage interest rate will change and house prices tend to fluctuate between periods of rapid rise and periods of stagnation.

Note 3: I’ve chosen the same figures as used to illustrate the NOAH ‘Shared Ownership’ scheme proposed for Key NHS workers.

3 Purchase by Partnership

The Spreadsheet below shows the purchase of the same house over 25 years by means of a Limited Liability Partnership between the occupier and an investor. The same figures are used for the down payment, return on investment and house price inflation as above.

Note that the house is owned by the Partnership, not by the occupier or the investor. The down payment of £10,000 gives the occupier an initial share in the Partnership of 9.1%. Each year the occupier buys 3.64% of the Partnership from the investor. At the end of 25 years he has bought out the Partnership and owns the house. The end result is the same.

The basis of payment however is quite different. The Partnership’s property will generally increase in value, e.g. 4% p.a. In addition it receives an agreed rent from the occupier. In this ex-ample this is 1.5% of the current value of the property. The overall return is therefore 4.0 +1.5 = 5.5%.

For example, in the first year the occupier pays the Partnership rent of £1,615 but receives 9.1% of this back making his rent bill £1,500. He also pays £4,000 to buy

3.64% of the Partnership, increasing his own share to 12.7% in the second.

Each year he buys a further 3.64% share in the Partnership, and each year all values, payments and discounts are 4% higher than the year before.

Over the 25 year term his monthly payment increases from £458.33 to £854.43 p.m. i.e. 2.5% increase per year. His income is likely to rise at least as fast. The first step onto the housing ladder is much easier to make.

The real importance of Partnership is its flexibility. Consider Mr Jones who loses his job after 5 years. He then owns 27.3% of the Partnership. It is unlikely to accept only £90,000 for the house because Mr Jones would get £24,570 of it leaving the investing partner only £65,430. If it forced a sale it would look for the best it could get. Mr Jones should get the open market value of his share, i.e. £36,500. That would help him move to a job elsewhere.

It is more likely that he would be excused buying his usual £3.64% share and pay only his rent of £1,387 (£115.58 p.m.) in the sixth year. That is much lower than any ‘affordable’ or council house ‘rent’. If he could not even afford that he might sell back some of his share of 27.3% to meet the cost. The Partnership would have no financial reason to evict him until that were exhausted.

The scheme does depend on the 4% p.a. assumed increase in house value. The figure could be agreed in advance. Or it could be in accordance with some national index. Or it could be a revaluation of the house by a qualified valuer.

Agreement on rent at 1.5% of current value is even more important. Investors may look for more than this because they may view the assumptions more ‘volatile’ than under a mortgage. For example, a rent of 3.0% would make the overall return 7.0%, and take the monthly payment up from £458.33 to £583.33 during the first year. But a 5.5% return over the long term, which is secured against property, would be attractive to many institutional investors. It is a better return than most have achieved!

4 Rental by Partnership

Partnership reverts to rental where the occupier does not buy increasing shares in the Partnership. In private renting it is usual for the occupier to put down a deposit of one month’s rent. In the spreadsheet below that amounts to a share of 0.2% of the Partnership. He does become a partner.

But such occupiers are generally in no position to maintain the housing in good condition. The Partnership will therefore have to look after the property. The cost of this can be estimated from government figures that local authority landlords have to use. For N Warks Borough Council this is £1,462 p.a. rising with inflation, which I’ve taken to be 3%. This charge is added to the occupier’s payments. Payment in the first year then amounts to £259.01 p.m. Social rents for a house valued at £110,000 are similar. Note that this is an open market scheme. There is no element of ‘Affordable Housing’ subsidy.

The occupier could also build up his 0.2% stake in the partnership when his circumstances permit. If he is able to do this he may also be in a position to look after the property. There should be Partnership rules that permit him to do so when his stake in the partnership reaches a sufficient level..

The table right shows how the payments would be for 10 years assuming the occupier buys no further share in the Partnership.

5 Further Comments

In the West Midlands the government looks for ‘affordable housing’ to be priced 44% below open market values. The £110,000 house considered here would therefore be valued at £61,600. Under ‘Purchase by Partnership’ the 10% down payment would be reduced from £10,000 to £6,160 and the initial monthly repayment would fall from £458.33 to £256.66. The occupier would only be able to sell it on the open market through a ‘right to acquire’ clause.

If the home were ‘Rented in Partner-ship’ the maintenance payments would not change, but the rental element would be reduced by 44%. The monthly payments under ‘Affordable Renting in Partnership’ would therefore fall from £259.01 to £198.65 p.m. (i.e. from £59.77 to £45.84 p.w.)

Ownership of a single house can be risky. The lowest priced houses are generally in ‘twilight areas’. If such a house were bought by mortgage and instead of increasing in value by 4% it fell by 10% in the first year the initial equity of £10,000 would not have increased. It would have shrunk to £995. The owner’s capital would be all but wiped out.

Current ‘shared ownership’ schemes are half rent and half mortgage. That half mortgage of £50,000 could still wipe out any equity held by the occupier.

Under ‘Purchase by Partnership’ such a risk is much less because it is shared. The occupier’s share would be £12,600 instead of £14,560. It has still in-creased because he has increased his share of the partnership from 9.1% to 12.7%

Such risks to a Partnership are much reduced if it pools the value of many houses rather than just one as assumed here. The average value trends are much more predictable and institutional investors therefore much more likely to accept low returns and low rental element, e.g. 1.5%.

Housing Associations and Local Councils already pool their housing stock. ‘Rental in Partnership’ should suit them very well, attracting institutional investment partners and giving tenants a form of tenure in which they too could invest. If government approval can be secured for ‘social housing’ partnerships with this form of tenure it should become very popular.

‘Purchase by Partnership’ would also be more financially secure if values were pooled among many occupiers. But the Englishman regards his home as his castle and wants to own it! A solution might be to pool the land values in a large partnership of occupiers, but assign the value of the bricks & mortar to another partnership of just that occupier with the investor. This would maximise his incentive to look after his property. If he let it fall down he (and the investor) but not the other occupiers would suffer the fall in value.

6 Conclusions

Partnership tenure based on rent sharing offers those with very low credit rating a route to accommodation at lower cost than current methods. It is also suitable for house purchase with much lower risk than by mortgage. Payments can be more readily matched to the income of the occupant. There is a simple migration path from rental to investment in property. It provides a way to pay for periods of low earnings.

Open market payments are forecast to be comparable to those prevailing for social housing. Payments could be even lower if the property were acquired and held at discounted values under ‘affordable’ social housing principles.

The use of Limited Liability Partnerships in connection with property ownership is a new option. The hotel industry has already made use of it. It is even more suitable for housing.

Bill Powell