Viability of the Sector

How do we assure viability? Facilitating government investment in community housing - protecting the investment

The community housing Sector has been the subject of a number of reviews over recent years which address such issues as the application of economic parameters and settings to social benefit. These include the NSW Independent Pricing and Regulatory Authority (IPART) ‘Review of rent models for social and affordable housing’, and the Australian Government Productivity Commission ‘Report on Government Services.

The Sector has undergone significant and sustained policy change. These changes have occurred structurally, through the size and shape of the Sector; programmatically through new and adapted programs; and through policy changes in Commonwealth and State governments. Further change has come from broader economic conditions.

The community housing Sector is facing increasing complexity with regard to both the operating environment in which they are working and the operational complexities required of their businesses. Client needs are becoming more complex, service delivery expectations are increasing, and reporting and compliance requirements are growing. A large proportion of CHPs are also focusing on diversification as a means of responding to the reliance on low-growth, government-linked income sources. This has not only introduced an increasing range of challenges and requirements but has led to increased pressure on costs.

The Registrar recently commissioned an analysis of the viability of the Tier 1 and 2 NSW Sector; part of the process involved isolating several expenditure and income pressures, identifying core drivers, and conducting sensitivity analysis to consider possible future scenarios.

It was found there are several strategic and economic factors that are clearly acting on the Sector and although while providing some pressure, they have also collectively been set optimally for some time, as is the case in the broader economy. Existing pressures have a significant impact on the Sector and should be understood, monitored and their effects considered in a regulatory and policy context in years to come.

From an operating perspective, the Sector is forecasting continued and growing profitability. However taking into account interest and depreciation, while profitability is forecast to continue, it will do so at a declining rate as interest expense obligations grow and depreciation increases from growing portfolio sizes. Considering only housing related segments of CHP’s (i.e. excluding areas of business such as aged care), profitability is also anticipated to continue from an operating perspective.

Reflected in continued positive earnings, CHPs are forecasting that total income from housing related businesses will continue to be greater than total expenses. CHPs are forecasting that rent will form a larger portion of total revenue over the forecast period, with declines in capital grants and NRAS (as the scheme winds up). Property expenses are forecast to reduce in proportion of total expenses, while employee expenses are forecast to increase.

The analysis also showed that CHPs receiving transferred units as part of the Social Housing Management Transfers are forecasting lower profit margins than those not receiving transfers, however greater growth rates. By the end of the forecast period, profitability for the two CHP types generally equalises.

Pressures impacting CHP profit margins over time

The pressures noted above arise from a combination of policy and economic settings, and include:

• Rents/Subsidies - The end of NRAS and the general escalation rates of income streams smaller than the growth in costs of inputs (e.g. Commonwealth Rent Assistance and community housing rent).

• Maintenance costs and issues such as:
  • Costs are increasing faster than the income streams that offset them (especially in company projections where they are involved in the social housing management transfer).
  • Short term lease structures de-incentivise preventative maintenance, costing more over time.

• Employee related costs including:
  • Complexity of front-line staff mix required for service coordination (especially with increased expectations for the provision of ‘wrap-around’ services and for additional layers of reporting for the SHMT).
  • Executive and management staff required to operationalise more complex business models.
  • Corporate overhead costs, including: processes and systems, tenders, project management teams, joint venture costs, legal costs, data, reporting, compliance and monitoring.

• Strategic pressures such as:
  • Economic conditions have been largely optimal for a sustained period.  It is unlikely that these will remain in place over coming years.
  • Costs of capital are likely to increase which will have a greater impact due to increased diversification thorough borrowing and development. While the national bond aggregator will assist through discounting rates against the market, the underlying market rates will likely increase in the medium term.
  • Asset value growth rates are likely to be lower which results in less flexibility of strategy.
  • The flexibility of asset control and the ability to align the characteristics of the stock to the characteristics of the clients is a key efficiency mechanism for future planning.
  • Strategic business systems are required to be more complex and thus require more investment up-front and potentially in maintenance.

Two potential negative consequences arise from these pressures over time that require ongoing monitoring, as well as innovation in policy and regulatory responses over the long term. These potential negative futures include:

• The combination of these pressures and likely shifts in the housing markets in NSW reducing the collective/Sectoral viability over the long term.
• The need for businesses to diversify to mitigate these pressures generates additional commercialisation risks on the Sector.

Sensitivity Analysis

To this point the Sector has been able to deal with pressures through diversification with increasing maturity of commercial elements. The Sector has strong balance sheets indicating a systemic level of capital.

Analysis of the Sector’s 10-year forward projections has enabled the Registrar to isolate and identify key factors impacting viability. Targeted engagement (through self-reported survey data from CHPs) has assisted the Registrar to further develop and test key themes. It is clear the Sector is sensitive to movements in these pressures over the long term.

To quantify the level of sensitivity, analysis was undertaken by changing the average percentage growth rate by 1% to 2.5% (-% for income drivers and +% for expense drivers) between forecasts 2018 and 2027 for the key drivers.

The sensitivity analysis showed that the biggest impacts on the Sectors financial viability occur in small declines in assumed rental growth and assumed property expenses. This sensitivity analysis has significance for the design of any new housing programs in NSW and also the management of the current social housing management transfer.

Next Page - Part 5: Looking Forward