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MAY 2014

WWW.JRF.ORG.UK

REPORT

SMALLER HOUSING

ASSOCIATIONS’

CAPACITY TO

DEVELOP NEW

HOMES

Mark Lupton and Dermot McRoberts

This report

considers the capacity of smaller housing

associations to develop new homes and their ability

to utilise this capacity to provide significant growth.

Some commentators have said that the major unused capacity to develop new homes in the housing association sector is among smaller associations. There is a lack of hard evidence to support or deny the claims and the research for this report was therefore designed to consider this issue. The resulting report focuses on:

current development and growth of smaller associations;

financial analysis to consider potential unused capacity;

barriers to smaller associations utilising their capacity.

It suggests ways in which smaller associations might best maximise their use of capacity.

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CONTENTS

Executive summary

03

1 Introduction

05

2 What do we mean by small?

06

3 Financial analysis

10

4 Barriers to smaller associations utilising their capacity

16

5 Moving forward: how might smaller associations best

maximise their use of capacity?

22

Notes

31

References

32

Appendix 1: Data and assumptions

33

Appendix 2: Financial analysis of the associations

involved

34

Acknowledgements

35

About the authors

36

List of figures

1 Potential organic growth rate by year

12

List of tables

1 Sector – number of associations by size

07

2 Increases in stock over the last four years

13

3 Type of growth undertaken by the 15 associations for

which we have data

14

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03

EXECUTIVE SUMMARY

Background

There is a lack of hard evidence about the capacity

of smaller housing associations and their ability to

utilise any capacity to grow and develop new homes.

This project is therefore designed to provide some

clearer indications of the range of any potential

unused capacity and identify barriers to its effective

use.

Key points

Our research suggests it is reasonable to expect that, on average, the associations in this study could sustain future organic growth at a rate of about 5 per cent per year.

Effectively using the projected spare capacity of smaller associations would potentially increase the number of association homes built by around 2.5 per cent.

To utilise that capacity requires sufficient organisational capability or partnership arrangements, combined with access to new debt finance and grant funfding.

Potential barriers to smaller associations using their development capacity include access to the right skills and proper quantification of risk.

Smaller associations have some potential advantages. They often focus on a particular specialism or locality. Most also still have a strong voluntary ethos and their boards tend to be much ‘closer to the ground’ than their larger counterparts.

There are some advantages to smaller associations purchasing from – or managing stock for – larger associations (and others), rather than directly developing.

The way forward may be to encourage organic growth among smaller associations and for larger associations and potential partner bodies to

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develop innovative approaches to help them. This will not be easy at a time when the development environment for associations is particularly challenging.

It is vital that all associations ask themselves two questions:

If the association’s mission is to provide homes for those in need, should the development of new homes be a key part of this?

Do the association’s current size, structure and costs enable it to achieve its organisational purpose effectively?

About the project

The idea that the major unused capacity in the housing association sector is among smaller housing associations has attained the status of an urban myth. However, there is a lack of hard evidence about the capacity of smaller associations and their ability to utilise capacity to grow and provide new homes.

This project is therefore designed to consider this issue. The aim is not to come to definitive conclusions about the capacity of independent smaller associations (those with fewer than 1,400 units owned), but rather to develop some clearer indications of the range of any potential unused capacity and identify barriers to that capacity’s effective use.

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05

1 INTRODUCTION

The idea that smaller housing associations have the

majority of the sector’s unused capacity to develop

new homes has attained the status of an urban

myth. However, there is a lack of hard evidence

about the capacity of small associations and their

ability to utilise it to provide significant growth.

This project is therefore designed to consider this issue. The aim is not to come to definitive conclusions about the capacity of independent smaller associations, but rather to develop some clearer indications of the range of any potential unused capacity and to identify barriers to that capacity’s effective use.

The methodology for this work involved financial modelling, interviews with individual associations and a workshop involving representatives of the smaller associations involved in this study. The assumptions behind the financial modelling work described in this paper are shown in Appendix 1.

There were 1,238 Registered Providers (RPs) included in the 2012 Statistical Data Return (SDR). The bulk of these were housing associations and so we use that term in this research for the organisations we are looking at.

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2 WHAT DO WE MEAN

BY SMALL?

This study considers associations owning or

managing fewer than 1,400 units. These represent

78% of all associations, yet manage just 6% of all

associations’ stock.

The RASA associations

According to the 2012 SDR, 931 associations had fewer than 1,000 units of low-cost rented accommodation owned and directly managed. These associations are separately defined by the regulator in the Regulatory Arrangements for Small Associations (RASA) as requiring less regulatory engagement than larger providers.

This group would logically have provided the basis of this study. When considering the data it was, however, apparent that there were a significant number of associations with more than 1,000 units that could still be seen as relatively small and that had a wide range of surpluses and capacity. We therefore decided to consider associations with fewer than 1,400 units.

However, in looking in detail, we decided that those at the lower end of the range might not provide the best evidence base. Of these associations, 787 had fewer than 200 units and therefore were likely to have only limited capacity. Given their sheer numbers, it would be difficult to make generalised projections and find a suitable sample.

Looking at those with more than 200 units, there were 70 associations with between 200 and 400. However:

only 45 of these were not part of a group structure;

32 per cent of the units they owned were supported housing;

seven of the 45 had fewer than 100 general needs homes.

We therefore decided to take our sample from the 105 associations owning and managing between 400 and 1,399 units of low-cost rented stock.

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07

What do we we mean by small?

The profile of our sample

Table 1 sets out the profile of this group in relation to the sector as a whole.

Table 1: Sector – number of associations by size Directly managed

low-cost rental homes

No. of associations No. of low-cost rental accommodation units owned and directly managed

Proportion of total stock

None 238 0

0–49 358 7,338 Less than 1%

50–199 191 19,016 Less than 1%

200–399 70 19,842 Less than 1%

400–1,399 105 85,901 4%

1,400–4,999 131 413,335 18%

5,000–10,000 88 601,565 27%

Over 10,000 57 1,086,836 49%

Total 1,238 2,233,833

Of those 105 associations:

22 are part of a group structure with a larger association;

eleven principally own care and supported housing stock.

We excluded these 33 associations and therefore sought our sample from the remaining 72 associations.

Our sample

We then chose a sample of 19 associations that principally own general needs stock. This constitutes 26 per cent of both the number of associations and the stock owned by the 72 associations.

These 19 associations own 17,094 properties, of which 14,388 (84 per cent) are general needs rented properties. The gross historic cost of housing properties owned by the group totals almost £1.2 billion.1

We also looked at the accounts of two associations that principally provided specialist accommodation.

Lessons from this profile in terms of capacity

There are three points emerging from this profile that tell us something about the development capacity of smaller associations.

A significant number of smaller associations are in group structures

Of the associations with between 200 and 399 units, 34 per cent of associations and 26 per cent of our sample associations were members of a larger group.

Looking solely at overall figures for smaller associations hides the fact that many are part of a larger entity. They are therefore not, strictly

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speaking, ‘small’ and, in most cases, the larger organisation they are linked to has the capacity to support them in terms of development opportunities.

Many smaller associations manage properties for other

organisations

Within the associations listed as owning fewer than 1,400 units, there are many that manage properties for others. This includes some significant subsidiaries of larger associations and some specialist associations that manage care and support properties for others.

Associations that own between 100 and 399 units manage 3,368 low-cost rented properties for others. Associations that manage between 400 and 1,399 units manage 5,125 low-cost rented properties for others.

This suggests that many smaller associations are promoting themselves as effective local managers, and using their resources to develop their business in this way.

Many smaller associations are specialists, particularly in care and

support

Specialist care and support accommodation constituted:

32 per cent of the total rented units owned by associations with between 200 and 399 units;

16 per cent of the total rented units held by associations with 400 to 1,399 units.

This is significantly more than for larger associations. The SDR shows that 94 per cent of the properties of associations owning over 7,000 rented homes as at March 2012 were for general needs. So only the remaining 6 per cent comprised supported housing and housing for older people.

This is important in terms of the capacity of smaller associations to provide significantly increased numbers of new homes. Providers of specialist accommodation generally experience constraints:

They are valued on a cash flow basis which is discounted to take into account the specialist nature of the accommodation.

The risks of running a business principally involving care and support – with low margins and contract risk – are significantly different from those where the business is principally about renting general needs homes. In particular, this will require a cash reserve to hedge against risk.

Their development aims are likely to be as much about service

development as property development. Moreover, property development will most likely be aimed at funding more specialist homes.

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09

What do we we mean by small?

Southdown Housing Association

Southdown Housing Association’s core business is supported housing and registered care homes. It has built on average six new units per year over the last six years, mainly utilising the Social Housing Grant (SHG), and with Affinity Sutton as its development partner.

Southdown has entered into a review of its long-term asset strategy, driven principally by the wish to continue to develop the sort of properties to meet the identified needs which their client groups will require in the future. Here, there is a particular issue about getting the right properties to gain economies of scale. At the moment, much of its accommodation comprises smaller units and it is looking to develop some larger units to achieve improved economies.

The other key area of development relates to meeting the needs of younger people with learning and physical difficulties who are in transition from special schools to independence. Southdown has a number of older properties on larger sites and is considering how best it can use the land for development. In many cases this would involve demolition of the existing building and new development taking place. Of its £3 million reserves, Southdown sees £2 million as being a hedge against risk, which means it has some scope to use reserves for continued capital investment and development linked to its asset management recommendations.

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3 FINANCIAL

ANALYSIS

A table setting out the financial analysis of the

associations involved in this study is in Appendix 2.

This section sets out the salient points arising from

this analysis.

Key ratios

The key financial performance and strength ratios of the group compare favourably with the averages for all traditional RPs as reported in the Homes and Communities Agency’s (HCA) global analysis of accounts 2012:

Gearing (debt to gross cost of housing properties basis) is just 25 per cent compared with a sector average of 35 per cent, with typical maximum covenant levels for this measure ranging from 60 to 70 per cent.

Interest cover (EBITDA basis2) averages 250 per cent compared with a

sector average of 197 per cent and typical loan covenant minimum of 110 per cent.

Average operating margins are 30 per cent (sector: 23 per cent), ranging from 14 to 50 per cent.

These strong ratios demonstrate that the associations are relatively well placed to undertake organic growth from the perspective of financial capacity alone. Low gearing, strong interest cover and a reasonable level of operating margin are key indicators of the ability of the associations to increase debt levels and service the additional interest charges, in order to develop new homes.

Surpluses

Commentators we spoke to referred to the high level of surpluses of some smaller associations as an indicator of their extra capacity. In a low grant environment, a strong level of surplus is a useful proxy indicator of capacity for growth. In effect, the free cash flow generated from operations (EBITDA-MRI less interest payable) acts as a direct cash subsidy of project costs. A high level of surplus also indicates strong interest cover and is more

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11

Financial analysis

likely to be associated with an acceptable gearing ratio, both supporting increased debt levels.

However, the reported surpluses are only an indicator as, for example, surpluses may arise because of unrepeatable one-off factors such as asset sales. It is the key ratios themselves that are the best pointer towards the underlying capacity of associations.

Operating costs

Comparison with global aggregates also demonstrates the proportionally higher operating costs of the sample compared with sector averages. The average general needs management costs of £978 per property is higher than the sector average of £946.

Despite the inevitable distortions caused by differing overhead cost allocation practices, the management cost difference is important. The Chartered Institute of Housing (CIH) publication, Does size matter?, found that:

There is little evidence that size, better quality services and lower costs are related, with significant variations in cost between associations existing within the sector. Indeed, there is evidence of a correlation between high cost and poor performance, which can be interpreted in different ways.

– Lupton and Kent-Smith, 2012

The report could not look at the position of smaller associations, given the paucity of information on performance available via the regulator and HouseMark for associations with fewer than 1,000 units. However, one of its findings was that: ‘A clear local focus and concentration of stock appear to have real benefits in terms of both cost and service delivery performance’. This would suggest that smaller associations might be expected to have better cost profiles than larger associations.

There may be good reasons for the levels of costs among our sample associations. We have not enough detail from our sample to dig into these figures in depth and come to hard conclusions. However, the figures do suggest that, as smaller associations develop, there could well be opportunities for them to achieve economies of scale and efficiencies by limiting incremental growth in their operating costs and thereby reducing unit costs.

What level of capacity?

The sector average for organic growth in 2011/12 was 5.7 per cent (having averaged 11–12 per cent per year in the preceding years) and this level of capital commitment is not unusual among HCA investment partners operating substantial development programmes. However, it clearly requires sufficient organisational capacity or suitable partnership arrangements to deliver, combined with access to new debt finance and grant funding.

We have conducted some more detailed business plan projections on a small subset of the group in order to help establish organic growth potential. Our analysis, although limited by the detail and precision of data used, suggests that it is reasonable to expect that, on average, the associations could sustain future organic growth at a rate of about 5 per cent per year. This figure could be considerably higher in the early years as existing headroom is deployed. The graph in Figure 1 shows the potential organic growth for four of the associations in the sample.

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Figure 1: Potential organic growth rate by year

6.0% 4.0% 2.0% 8.0% 10.0% 12.0% 14.0%

0%

1 2 3 4 5 6 7 8 9 10 1112

Potential organic growth rate by year

13 14 151617 18 192021222324252627282930 Midlands North London London & SE

Given the challenging environment for development and the potential effects of welfare reforms on associations’ cash flows, a 5 per cent growth rate – while possibly on the cautious side – is feasible and sustainable for this group.

On the assumptions used, this would be consistent with annual output for the group of around 800 new homes and would equate to estimated year-end gross capital commitments in 2013 of around 16 to 18 per cent of the gross cost of housing properties, based upon typical development timescales.

This assumes a development mix of 66 per cent affordable rent and 33 per cent shared ownership. This level of shared ownership has been included given that associations expressed the view in our interviews that shared ownership has the benefit for them of stretching use of funding and potentially provides a useful capital gain.

This level of shared ownership may seem optimistic given that the

expectation in the HCA’s 2015–18 programme is for a 75:25 split. However, 20 per cent of the new stock of the associations in this study over the last four years – with less favourable market conditions – has been shared ownership or intermediate rent. We do therefore believe that this level of shared ownership is feasible in current market conditions.

It certainly needs to be borne in mind that a lower level of shared

ownership would result in lower output. In terms of the overall findings here, this assumption needs to be set against our estimate of a 5 per cent growth rate overall being on the cautious side and therefore the two potentially balance each other.

Covenants and security

It is important to stress that associations with private borrowing will be obliged to adhere to a range of financial covenants, as set out in individual loan agreements. Given the scope of this project, we have not been able to review individual loan agreements and our analysis of forecast small

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13

Financial analysis

associations’ capacity is therefore based upon standard assumptions for loan covenant performance levels that are typical for the sector.

In practice, covenants will vary and could be more or less favourable than the generic level used, with a consequent impact on potential organic growth capacity. Impairment risk is also a relevant consideration, as discussed in Chapter 4.

Although the market for unsecured lending to associations appears to be slowly evolving, at present almost all current loans to the sector are secured by fixed charges on housing properties. Security values are assessed on two main bases: existing use value as social housing (EUV-SH) or tenanted market value (MV-T). The lack of availability of unencumbered housing stock can serve to act as a limiting factor on growth for some associations, a position which can be exacerbated by the current low interest rate environment.

This can be the case even if balance sheet and revenue-based covenants indicate scope for expansion. It is particularly the case as each new home developed now is unlikely to generate sufficient loan security value to secure all the related debt required, with consequent gradual erosion of any existing surplus security.3 This issue is not unique to smaller associations, of course.

Development and growth

The associations in our sample provided us with details of their increase in stock over the last four years, set out in Table 2.

Table 2: Increases in stock over the last four years Association Region Accommodation

owned 2009/10 2010/11 2011/12 2012/13 Total stock increase – last 4 years

1 Midlands 402 0 61+4 0 5+3 66+7

2 South 488 0 0 0 16 16

3 North 499 18 18 5 16 57

4 North 515 76 41 80+68 20 217+68

5 London 538 48 18 11 12 89

6 South 557 3 2 5 1 11

7 London 617 22 1 39 89+10 151+10

8 Midlands 636 0 0 3+4 0+3 3+7

9 London 712 0 9 1 1 11

10 London 718 0 15+4 0 0 15+4

11 North 874 15+8 61 20 6 102+8

12 Midlands 944 3 7 21 9 40

13 London 973 0 0 6 7 13

14 South 1,000 27 48 28+3 42+11 145+14

15 North 1,014 27 0 0 66 93

16 South 1,096 63+10 223+14 27+33 28+8 341+56

17 London 1,201 0 16 1 0 17

18 North 1,234 8 0 15 3 26

19 London 1,386 10+67 52+32 235+47 64+60 361+206

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These figures reflect a range of development and growth activities by the associations involved. Just three of the 19 associations have undertaken 57 per cent of the activity and 12 associations have produced only 18 per cent of the homes provided by the whole group.

It is also the case that there is quite a mixture in terms of whether growth is the result of new development or transfers from other bodies, normally other associations. We have data about the type of growth undertaken for 15 associations, and our analysis of it is shown in Table 3.

Table 3: Type of growth undertaken by the 15 associations for which we have data

Type of growth % of increase in stock

Properties developed with grant 67% Properties developed without grant 2%

Properties purchased 7%

Transfers from other bodies 23%

At the financial year end, this group of associations reported overall capital commitments of £66 million, or around 6 per cent of the historic cost of housing properties. More than half (11) reported no or minimal commitments, indicating very little pipeline development activity was underway at the year end.

Iceni Homes Limited

Iceni Homes Limited is a private company owned by three associations: Colne Housing Society, which owns and/or manages over 3,000 homes, Suffolk Housing with 2,500 homes and Hundred Houses with 1,250 homes.

The company is a vehicle to find site opportunities, bid for and undertake new build and rehab construction work and any other new business opportunities on behalf of the shareholders.

Established in 2004 as a response to investment partnering, Iceni has developed some 1,000 homes for its partners and has gift aided some £800,000 plus to its shareholders and made significant savings on VAT and consultants’ fees. The company has ten staff based in Colchester, Bury St Edmunds and Cambridge.

Iceni is currently investigating, with its partner associations, the options for developing market rent and homes for sale. This includes identifying the most tax efficient vehicle for delivering these schemes to maximise profits which will be gift aided back to its association owners to allow them to provide more additional affordable housing.

The partner associations are also considering the possibility of another association or local authority joining them in the near future.

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15

Financial analysis

Conclusions from the financial analysis

To the question, ‘Is there spare capacity available?’, the answer is clearly that there is. However, there are three important points to make.

Can utilisation of spare capacity make a major impact on new

homes?

A broad estimate would mean that a 5 per cent growth in assets could supply 800 homes per year from the sample associations. The average figure for the growth of units by this group of associations over the last four years has been around 480 units per year (although a proportion of these were transfers from other associations rather than newly developed homes). This suggests that there is scope for the development of around an extra 300 units per year.

If we scale up the projection to the whole of the 400–1,399 group of associations, this would mean that they could produce in the region of 1,230 extra homes per year.

Overall, associations developed around 50,000 new homes during 2011/12. Effectively using this projected spare capacity of smaller associations would potentially increase the number of association homes built by around 2.5 per cent.

This is significant and worth working for. It has to be borne in mind, however, that it is not as great as some commentators have suggested, not least because of the points we made above in terms of the number of specialist smaller associations and smaller associations in groups.

Can improved operating cost really help?

While Does size matter? (Lupton and Kent-Smith, 2012) found no evidence that there is an optimum size to achieve efficiencies through economies of scale, it also found that scale might be important if an organisation can make the necessary changes in its culture and approach to achieve any scaling effects or benefits from growth.

Within the sector average for traditional associations, there is a considerable range in performance. Some achieve operating margins close to or above 40 per cent – often, but not exclusively, very large associations – with unit general needs management costs of no more than £600. This suggests that the capacity for limiting costs during a period of organic growth could be even stronger than a comparison against averages alone would indicate.

Smaller associations trying to achieve more growth should therefore be in a position to link that growth directly to achieving improved operating cost performance.

How to use capacity effectively

The finding that there is extra capacity to provide homes is important. However, making it happen requires sufficient organisational capability or suitable partnership arrangements, combined with access to new debt finance and grant funding. We discuss these issues further in Chapters 4 and 5.

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4 BARRIERS

TO SMALLER

ASSOCIATIONS

UTILISING THEIR

CAPACITY

Smaller associations face similar challenges to larger

associations in terms of issues around rents, benefit

changes and affordability. Their local focus may help

in interactions with tenants in dealing with these

issues, but they do not have the same range of

resources as larger landlords in terms of developing

strategic approaches to these challenges.

It is also the case that many smaller associations are mixed businesses and growth may be as much about developing services as about building new homes.

Elim Housing Association

Elim Housing Association owns and manages a diverse stock of nearly 600 general needs homes and 250 units of supported housing. Its aim is to continue to develop its business in terms of special needs services and the development of new general needs homes.

Elim has fostered a range of partnerships with other, often larger, housing associations. It has been successful in winning a number of significant contracts to provide a range of support services throughout the west of England and has become a leading provider of sites for Gypsy and Traveller communities.

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17

Barriers to smaller associations utilising their capacity

There are a number of potential barriers specific to smaller associations utilising their development capacity, which have been identified as part of this work.

Organisational capacity

Even where there is clear financial capacity available to an association, a lack of organisational capacity – the particular skills, expertise, contacts and experience essential to delivery of housing development – may limit its ability to fully exploit that capacity.

Having the range of development and financial skills available to manage a programme of development or to procure new properties is a key issue for all associations, but smaller associations do not normally have substantial rolling programmes that can justify the recruitment of skilled staff and achieve the stability necessary for continued success.

Some of the associations in our study have such skills in-house; others have ongoing relationships with larger associations that provide the skills for them, with varying degrees of satisfaction. However, there is an important issue in relation to how a smaller association can be an effective client when working with a larger body without having the skills themselves. This highlights the importance of good ‘relationship management’ as much as technical skills.

Four of the associations in our study were looking to increase their development activity. For associations that are not developing but wish to, having the confidence to consider risks and understand how systems work and buy in the right skills are key issues. Developing mechanisms for supportive approaches from other associations appear to be particularly important here.

Those associations that are developing also suggested that there are challenges in terms of retaining staff with the right skills. Staff will inevitably aspire to jobs that are better remunerated than a small organisation can pay.

It has also been suggested to us that it is not just professional skills that are important here. Having wider skills and understanding in terms of finance, development and risk management at board level are also crucial.

Properly quantifying risk

Some of the associations that we interviewed for this study, and a major lender to smaller associations, highlighted that boards of smaller associations may be less likely to embrace the risks of development.

It has a small development department and is part of the New Futures development consortium of which the Aster Group is the lead partner. Elim sees its future development role being less about grant-funded affordable housing – given the reduced grant rates to be available – and more about developing the market for rented homes aimed at specific market needs where it has particular expertise in the core areas in which they work.

Elim sees its route to developing its business as based on delivering efficiencies and value for money while establishing and maintaining new alliances with a range of public, voluntary and charitable organisations.

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In Chapter 3 we saw that 57 per cent of development over the last four years has been undertaken by just three of the sample associations. Twelve have produced only 18 per cent of the homes provided by the whole group. This does suggest a level of caution about development among many smaller associations.

This caution is understandable in some ways. If a smaller association has one large development and it goes wrong, it can have significant adverse effects on the association’s long-term prospects.

A material risk for any developing association is that a scheme will encounter financial difficulties, or that property sales/values will not be achieved. This results in the association taking an impairment charge or loss to the income and expenditure account. This exposure can be more acute for a small association with a heightened risk of loan covenant breach and a smaller income and expenditure account less able to accommodate such unexpected charges. The relative risk for a small association can also be greater due to the challenge of assembling sites of sufficient size to be financially viable.

Associations that want to develop their business have to be clear and realistic about what can actually be delivered, particularly at a time when associations face a number of challenges in delivering their core purpose.

So while it is understandable that smaller associations may be cautious, it is also the case that there is a danger of focusing purely on the risk of particular actions, rather than setting these against the potential gains, particularly in terms of meeting an association’s overall priorities. Properly quantifying risk is important for an association. Effective appraisal of risk should also involve associations having in place mechanisms and policies to mitigate particular risks.

If smaller associations are unable to appraise and manage risk properly, then this does add weight to the argument that they have capacity available which has been supported by public funds and which could be better used by their having relationships with larger bodies. It could be important here to develop supportive mechanisms that would encourage small associations to be less risk averse but still risk aware.

Risk is not confined to developing new homes, and an association can overreach itself by moving in directions other than its housing objectives, as the case of Sadeh Lok (see box) demonstrates.

Sadeh Lok Housing Group

In June 2010 Sadeh Lok Housing Group received a damning regulatory judgement from the Tenant Services Authority (TSA). The judgement highlighted matters of serious concern relating to governance, finances and risk management.

The organisation had within its group structure a 1,100-home association and seven subsidiary companies, both commercial and not for profit. Services were provided nationally, from Hampshire to Newcastle, and included employment, recruitment and children’s services.

The association instigated a major transformational change programme to revive and refocus the business. Five new board members, including a new chair, were recruited and a new senior management team was appointed. A five year corporate strategy was developed by the board, tenants and staff to refocus strategic priorities.

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19

Barriers to smaller associations utilising their capacity

Ability to borrow

Our analysis indicates that a majority of the sample reported interest cover well in excess of the typical minimum levels required by funders, indicating good capacity to service new debt. Balance sheets also appeared to suggest considerable scope to accommodate additional borrowing, with conventional gearing/leverage measures well within typical funder limits.

This suggests that raising funds should not be a major barrier for smaller associations. However, some associations were concerned about this and there are some points to bear in mind here.

Raising loan finance is an expensive process and, while some costs are broadly or directly proportional to the size of facility (e.g. arrangement fees), others, such as related legal and other fees, are not necessarily so. In a more difficult funding market, some banks may be unwilling to offer funds to new clients or to offer small tranches of funds on competitive terms, although there are increasing signs of improved credit availability.

The length of the loan is important. Many smaller associations have relatively short-term loan deals. Treasury strategies have become more complex as bank debt is generally only available for the short to medium term and managing re-financing risk presents new challenges to associations, particularly small ones with limited options to access capital markets directly. ‘Club’ bond issues, launched by The Housing Finance Corporation and others, provide a flexible long-term funding route that is a credible option for many small associations, but not necessarily all. Associations need to ensure that the covenant and security requirements are compatible with their growth ambition.

Smaller associations also need to be able to access the treasury

expertise required to manage greater complexity. The development of more collaborative financing options and cost-effective treasury advisory services could prove important to unlocking capacity at acceptable cost.

Access to land

Finding land in the right place at the right price is a key issue for all

associations that wish to develop. Some associations in the study highlighted how they are often outbid by other bodies, including larger associations. Whether this was a significant barrier for an association seemed to be determined partly by the local land market and partly by an association’s ability to utilise its localised relationships to help secure development.

Local authority land and Section 106 agreements appear to be particularly significant for smaller associations. Some associations also mentioned working with developers that are looking for an effective local input in terms of knowledge and ongoing management.

In just 18 months, subsidiary companies were demerged back to independent status, negotiations were successfully concluded with funders and a loss of £2 million in 2010/11 was turned to a profit of £350,000 within one year. In February 2012, one of the TSA’s last regulatory judgements saw Sadeh Lok Housing Group upgraded for both viability and governance.

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Moving forward

Despite the barriers identified in this chapter, several of the smaller associations we spoke to are reappraising their businesses and are

developing arrangements to utilise their capacity to take their organisations forward to meet their aims and objectives.

In the next chapter we will look at some of the options that might be employed by smaller associations themselves and by others to encourage and facilitate such approaches.

Croydon Churches Housing Association

In 2011 Croydon Churches Housing Association (CCHA) made the decision to transfer its support services to other specialist support providers. The services had been running at a loss for a number of years and CCHA could not compete with some of the larger, more specialist support providers.

CCHA has retained the housing and property management of these properties and now promotes its management services to other bodies. It works with support providers supplying housing and property management as part of a bid for support contracts in particular areas. It also now manages 69 general needs units for other associations. In shrinking the support services, CCHA reduced staffing from 70 to 42 staff. This included reducing corporate services to ensure that front-line services were still in place to protect their management services.

Part of this reduction involved dissolving the New Business Team and moving to an arrangement whereby the client role for future development was driven by the Chief Executive and front-line staff. CCHA believes this is working well, particularly as the people that are going to have to manage and maintain the scheme actually have an input right from the beginning.

When the HCA announced its current programme, CCHA sought to move to a development partnership with another association in order to move forward without a New Business Team in place. It looked at five organisations, using clear criteria including:

Does the organisation have the same values and ethos as CCHA?

Does it have a good reputation generally?

Is it used to delivering for a partner?

Does it have sufficient resources and expertise?

Is it likely to be competing with us for the same sites?

What services can it provide?

Are its fees reasonable?

CCHA’s key partnership is now with Orbit. It has one scheme completed through the partnership, has another two on site and is currently evaluating options for a fourth site to meet its development objectives by the end of 2015.

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21

Barriers to smaller associations utilising their capacity

CCHA is pleased with the partnership to date and believes it is working because of the clarity of relationships between the two parties. The fact that CCHA only deals with two local authorities means it is more influential in Croydon and Sutton, given its local links, despite Orbit being much larger nationally. However, CCHA can benefit from Orbit’s particular resources, experience and contact with developers and contractors. Orbit manages the finances throughout the building process with CCHA paying a 10 per cent deposit when the scheme is committed to and then paying nothing until handover.

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5 MOVING FORWARD:

HOW MIGHT SMALLER

ASSOCIATIONS BEST

MAXIMISE THEIR USE

OF CAPACITY?

While the development capacity of smaller

associations is not as great as some people have

been suggesting, the current chronic need for

more affordable housing, and the values and aims

of housing associations, mean it is important to

try to make fuller use of the sector’s development

capacity.

It is equally important, however, to recognise what a diverse set of organisations are covered by the term ‘small associations’. Given the disparate range of geography, objectives, organisational history and needs they address:

care has to be taken in terms of generalised statements about smaller associations;

reasons why associations are unable to maximise development or choose not to do so will vary;

‘one size fits all’ approaches to unlocking capacity are unlikely to be appropriate in looking for ways forward to encourage development. The idea that there should be major merger activity among smaller

associations seems fanciful given this diversity and the time and effort that would be required. Moreover, there is no certainty that such moves would significantly alter the situation, given that the Does size matter? report (Lupton and Kent-Smith, 2012) found little evidence that mergers in themselves really give significant benefits.

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23

Moving forward: how might smaller associations best maximise their use of capacity? Similarly, it seems unrealistic that there could be a major centrally

determined drive for smaller associations’ capacity to be transferred to larger associations for their use. There is no obvious mechanism to take this forward even if the logistics of undertaking such a move could be worked out in a practical way.

It is important to recognise that smaller associations are part of a wider association sector. In seeking to use the spare capacity available to smaller associations, we perhaps need to challenge the sector as a whole – not just the smaller associations themselves – to consider how to utilise that capacity. If the sector as a whole does not demonstrate its effectiveness in releasing capacity, it will face continuing scrutiny from government.

Some people that we talked to during this study expressed concerns that government might introduce a ‘tax’ on associations that are perceived not to be utilising their capacity. Irrespective of the practicalities of developing such a tax, it has the potential to mitigate efficiency gains. The focus moves to avoiding the tax rather than maximising the amount recycled.

Indeed, before 1988, all surpluses were clawed back by the Housing Corporation via the Grant Redemption Fund, regardless of whether they were the fruits of good management or good luck.

The way forward for associations and government would seem to be to encourage organic growth among smaller associations and for larger associations and potential partner bodies to develop innovative approaches to support them. This will not be easy at a time when the development environment for associations is particularly challenging.

The points below are designed to suggest some ways in which this might be done.

The importance of local and specialist knowledge

In looking at how smaller associations might organically expand their

capacity, it is important to be clear about the potential advantages they have, especially their usual focus on a particular specialism or locality. Most also still have a strong voluntary ethos and their boards tend to be much ‘closer to the ground’ than their larger counterparts.

This local or specialist knowledge should give them advantages, not least in terms of their ability to assess local needs, develop focused management arrangements and have a strong network of relevant contacts. Indeed, smaller associations might consider how they use these advantages to promote themselves as ‘voluntary and value-led’ bodies, both individually and collectively. This could involve developing more specific approaches that provide mutual support and also differentiate them from the larger, more overtly commercial organisations.

York Housing Association

York Housing Association (YHA) owns a mixed portfolio of stock, catering for the full variety of housing needs in York and the surrounding areas. It owns 311 general needs homes, 143 for older people and 288 care and support units.

It recently made a strategic appraisal of its position and future direction and decided that it would:

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How smaller associations can challenge themselves

The changes taking place within the climate in which associations operate provide considerable challenges. They also mean, however, that associations are less reliant on government funding and no longer have to shape their service delivery to the requirements of the regulation and inspection regimes.

Associations are therefore now in a better position to think through their own independent approach to the services they provide. Indeed, it will become crucial to an association’s success in future that the board is clear about its aims and values and about how it is running the business in order to meet them, while providing effective services to customers.

This amplifies the need for associations to be clear of the importance of combining competence on the business side (so as not to waste precious resources that could enhance services or provide new homes) with fulfilling the aspirations and demands provided by their values.

In terms of being businesslike, while many smaller associations are locally focused, some have unusual patterns of stock ownership, others have properties in expensive locations and many developed some time ago and have ongoing stock investment needs. It is as important for smaller associations to appraise their asset holdings properly and manage them effectively – including, where appropriate, rationalising stock – as for larger associations.

This suggests that smaller associations, as much as larger associations, need to identify their strengths and ask themselves the question: Are we using our resources in the best way to meet our values and objectives?

This will mean that associations will come up with different answers, which could include:

continuing to develop by a mixture of grant, cross-subsidy from asset management (potentially including sales) and converting social rents;

strengthening their position as a local housing provider by building shared

continue to respond to specific requests for supported housing needs without actively looking for significant further development of this type of accommodation;

seek to expand its stock by 140 units over the next five years;

seek economies of scale from any growth.

YHA would prefer to expand its stock through new properties as this adds to the overall stock of affordable housing in the area. However, to ensure it meets its loan covenants and is not straining its gearing ratios, it is aiming for a balance between development and acquisition of existing homes, with 70 new build and 70 acquisitions from other associations.

It has looked hard at its operating costs, including benchmarking them against other similar and local organisations. As a result, YHA is aiming to reduce its operating costs as a percentage of turnover as it grows. YHA has its own development team, which also undertakes work for other smaller associations. This includes one arrangement involving a swap of YHA’s development expertise for the other association’s HR resources.

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25

Moving forward: how might smaller associations best maximise their use of capacity? ownership or market rent homes that provide for local needs, and cross-subsidy for social housing;

developing partnerships with other associations or bodies with relevant skills;

becoming a manager of choice for other associations or bodies that are rationalising stock or developing;

developing the business locally in ways other than building new homes. A recent ResPublica pamphlet, Acting on localism (Duncan and Thomas, 2012), has argued that associations could have a major role in creating new and dynamic partnerships with local communities and public sector agencies;

continuing to focus on its specialised housing and services.

All these are positive options for smaller associations. The alternative, however, was expressed to us by one association in the study: ‘Let’s forget Affordable Rent, play the longer-term game, accept now is not the time to develop and just aim to be still here in ten years’ time.’

Given the risks and complexity of developing new homes in the current climate, this is an understandable reaction. However, does this mean that the association has resources that are not being used to meet its objectives? Is its continuing management role sufficiently unique and important?

Most small associations are charities. This means they have ‘charitable’ objectives that often include building more homes at rents their tenants can afford. In this context, boards of smaller associations might consider whether merger or wider alliances will provide a means to deliver their objectives in today’s more challenging environment.

The key point for most associations therefore seems to be that it is necessary to be clear about the association’s purpose and values:

If the association’s mission is to provide homes for those in need, should the development of new homes be a key part of this?

If development is too risky, can the association’s mission be satisfied by continuing to manage homes and/or demonstrating wider social value?

Do the association’s current size, structure and costs enable it to achieve its organisational purpose effectively?

Might the resources of the association be better utilised to meet its mission if it combined with others?

What might smaller associations be able to do to support

each other?

Joint working

The examples of Iceni Homes (above) and the North River Alliance (see box below) show that there are ways in which smaller associations can collaborate on development issues and have a significant impact.

Islington and Shoreditch Housing Association

Islington and Shoreditch Housing Association (ISHA) has over 2,000 homes4 focused on housing for people in north and east London. It has

a subsidiary, Lien Viet Housing Association, which helps to address the housing needs of the south-east Asian community. It markets itself as ‘Working with residents for residents’.

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The associations we spoke to identified a number of potential hurdles to the effectiveness of collaborative arrangements, including competitive relationships between members, and extra procedures and issues around control and priorities. Nevertheless, the existence of these two flourishing development consortia suggests that this is a real option for associations.

The scope for collaboration will depend to an extent on the association’s location and its ability to make common cause with other similar associations. It may seem attractive for such partnerships to be formed by associations working in the same local area. However, some associations in this study felt there were advantages to partnerships with associations working in different market areas so that partners were not competing locally.

On the wider issue of operating costs, there was one cost-sharing vehicle identified which included one of the case study associations. Some associations also reported that progress had been made in jointly using benchmarking information to focus on costs in terms of internal audit, gas maintenance and insurance. However, there was a danger that complicated administrative arrangements would be needed to develop cost-sharing arrangements and incompatibility of associations at different stages of developing their approaches. There also seemed to be the view that these arrangements were better used in improving organisational learning and performance than in reducing costs.

Two associations in this study already had a developing arrangement whereby one provided development expertise to support the other

association, who in turn supported the first association over HR issues. This might be something that could be developed further by associations forming partnerships, with individual associations within the partnership developing

Despite its relatively small size, ISHA has an active development programme and currently has just over 300 dwellings in development. It is also developing approximately 50 dwellings for a number of small and specialist housing associations. It is the lead association in the North River Alliance (NRA), a development consortium comprising 11 locally based housing associations operating in north and east London. The associations in the NRA range from general needs associations with over 3,000 homes to small specialist providers.

By combining the development aspirations of the various community-based and specialist housing associations, the NRA has been able to compete successfully with larger associations to access grant. Since the NRA was formed in 2004, it has developed nearly 2,000 new homes. It remains a significant developer of social housing, accessing £13.8 million in Greater London Authority (GLA) grant to deliver 578 homes in London for the 2011–15 programme. Despite the challenges of the funding regime, and competitive market conditions, it is on target to deliver its entire programme.

The consortium jointly employs a full-time coordinator to manage the NRA development programme. Working together means the smaller associations in the NRA can call upon the development expertise of the developing associations and the process is simplified by having a standard format for development agreements. The funding arrangements are flexible, depending on the availability of loan facilities. Value for money is obtained via the use of NRA-wide frameworks for both large and small contractors and consultants.

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27

Moving forward: how might smaller associations best maximise their use of capacity? particular specialisms which are then are available to each member of the partnership.

Our analysis in Chapter 2 also highlighted the fact that the development of more collaborative financing options and cost-effective treasury advisory services could prove important to unlocking capacity at acceptable cost.

Wider mechanisms regarding skills and support

We have highlighted above the issues faced by associations in terms of the skills of both professional staff and board members and around the importance of developing confidence within non-developing associations to take on the risks of development.

This is perhaps an area where there is potential scope for smaller associations to work together by:

proactively organising and procuring joint training programmes for staff and board members on issues around development, finance and risk;

creating mechanisms for supportive approaches by developing smaller associations to help those who want to develop, perhaps by new forums and good practice sharing;

setting up a fund to commission research and good practice advice specifically aimed at smaller associations.

This could be done partly by use of the existing groupings of smaller associations. There are regional groupings with London and the north west being particularly active. SPBM (Skills & Projects’ performance benchmarking service) links over 100 smaller associations nationally through a network of regional and specialist benchmarking clubs. Using such bodies to develop a wider dialogue about development options may be worthwhile.

Smaller associations do however need to think through carefully what skills they require to meet their particular needs. So if they want to grow and they recognise that development skills are in short supply, this might principally be about forms of growth through partnerships and purchasing homes. It would therefore be important to focus on developing their partnership working and relationship management skills alongside the joint development of treasury management expertise with other associations.

A new generation of small Registered Providers?

Since the Housing and Regeneration Act 2008, some 23 organisations have registered as For-Profit RPs. All are small, generally setting out with no stock at all. Some are stand-alone enterprises, but most are subsidiaries of larger entities that wish to retain and manage the affordable element of development that they are undertaking.

These organisations might provide a useful experiment in increasing the capacity and productivity of the sector through equity-funded small organisations. Whether this happens in practice remains to be seen, but smaller associations should perhaps monitor progress to see if useful joint working or benchmarking arrangements might arise.

How might larger and smaller associations work together

more effectively?

There were a variety of arrangements for development among the associations in our study, with three having development partner status. Several had some kind of working agreement on development with a larger

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association. There were, however, few models of genuine collaborative working between smaller and larger associations other than the ‘lead developer’ model.

There appear to be varying levels of satisfaction with these arrangements. A particular issue raised by some smaller associations was that they felt larger associations often treated their work as ‘secondary’ to the larger association’s own wider development work. However, we also spoke to three larger associations that worked with smaller ones on development projects. They said that smaller associations were sometimes not clear about their role and what they wanted, which made liaison very time consuming.

This suggests that, where smaller associations work with larger ones, there needs to be clarity on certain issues:

Smaller associations need to be clear about their role as an effective client. This means identifying the criteria for selecting a partner and, as we said in Chapter 3, developing skills related to the client role and relationship management. In doing so, they need to understand the resource implications for the larger association that is working with them.

Larger associations need to be clear about their role in working with smaller associations:

o If they see this as a purely commercial arrangement, then the

professionalism of their relationship as a contractor to the client body is crucial. In doing so they need to take into account the constraints under which smaller bodies work.

o If they are committed to supporting local associations to develop beyond a purely commercial relationship, they need to consider what level of ‘mentoring’ this involves, particularly for those smaller associations that wish to recommence development. If this is part of a longer-term programme of collaboration, it might involve supporting boards of smaller associations in understanding the risks and being able to move forward at the right speed.

The provision of a full development agency service to smaller associations would help overcome a number of the obstacles identified as impeding growth. This would include development phase activity (and risk) carried out on balance sheet by the large association and property sold at cost to the small partner on completion.

L&Q has made an offer to smaller associations in London to support them in development by providing development finance and project management. Where there are for-sale properties within the scheme, the capital gain from any sale will be shared 50:50 between L&Q and the smaller association. L&Q has offered to set aside £10 million to be matched by £10 million from small associations to build homes. This could be used to raise a further £80 million by using L&Q’s balance sheet, which allows it to borrow on cheaper and longer terms than smaller associations would normally be able to do.

However, it was also put to us by some smaller associations that they would benefit from being able to buy the specific skills they lack from larger associations rather than buying a ‘full’ service.

Not just about development?

It is also important that the focus is not just on new development by smaller associations. Many have bought properties from developing associations

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29

Moving forward: how might smaller associations best maximise their use of capacity? and it might also be possible for a wider variety of arrangements to emerge where smaller associations trade their surplus capacity in exchange for managing developing associations’ properties or functions.

Several associations in this study have also taken over properties from a larger association as a result of rationalisation of stock by the latter. As associations become more sophisticated in analysing the contribution of their stock to their overall business, rationalising stock increasingly involves selling smaller tranches of properties. Indeed, even with larger stock rationalisation, most portfolios are ‘lotted’ on a local authority basis, giving small associations a chance to bid. Many smaller associations have already benefited from acquiring stock from larger associations and are in a good position to market themselves to benefit further.

Smaller associations purchasing from or managing stock for larger associations – either as part of asset management strategies or as part of development activity – has some advantages over directly developing, particularly in terms of the reduction in risk for the smaller association. It is also an effective way of recycling its money into new provision because larger developers have the resources and expertise and can then utilise those resources.

It is also the case that, as the report, Flexible and focused, argued: Larger associations could play to the perceived and actual strengths that smaller associations have by subcontracting housing services to their outlying sites or estates, and buying in services likely to deliver better tenant satisfaction.

– Cope, 2012

Rockingham Forest Housing Association

Rockingham Forest Housing Association was formed by a stock transfer and now owns 637 homes in Northamptonshire. It wishes to develop its activities by expanding its portfolio of market-rented properties, given the way that demand for such properties has grown significantly in the areas in which it operates. This would allow it to use any surpluses to support its social housing activities.

Rockingham Forest also has a management agency agreement with Circle to manage its homes in Northamptonshire, which are a mixture of general needs (43), shared ownership (65) and market rent (43). The contract places all tenancy management responsibility for the homes on Rockingham Forest, which uses its own IT and administrative system to undertake the management.

Rockingham Forest did not take on any extra resources to manage these properties and both sides have to put a fair amount of effort into effective communication. However, it produces a good income for the association and has allowed it to reduce its marginal operating costs significantly.

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The role of the HCA and local authorities

Local authority land and Section 106 agreements appear to be particularly important for smaller associations. If their local focus is used to develop localised relationships, it can give them very specific advantages that will help to secure development. This includes working with developers that are looking for an effective local input in terms of knowledge and ongoing management.

In their quest to maximise the efficiency and use of associations’ capacity, the HCA and the GLA might perhaps consider how they could be more proactive in their enabling roles to ensure that smaller associations have better access to development opportunities and partnership working.

Authorities and the HCA and GLA could perhaps also be more proactive in their use of the agreements they enter into with the big providers that give access to land, planning or grant. These could potentially open up access for smaller associations. For instance, they might set an expectation that a provider developing in areas where it does not have a significant local management presence should seek an active local player to buy or manage the built stock.

The need for a wider challenge to the sector?

There is clearly scope for smaller associations to utilise their capacity more fully. How far they can do this will depend on individual associations’ appetite and ambition, and how development fits in with their overall strategy and business priorities.

One conclusion that might be drawn from this report is that there is scope for more challenge to smaller associations to justify whether they are best utilising their capacity to meet their aims.

However, some commentators we spoke to suggested that spare development capacity is not just an issue for smaller associations, but is also relevant to larger ones. Certainly, a quick look through the accounts of a few associations with between 1,400 and 7,000 units suggests that there is considerable variation in development performance in terms of their underlying capacity to develop.

At the other end of the scale, while the large number of very small associations are unlikely to have significant levels of development capacity, some associations in our study said that being able to use the capacity of an association with 50 homes might really help an association with 400 homes to develop more.

It might be that the regulator, or perhaps the sector itself, needs a mechanism whereby associations that are not utilising their capacity can be identified and challenged. This could take the form of a template for a ‘capacity audit’ which would allow an association to challenge itself as to whether it is best using its capacity.

We do not suggest there should be any heavy-handed approaches to forcing associations down particular paths, particularly given the risks involved in development at reduced grant rates. The associations are, after all, independent bodies. Rather, a mechanism should be developed that makes associations aware of their possibilities, outlines options they might take and encourages them to challenge themselves as to whether they are working to best meet their aims and objectives.

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31

NOTES

Chapter 2

1 Based on figures from the associations’ financial statements.

Chapter 3

2 EBITDA is created by considering a company’s earnings before interest payments, tax, depreciation and amortisation are subtracted for any final accounting of its income and expenses.

3 We have not examined the collateral position of the associations in this study; our forecast is based upon debt service and balance sheet capacity only.

Chapter 5

4 Islington and Shoreditch had under 1,400 units of low-cost rented accommodation owned and directly managed, according to the 2012 SDR data, so it was within the 400–1,400 range of associations for this study.

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REFERENCES

Cope, H. (2012) Flexible and focused: the specialists at the heart of neighbourhoods. g320. Available at: http://www.lqgroup.org.uk/_assets/files/flexible-and-focused_fullrpt.pdf

Duncan, P. and Thomas, S. (2012) Acting on localism: the role of housing associations in driving a community agenda. ResPublica. Available at: http://www.respublica.org.uk/item/Acting-on-Localism-The-role-of-housing-associations-in-driving-a-community-agenda

Lupton, M. and Kent-Smith, J. (2012) Does size matter? Or does culture drive value for money? Chartered Institute of Housing. Available at: http://www.cih.org/resources/PDF/Policy%20 free%20download%20pdfs/Does%20size%20matter.pdf

Figure

Table 1 sets out the profile of this group in relation to the sector as a whole.
Figure 1: Potential organic growth rate by year 6.0% 4.0% 2.0%8.0%10.0%12.0%14.0% 0% 1 2 3 4 5 6 7 8 9 10 1112
Table 2: Increases in stock over the last four years Association Region Accommodation
Table 3: Type of growth undertaken by the 15 associations for which we  have data

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