As an architect working on both public regeneration projects and private residential and mixed-use developments which have run into serious problems over the past two years, I have an obvious interest in finding alternative ways to finance such developments. I have also been aware for some years of the problems of managing residential developments, where the current model is selling individual apartments or houses to investors who then rent them on short-term leases. The tenants have no say in the management of the development and the investors no interest. The result is that the owner-occupiers, often a very small proportion of the occupiers as a whole, are the only active participants in the management company. I know from managers of such developments and as an owner-occupier myself that this creates many problems.
One other major problem with public or private developments is rebuilding or redeveloping them when they become obsolete. Currently, each house or apartment is owned freehold and many local authority estates have been sold to the tenants. I have found over the years that bringing a large number of owners together is an almost impossible task.
When I came across the Community Land Partnership ideas put forward by Chris Cook of the Nordic Enterprise Trust, I recognised that this model could be an answer to both our financial and management and redevelopment problems. It offers an alternative path to property ownership and a stake in the management of developments for all tenants. It also presents a very stable and secure development model which should be attractive to pension and other investment funds. It shares some features with current tenant-purchase schemes and rent-to-buy schemes but provides a much more flexible framework.
I got together with an accountant, Kieran Ryan, who has considerable experience in property development, and a solicitor, Kevin Ryan, to investigate the feasibility of the model in the context of current finance, tax, management and property legislation in Ireland. We have consulted a number of interested parties, including banks, property developers, local government officers and property managers.
We consider that the proposed model can work satisfactorily in Ireland without any change in legislation though some adjustments might be made if it became common practice. There could also be considerably wider benefit in revising current 100-year-old legislation on Limited Liability Partnerships in line with recent legislation introduced in the UK and many other countries.
Applying equity partnership to urban regeneration projects
Set out below is a worked example of a major urban regeneration project in central Dublin within the canal ring. The calculations are based on a scheme selected following consultation with the existing tenants.
The land is owned by the local authority and its value is taken as nil when calculating “Capital Rent”. If land is valued at €1m or say €23,000 per dwelling, this would be added in calculating sum required to purchase Equity Shares. If own-door duplex/apartments are located at ground level in all apartment blocks, except those with commercial uses, more than one-third of all dwellings would have own-door access. This represents the general proportion of households with children across the city.
Therefore, the ‘capital rental’ is very affordable and there should be no problem letting the whole development. Tenants of the existing development or other prospective occupiers on the local authorities list would receive the appropriate level of subsidy.
Once the development is fully let, therefore it presents a very secure form of investment, so that if tenants or occupiers leave they can be easily replaced. They are not under pressure to pay more than the ‘capital rent’ but even at low current market rents, they can build up a substantial equity share within a reasonable period. If they have financial difficulties such as losing their job, they can just pay the current capital rent or even reduce their equity share until they are in a position to pay the required level of rent. If, on the other hand, their financial position improves, they can purchase additional equity shares.
The potential role of a pension fund
Such a secure form of investment must be attractive to pension funds. The basic capital rent at, say, 2,5% currently represents a good return for a pension fund but the figures also show that a 3% return does not make the scheme unaffordable. This return is independent of service charges. In addition to his basic capital rent, which is index linked, the occupiers are buying equity shares with their surplus rent which goes to pay off the original capital invested which the pension fund can now invest in further projects, but they are likely to hold a substantial share in perpetuity because, when occupiers leave, they are paid the full value of their share but the dwelling reverts to the partnership. It is proposed that a pension fund could purchase a portion of the equity partnership to either buy out the original investors or a substantial portion of their investment. The payment would include the sum invested plus a reasonable return in the current market for that sum. A reasonable figure in the current situation would be say 10%. This would increase the capital rental required by 10%.
The occupier
As shown in the above figures, equity partnerships offer many attractions to a potential occupier. It gives him/her much more certainty than current rent-to-buy schemes. It requires no borrowing and offers great flexibility depending on his/her financial circumstances at different times. It also involves occupiers in ownership and an input into the management of the scheme which tenants to not normally have. If occupiers want to leave the scheme, they are paid the full value of their equity share. If they have bought out their full share, they will receive the full market value of their dwelling.
The level of total rent required by the tenant to acquire the full equity share over a thirty-year period is calculated as the capital rent which will reduce by the proportion he pays above the capital rent each year plus an annual repayment at 1/30 of the capital cost, plus the operating / maintenance cost:-
Payments required to purchase full equity share over 30 years.
Capital Rent at 3.0% requires a total rent of – €11,641 p.a. = €10,574
Capital Rent at 4.0% requires a total rent of – €12,533 p.a. = €11,861
Average projected net market rental payment is – €11,784 p.a.
Therefore the owner can purchase a full equity share in thirty years at a net rental payment less than market rents if Capital Rent is at 3.0% or just above if Capital rent is at 4.0%.
I have not included the commercial elements of the project. If the density was increased to achieve say 900 units it would reduce the land cost per dwelling to €19,000. The density would still be a relatively low 51/acre for an inner city site and could be achieved in a low height format. This demonstrates the attraction for occupiers who may well be able to purchase their equity shares in a much shorter period if their financial circumstances improve. If their circumstances deteriorate then they can revert to paying the capital rent only or even sell some of their equity shares if necessary. Note: the figures shown are for 2010 Future rents will vary with the cost of living index.
The investor
For a local authority or a government agency, particularly one wishing to undertake a regeneration scheme, the equity partnership model offers an attractive alternative to conventional fiance particularly if a pension fund can be persuaded to take on the bulk of the funding once the development is fully occupied. It also offers an excellent management structure in which the tenants can be engaged and is much better alternative than selling dwellings to tenants in the current way because the local authority or agency does not lose the opportunity to redevelop schemes when they eventually deteriorate after a long period.
The operator
Housing associations might be strong candidates for the Operator role, as some of them have a good reputation for managing not only their own social element in current housing projects but also the public realm in the private element of such schemes. They could perhaps also act as the Developer / Operator on behalf of local authorities or government agencies and take on the Custodian role as their boards and senior staff include a wide range of appropriate professionals.
Advantages and disadvantages
Advantages:
- The model is not a straitjacket; it is inherently flexible and would be tailored to each regeneration opportunity.
- The model offers the potential to attract outside investment when fully let and demonstrably in successful operation. It should be particularly attractive to pension funds.
- For occupiers, they can own their dwelling, in time, without having to borrow. They also have an input in the management of the development as a member of the equity partnership: something they would not have as a renter of an investment property. They also become members of a community of stakeholders with a shared future. This core feature should make for more stable tenancies and a better experience for the occupier than possible in the private rental sector. An equity partnership also offers greater security of tenure compared to the private rental sector.
- For the local authority / investor – the model has many advantages, particularly its flexibility; it can give the local authority continuing control over key issues of social policy, while being able to dispose of a substantial element of its investment at early stage, to a pension fund or other investor.
- The development company has a project which it can easily let and which, when let, has a ready market for investors to buy out its share.
- It presents a much better framework for reconstruction or redevelopment, when the development becomes obsolete.
Disadvantages:
- The model is new and unproven in Ireland. While we do not see it as unduly complex or “over-engineered”, it may be viewed in that light.
- For those on low incomes and / or paying social rents, the possibility of building an equity stake may remain quite abstract.
- Residents may be reluctant to commit resources towards an equity share until the regeneration scheme is a proven success.
Examples of additional projects:
Conclusion
I consider that the equity partnership model presents a much better alternative to the current public-private partnership one as it does not require a private development company but only a contractor. It can recover the capital invested by the public body at an early date at a much lower cost to the taxpayer. It could form a major element in current proposals by the Construction Industry Council for funding major infrastructure projects using pension funds.
In the private sector, particularly in relation to projects whose funding loans will bring them into the NAMA portfolio, the equity partnership model must be a strong candidate as an appropriate development structure.
Current Irish legislation for Limited Liability Partnerships probably needs bringing up to date in line with recent legislation in the UK and elsewhere. The Limited Company is not a suitable vehicle for such developments. Equity partnership presents a model for future housing and mixed-use development which is very flexible and which promises home ownership to the occupier without the burden of a mortgage while at the same time offering a stake in the management of the development. For the developer and a bank, it substantially reduces the risk which has been so catastrophically exposed in the current market collapse. For the public authority, it presents a much more economically- and socially-sustainable model for development. If we wish to reduce the risk of future property bubbles, we should seriously consider using equity partnerships.
July 2011 update
While there is considerable interest from Funds for financing affordable housing, interest rates here have increased. It’s therefore thought necessary to consider an interest rate of 5% for calculating Capital Rent. However further decreases in land value and building costs help to balance the equation.
A further study of the Dolphin House Regeneration Project, using a lower rise solution without underground parking and using current service charges on a comparable scheme, shows that Capital Rent, plus service charges are very affordable, and the purchase cost of a full equity share is close to the current market rent.
Dolphin House Regeneration Project: July 2011
A second study of a further publicly owned site in the outer suburbs shows comparable results. Both studies are based on designs costed by a leading construction company.
Dublin Fringe Rail Based New Build: July 2011
Below are links to further recent outline studies based on a 4% interest rate, which would be still be very viable at 5%. We are hoping to undertake a detailed study on a “Ghost Estate” shortly.
New Build Development in Limerick Regeneration Area: July 2011
Ghost Estate: July 2011
Dun Laoghaire Apartments: July 2011
Sandyford Site for HCSA: July 2011