Published: 13 Mar 2014 by Pete Jefferys

With public finances firmly in the political spotlight, we recognise that calls for more investment in affordable homes need to be accompanied by ideas for how to pay for it.

We’ll soon be publishing a report by Capital Economics to look at several options, but in advance of next week’s Budget, here’s a sneak preview of three ideas that we’re exploring.

1. Help small, local builders who are being starved of development finance.

We’ve said consistently that we think that the Help to Buy scheme – which provides state-backed mortgages and equity loans – is the wrong approach to the broken housing market. Pumping more mortgage debt down the broken pipes of our house building system will only lead to higher prices. But the policy mechanisms used in Help to Buy are interesting – not least because they avoid adding to public sector debt. Could these mechanisms be used instead to get investment into home building in a sustainable way?

Small, local builders historically built a large proportion of house building in England – and provided a lot of local jobs too. They still do in most other advanced countries, but in England many smaller builders have been forced out of the market or merged into the larger players. By 2012, large builders who build more than 500 homes per year controlled nearly 70% of the market. This concentration reduces the industry’s resilience to shocks, because so much house building is dependent on so few companies operating on the same business models.

Small builders’ associations often say that access to development finance is one of the major barriers they face to building more homes, as banks have cut back lending to them since the credit crunch. Could some of the contingent liabilities set aside for Help to Buy be switched into a new scheme to incentivise lending to SME builders?

One option would be for the government to take on a risk-sharing guarantee with banks to lend to SMEs, with the support conditional on providing affordable housing development. This would be similar to the ‘Funding for Lending’ scheme, which incentivises banks’ credit allocation to businesses or households. Addressing the balance of credit allocation would enable SME firms to re-access credit markets and therefore invest to build. It would also reduce the cost of funding, to the benefit of small, local builders.

Capital Economics estimates that diverting some of the guarantees of the Help to Buy scheme towards SME builders  could lead to an additional 18,000 homes over the next parliament at current build rates.

2. Use a leasehold models to get homes built on local authority land

The major up-front cost of getting homes built is land. While we think that land market reforms are needed across the entire market, there is a particular opportunity for public sector land owners to get more land supply into the system for home building.

While there have been calls for public land to be “gifted” to developers, this would represent poor value for money for the public sector and cash-strapped local authorities would rightly be reluctant to take the losses on their books. A more pragmatic intervention would be for local authorities to retain ultimate freehold ownership, and sell developers leases on the land (say for 125 years). This reduces the upfront cost for builders and means that the public sector isn’t giving away valuable assets for nothing.

By leasing land to affordable housing providers, local authorities could also share the rental income of the land. This could even mitigate the need for direct investment from government to build affordable housing on these sites.

The downside for local authorities would be the lower cash receipts from not selling the land at full market value. But the benefits from increased construction activity, more affordable homes and the future returns to the authority would be felt for years to come. Capital Economics estimate that greater use of these models could get us building over 34,000 new affordable homes over the course of a parliament.

3. Relax artificial local authority borrowing caps to get them building

The most important group of builders to have fallen out of England’s house building system over the past few decades are local authorities themselves. These sleeping giants of house building should be part of a healthy  mixed economy.But policy interventions to get councils building again have to recognise that the capacity and appetite for development differ across the country.

Today, 171 councils with retained housing stock manage their housing through a Housing Revenue Account (HRA). These accounts have strict caps on them, set by central government, which limit borrowing to invest. Currently these borrowing caps are set at least £7bn below what the market would happily lend – even after George Osborne raised the cap by £300m in the 2013 Autumn Statement., because HRA borrowing adds to the public debt.  This means that the Treasury is incentivised to limit additional borrowing, no matter the financial position of local authorities.

The UK is unique in Europe in classifying a very wide range of bodies and activities as within the definition of ‘public sector’ used to measure public debt. All other EU countries and most other OECD countries split out certain types of investment from general government expenditure when reporting public debt, including borrowing by ‘public corporations’ to build affordable homes. A pragmatic reform would be to further raise the artificial borrowing caps gradually over five years, while monitoring value for money from extra local authority investment. To avoid the extra investment counting against the politically sensitive measure of debt, the government could look at reform to modernise our accounting rules in line with international practices.

Capital Economics estimate that raising local authority borrowing caps within prudential limits would lead to an extra 49,000 affordable homes over the course of the next parliament.

Building the affordable homes we so desperately need will require public investment – but there are smart, sensible ways of funding some of it without running up excessive debt, building on measures already in place. Fingers crossed for next week’s Budget.