ARCH, CWAG & NFA Consultation: Council Rents after 2020

ARCH, CWAG & NFA Consultation: Council Rents after 2020

About ARCH, CWAG and the NFA

165 councils in England own over 1.6 million homes, either managing them directly or
through Arms-Length Management Organisations. ARCH represents councils that have
chosen to retain ownership of council housing and manage it directly. CWAG represents
councils whose housing stock is managed by ALMOs and the National Federation of
ALMOs represents 37 Arms-Length Management Organisations managing over 500,000
homes in 40 local authorities. Together we represent over 1.2 million council homes, one
third of the social housing in England.

Introduction
The Housing White Paper Fixing our broken housing market confirms that the Government
will continue to reduce council and housing association rents by 1% a year for the next
three years. But it promises discussions with the sector before setting out, in due course, a
rent policy for the period beyond 2020.

This paper sets out options for council rent policy after 2020, on which ARCH and the NFA,
in conjunction with the Councils with ALMOs Group (CWAG) are seeking views. We are
inviting responses from councils with housing, ALMOs, council tenants and tenants’
organisations, and other relevant consultees. Based on responses received, we intend to
develop a proposal to put to Government later this year. A major consideration is the impact
of future rent policy on investment in the existing housing stock and the possibility of
building additional homes. Councils and ALMOs are therefore asked, in their responses,
not only to comment on the policy options but also to estimate their impact on future
spending and investment. We plan to use this material to build an evidence base to support
the proposal to Government.

Responses are requested by 30 June.

Issues for consideration

Views are invited on five main issues:

1. The annual rate at which rents, in aggregate, should be expected to increase after 2020.

2. The level of annual rent increase, if any, which would be needed after 2020 to maintain
   the existing housing stock to the minimum Decent Homes Standard and repay HRA debt
   by 2042.

3. Whether the current formula should continue to be used to calculate guideline rents for
   individual council properties.

4. Whether freedom to make local decisions on rent levels should be returned to councils.

5. The likely impact of the proposal to limit council rents’ eligibility for housing benefit to the
   applicable Local Housing Allowance.

The Challenge
Any proposal on rents policy after 2020 is a bid for public expenditure, since the
Government will be expected to contribute towards rents due from tenants on low incomes
through housing benefit or Universal Credit. It will therefore be necessary to show clearly,
with compelling supporting evidence, the public and social benefits that derive from the
preferred proposal, compared with the alternatives.

Under the self-financing settlement implemented by the Coalition Government in 2012,
councils took on £13 billion in extra debt in exchange for the freedom to retain rent income
in full and make robust long-term plans for investment, including the construction of new
homes. The settlement envisaged that rents would increase, where necessary, to converge
with local housing association rents and thereafter increase annually by 0.5% more than the
Retail Prices Index. This provided financial capacity estimated to be sufficient for councils
to build 550,000 new homes over the business plan period of 30 years1.

This potential has been compromised by subsequent Government decisions: firstly, the
decision to change the annual guideline increase from RPI + ½% to CPI + 1% from April
2015, and end the allowance for convergence, and, secondly the decision to reduce council
rents by 1% a year from April 2016 until March 2020. The first of these is estimated to have

1CIH & CIPFA Investing in council housing: the impact on HRA business plans 2017
http://www.cih.org/resources/PDF/Investing%20in%20council%20housing%20CIH-
CIPFA%20July%202016.pdf

reduced the capacity for new building from 550,000 homes over 30 years to 160,000, the
second to have further reduced it to 45,000, an annual rate no higher than that achieved a
decade ago2.

In addition to these changes in rents policy, long-term financial planning for council housing
has been undermined by uncertainty about the impact of Government welfare reforms,
particularly the introduction of Universal Credit, on rent arrears and rent collection costs.
From 2018 there is also the as-yet un-costed threat of an annual levy on HRA assets to
fund Right to Buy discounts for housing association tenants. Taken together, these
developments are sufficient to raise serious questions about the ability of some councils
both to meet the long-term needs of their existing stock and to repay the debt on it.

In developing a proposal for rents after 2020, ARCH, CWAG and the NFA will want to be
able to demonstrate that it will allow all councils and ALMOs to raise sufficient income to
meet the long-term needs of their existing stock and also permit them to make a significant
contribution to raising the annual output of new homes to the 250,000 envisaged by the
Housing White Paper. The White Paper acknowledges that traditional council
housebuilding funded from the Housing Revenue Account should continue to provide “a
small, but growing source of new homes”. The likelihood is that whichever Party forms the
next Government will pursue a similar policy. If councils are to expand new construction
funded from the HRA the implication is that rents will need to be higher than they otherwise
would. This implies additional spending on Housing Benefit and Universal Credit, but also
additional rent income from tenants not in receipt of benefits. In deciding on the appropriate
level of rents after 2020, the additional benefits expenditure should be weighed against both
the additional income that councils will receive from tenants not on benefits and the public
benefit that will derive from additional investment, including in new homes.

Principles for National Rents Policy

A national rents policy for council housing needs to strike a balance between four criteria:

           Adequacy and sustainability – as argued above, aggregate rental income should
           be sufficient to finance the long-term management and maintenance of the existing
           stock, repay the debt associated with it, and, allow for provision of a significant
           number of additional dwellings;

           Freedom – the right of individual councils to set rents according to local policies and
           priorities;

           Fairness – the principle that the rent paid by any council tenant should be similar to
           that paid by any other tenant in a similar property, whether owned by a council or

2   Ibid

housing association, and that variations in rents among properties and locations
       should reflect variations in the size and quality of those properties and the quality of
       the locations;

       Affordability – rents payable should be affordable by all tenants, whether or not in
       receipt of housing benefit;

ARCH and the NFA believe that current policy fails three of these four criteria. It denies
local authority landlords the freedom they have traditionally enjoyed to set rents according
to local policies and priorities; it is unfair, in that council tenants may be expected to pay
significantly different rents for similar properties owned by the same or other councils or
housing associations, and it is unsustainable, in that continuation of the current policy of
rent reductions would deprive councils of the income necessary to meet the long-term
needs of the council housing stock.

Background – the evolution of national policy on council rents since
2002

Freedom
For all but two relatively brief periods in the history of council housing, local authority
landlords have been free, in law, to set the rents of individual homes and determine the
amount of any general increase in rents, in accordance with local policies. Government has
sought to influence local decisions through guidance and through financial incentives, but
only rarely through direct prescription of rents. Current law, which requires that the actual
rents chargeable on properties must, with minor exceptions, be reduced by 1% a year until
2020, has no precedent other than the Heath Government’s short-lived attempt to impose
fair rents on council homes.

Councils’ basic powers, which have been overridden by current legislation, are set out in
Part II of the Housing Act 1985, which provides only that councils should make “reasonable
charges” for homes and review them from time to time. Until 2016, Government influence
on local decisions on rents was exercised through guidance, never binding, and the subsidy
system. Until the introduction of self-financing in 2012, each council’s subsidy was reduced
annually by the product of a notional rent increase, leaving it to strike a balance between
raising rents and cutting expenditure to find that amount. Most councils in most years opted
to increase rents by the guideline amount.

The self-financing settlement apportioned debt to local authorities on the assumption that it
could be repaid from rent income, net of management and maintenance costs, over 30
years, assuming that rents continued to increase in line with the guidelines set out in pre-
existing policy. This locked in an enduring financial incentive for councils to follow rent

guidelines in order to meet the long-term needs of their stock. The great majority of councils
continued to follow guideline rent increases until 2016, despite the shift from RPI to CPI and
the end of the convergence allowance in 2015.

While the housing subsidy system discouraged councils from setting rents lower than
guidelines, the housing benefit system discouraged them from setting rents higher. Housing
benefit subsidy payable to councils was restricted to a limit rent based on the formula rent
payable on any property, so that housing benefit paid to any tenant on a rent higher than
the limit would have to be financed locally. A very small number of councils chose to set
rents above formula on the basis that the income raised from tenants not receiving housing
benefit more than compensated for the loss of housing benefit subsidy.

In introducing the Welfare Reform and Work Bill in 2015, the Government never explained
why it had decided to take direct control of council and housing association rents rather than
continuing with the previous approach of guidance and financial incentives. ARCH, CWAG
and the NFA consider there are no good reasons for the Government to directly continue to
control rents after 2020 and would argue for a return to the status quo ante, returning local
freedom over rent-setting.

Fairness
In 2002 the Government introduced a rent restructuring policy that sought to improve
fairness by ensuring that council and housing association tenants paid similar rents for
similar properties and that rent differentials between properties of different sizes and in
different areas more closely reflected market differentials. Formula rents were calculated
for all properties and guideline rent increases set annually. The basic increase was set at
½% above RPI, but since, at that time, average council rents were significantly lower than
average housing association rents, the annual increase included an additional allowance for
convergence limited to a maximum of £2 a week.

In 2013 the Government announced its intention to change, from 2015/16, the annual
guideline increase from RPI + ½% to CPI + 1% and to end the allowance for convergence.
At this time, an estimated 500,000 properties had not reached convergence, hence around
30% of council tenants were still paying less than the formula rent.

Further, a relatively small number of new homes provided since 2010 through the HCA’s
Affordable Housing Programme are not subject to formula rents but let on “affordable” rents
of up to 80% of market levels.

In 2016, therefore, rents payable by council tenants were far from realizing the Labour
government’s ambition, set 14 years previously, that tenants of similar properties should
expect to pay similar rents. The rent chargeable on any specific property could be
“affordable” or “social” and at or below formula, according to its history. With minor
exceptions, the Welfare Reform and Work Act locks in these anomalies for a further four

years. Restoration of local freedom over rent setting from 2020 would provide greater scope
for councils to address these, if they choose, although HCA policy would also need to be
changed to allow a move away from “affordable” rents on properties funded through the
AHP.

An important question for future policy is how much weight should be given to the principle
of a consistent approach to rent setting across councils and housing associations after
2020. Both sectors have moved a long way over the last 15 years, using a wider range of
funding models and offering a wider variety of rented properties. And, if the existing
approach to the calculation of formula rents is to continue, there is arguably a case for
revisiting the basis of the calculation. Formula rents were calculated for 2002 with reference
to local property prices and regional earnings at that time, and have increased annually
since then by a nationally uniform percentage regardless of regional and local variations in
housing or labour markets. Because, in particular, house prices in London and the South
East have risen faster over the last fifteen years than in other regions, council rents are now
much closer to market (and “affordable”) rents in the Midlands, North and West than in
London and nearby regions. Work carried out for the ARCH submission to the 2015
consultation on Pay to Stay estimated that council rents in London in 2014/15 averaged
65% of market rents, while in the North, North West and Yorkshire and Humberside regions
they were close to 90% of market rents. These regional averages mask substantial
variations between and within local authority areas but serve to make the point that the
relationship between market, “affordable” (80% of market) and formula rents varies widely
between local authorities.

Fairness does not dictate that council rents should be set at the same percentage of market
rents in all areas. Affordability is also a consideration, and the gap between market rents
and average incomes is also much wider in London than in some Northern areas.
However, the current position is not the intended outcome of a considered policy, and is
arguably unfair and in need of review.

Affordability

Council rents are set according to the characteristics of the property, not the individual
tenant. The household incomes of council tenants vary significantly, although most are on
lower incomes. DCLG’s impact assessment for the Pay to Stay policy quotes data from the
English Housing Survey 2015 showing that 87% of council tenants had household incomes
below £30,000, which was then roughly equivalent to the median household income.
Consequently, rents have always been less affordable for some tenants than others, with
those on the lowest incomes needing help from the benefits system. If it can be assumed
that the benefits system will provide adequate help for those entitled to receive it,
affordability needs to be assessed from the perspective of those tenants whose incomes
are just too high for any housing benefit entitlement.

There is no universally accepted method of assessing affordability, but it is possible to look
at changes in the affordability of council rents over time. In 2002, the rent restructuring

policy introduced an annual basic increase (i.e. disregarding the allowance for
convergence) in guideline rents of ½% above RPI, which continued for the next ten years;
the same basic increase was written into the self-financing settlement. From 2015, it was
replaced by an annual increase of 1% above CPI, until this was superseded by the rent
reductions imposed by the Welfare Reform and Work Act in 2016.

There is no clear justification in the policy documents of the time for the proposal to set
long-term above-inflation annual increases in rents. The most likely reason is the
expectation that earnings, and thus household incomes, would also rise faster than prices,
so that affordability would not be compromised. Based on the movement of earnings and
prices over the previous two decades that was reasonable, and for the first few years after
2002, earnings continued to rise faster than prices. However, after 2008 the relationship
was reversed and price inflation outstripped earnings. Figure 1 shows average earnings
from 1997 to 2016 in current and constant (2016) prices. It shows how real earnings fell
between 2008 and 2014 and that, although they have been increasing for the last three
years, they have still not recovered to their pre-2008 level.

Figure1: Median full-time gross annual earnings in current and constant (2016) prices

April 1997 to 20163

3 Source: Annual Survey of Hours and Earnings 2016 Provisional Results
https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours/bullet
ins/annualsurveyofhoursandearnings/2016provisionalresults

Figure 2 compares the rate of increase of council rents with earnings and prices since 2002.
For 2002 to 2016 it compares actual average council rents in England with movements in
median full-time gross earnings and the consumer price index. For the four years to 2020 it
models the impact of the four-year rent reductions, assuming that earnings and prices both
increase at 2% a year.

Figure 2: Indices of earnings, prices and council rents 2001-2016 and estimates for
2017-2020 (2002=100)4

It can be seen that, from 2002 to 2008, rent increases closely followed the rate of increase
in earnings, but for the next six years – the worst years of the recession - they increased
significantly faster than earnings. In 2002, average council rents stood at 12.3% of median
full-time earnings; by 2016 the ratio had risen to 16.3%. On the assumptions given above,
rent reductions will bring the ratio back to around 14.5% by 2020, similar to the level at the
introduction of self-financing in 2012.

These results do not demonstrate that, by 2016, rents had become unaffordable. One
implication of the convergence policy adopted in 2002 is that council rents were, at that
time, lower than necessary to ensure affordability, and could be safely allowed to rise to the
then higher level of housing association rents. Indeed, in 2002, average housing association
rents were around the same percentage of average earnings – 14% - as predicted for
council rents for 2020. However, the analysis above does illustrate the potential risks
associated with assuming that an above-inflation increase in rents is sustainable for the

4   Earnings: UK Median full-time gross earnings from Annual Survey of Hours and Earnings
    Prices: All Items Consumer Prices Index, annual increases to April.
    Rents: Average Council Rents: England DCLG Local Authority Housing Data Table 701

whole of a 30-year business plan period.

One response would be to link future rent increases with increases in earnings rather than
CPI +1%. However, this would introduce an additional element of uncertainty into the
business planning process. An alternative would be to recognise that the rent settlement
negotiated with Government is unlikely to be for longer than 10 years, with the opportunity
of review in the light of the divergence of earnings and price increases after that time, or
earlier if it were to become necessary.

Rents and benefits
This section considers the issues arising from the operation of the benefits system for
general needs housing. Special needs and supported housing involve additional issues on
which the Government has recently consulted, and which are not addressed in this
consultation paper.

Throughout most of its existence, the housing benefit system for general needs housing has
operated on the principle that the actual rents paid by council tenants are classed as eligible
rent for calculating housing benefit, so that tenants on the lowest incomes have their rent
fully met by housing benefit. Councils that charged rents that were higher than levels
specified by DWP could have their rent rebate subsidy from Government reduced and be
required to fund part of their housing benefit expenditure from local General Fund
resources, but their tenants still received housing benefit relating to their full rent. The
abolition of the spare room subsidy (the “bedroom tax”) by the Coalition Government made
the first major breach in this principle. Even more important for future rents policy, however,
is the proposal to limit from April 2018 the rent eligible for housing benefit (or the housing
element of Universal Credit) to the relevant local housing allowance (LHA), which, for single
tenants under 35 will be the single room rate.

LHAs are set for Broad Rental Market Areas (BRMAs) which are defined as areas ‘within
which a person could reasonably be expected to live having regard to facilities and services
for the purposes of health, education, recreation, personal banking and shopping, taking
account of the distance of travel, by public and private transport, to and from those facilities
and services.’ Most cover more than one local housing authority area; some local
authorities may have areas in more than one BRMA. When first introduced, LHAs were set
for each BRMA in line with the median private market rent in that area, and adjusted
monthly up or down in line with market movements. In April 2011, the method of calculating
LHAs was amended to make them equivalent to the rent payable on the 30th percentile of
properties (i.e. the cheapest 30%). From April 2012 LHAs were frozen, and subsequent
increases limited to CPI in April 2013 and a maximum of 1% in 2014 and 2015. In the
Summer Budget that followed the 2015 General Election, LHAs were frozen for a further
period of four years.

The declared purpose of these restrictions, apart from limiting spending on housing benefit,
was to exert downward pressure on private market rents. In practice the effect seems to
have been that private landlords have become more reluctant to accept tenants on benefits,
with a consequent reduction in the supply of accommodation available. However, the effect
of severing the connection between LHAs and the movement of actual market rents is likely
to have been that the relationship now varies widely from area to area and bears little
relationship to the variation in market conditions.

The relationship between council and market rents also varies from area to area, for
reasons given above. It is therefore likely that the impact of the proposal to limit eligible
council rents to the relevant LHA will also vary among councils. Most, if not all, councils will
be affected by the proposal to restrict single under-35s to the single room rate. ARCH,
CWAG and the NFA are opposed to this proposal and have made representations against
it. However, it is essentially a proposal on occupancy – in effect an extension of the
bedroom tax – rather than a matter for future rents policy. However, the wider proposal to
restrict benefit to frozen LHA levels council undermine any policy for council rent increases
after 2020. We are keen to receive information, particularly from councils and ALMOs, on
the likely impact of this wider proposal to limit. Views are invited on whether this should be
tackled by dropping the link between council rents and LHAs or by increasing LHAs so they
more nearly reflect actual market rents.