Be wary of social housing stocks

Housing associations are not-for-profit organisations operating at arm's length from both government and local authorities, making them less susceptible to short-term political pressure.They were first established in the mid-1970s and have steadily taken over the role of providing social housing from local councils, which were discredited by their poor record of management, maintenance and quality of construction during the 1960s and 1970s.

Unfortunately, social-housing stock remains inadequate. Associations wishing to expand have resorted to debt finance, but borrowing constraints are now creating an investment opportunity. Hence Civitas Social Housing (LSE: CSH) raised £350m in a stockmarket flotation last November, and now Residential Secure Income (LSE: RESI) aims to raise £300m. Their approach is described as "alternative equity-like finance", whereby the funds buy the houses from housing associations or local authorities, but outsource the management, rent collection and maintenance back to the vendor.

From an investor's point of view, this looks attractive, with a dividend yield of 5% per annum on a fully invested basis, rising in line with inflation. Both funds target a return in excess of 8%, by using debt to boost yields.

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The problem is that this set-up implies an unfavourable cost of capital for the vendors, in what is essentially a sale- and-leaseback transaction. "This is an expensive way to raise money," says Tom Paul of housing association Optivo. "Why do this when long-term bonds for larger housing associations can be issued at 90 to 120 basis points over gilts?" The reason? Market inefficiency. "Some smaller associations are reluctant to sacrifice their independence for greater efficiency or to pay the cost of negotiating out of restrictive bank covenants on long-term low-margin loans."

"I am bemused as to how [these vehicles] are going to make spectacular returns from dealing with housing associations, when buy-to-let struggles to get returns of 3.5%," says Adrian Bell of Rathbone, which advises housing associations on debt. "They are targeting returns housing associations can't make for themselves." He points out that Hyde Housing, one of the sector giants, has borrowed 40-year money at 3% per annum, showing that cheap finance is available to those associations with sufficient scale.

Around 85% of Civitas's rental income is paid directly by government or local authorities, as Civitas focuses on homes for "supported living, extra care or other specific needs". However, the rent exemption for these tenants is currently under review, notes Bell. With Residential Secure Income, the focus is on shared ownership, which accounts for much of the £263m of homes that it is in negotiations to buy. The risk here is that the tenants default on their payments.

Bizarrely, the Public Works Loan Board, an offshoot of the Treasury, is prepared to lend cheap long-term money to local authorities to invest in commercial property, but not to invest in social housing (either directly or indirectly via housing associations). This, surely, is a restriction that will be removed soon, cutting the ground from under the sale-and-leaseback crowd. Given these uncertainties, Residential Secure Income is an issue to be wary of, while it makes sense to cash in a 10% profit on Civitas.

Activist watch

Activist investor Marcato Capital Management has given an ultimatum to US-listed Deckers Outdoor, the maker of Ugg boots: sell itself at a good price or face a fight to replace its entire board and install a new management team, says Scott Deveau on Bloomberg Markets. Despite its profitable Ugg brand, which accounts for 80% of the company's sales, Deckers has failed to grow earnings and boost shareholder value, wrote Marcato managing partner Mick McGuire in a letter to the board. He also expressed concern about a lack of progress in cutting costs and questioned whether Decker's chairman, Angel Martinez, will be distracted by his bid to become mayor of Santa Barbara in California.

In the news this week

Britain's financial regulator has pressed the "nuclear button" on Britain's investment industry by introducing a "swathe of strict new rules" aimed at building trust in the £7trn market, says Lucy Burton in The Daily Telegraph. The Financial Conduct Authority (FCA) has confirmed it is pushing ahead with some of its more controversial ideas, including calling for a single "all-in" fee that includes trading costs and asking investment managers to put two independent directors on fund boards.

Other proposals include establishing standardised benchmarks designed to make it easier for investors to compare funds. The FCA also wants the government to give it regulatory oversight of investment consultants, who play a crucial role in determining how most UK pension schemes invest their money. The remedies proposed in the FCA's report are subject to consultation over the second half of this year.

Legendary music producer Quincy Jones, who worked with Michael Jackson and Frank Sinatra, has lent his name to an ETF that will track music and media stocks, says FT Alphaville. Bean Markets, the firm behind the Quincy Jones Streaming Music, Media & Entertainment Index, aims to "identify disruptive consumer-centric investment themes" and "identify an accomplished, respected and recognised figure to humanise the investment theme".