Back in 1986, the United States changed its Internal Revenue Code in a way which has since unleashed the creation of tens of thousands of affordable homes every year.
Under the Low Income Tax Credit Program, investors in specified properties which undergo development now receive tax credits of either nine per cent or four per cent of depreciable basis (with state bond financing) in exchange for agreeing to rent a portion of the housing at below market rates.
To qualify, for at least 30 years, developments must either have an occupancy rate of 20 per cent by households whose income is at or below 50 per cent of area mean income (AMI) or at least 40 per cent by households whose income is at or below 60 per cent of AMI. Rents charged cannot exceed 30 per cent of income of the tenants at the top of the selected AMI category.
The impact has been significant. Between 1987 and 2014, around 2.78 million dwellings have been created through 43,092 separate development projects. Over the 20 years to 2014, an average of 107,000 dwellings have been created each year across around 1,420 projects. Around 80 per cent of the credits have been received by profit making entities, with banks being the most significant source of investment.
This is one example of a growing phenomenon of using social impact investing (SII) to help address housing shortages for low income households. Whilst amounts raised through SII in Australia are estimated to have been a modest $2 billion in 2013, this is expected to have reached $8 billion by 2018 and potentially risen to as much as $32 billion in the 2020s.
In 2016, an Impact Investing Australia report nominated housing along with health as an area where there was unmet demand for institutional investors in SII. In a recent report prepared for the Australian Housing and Urban Research Institute (AHURI), researchers from the University of New South Wales, Swinburne University and the University of Western Australia concluded that significant potential existed for SII to contribute toward affordable housing delivery in Australia.
Momentum is growing as affordability problems worsen and an aging population places greater pressure upon governments. In 2015, a report by the Australian Council of Social Services put the number of Australians who live in a state of ‘housing stress’ (spending 30 per cent or more of their gross household income on housing) at around one million. Around 200,000 Australians are currently sitting on waiting lists for social housing, according to an Australian Institute of Health and Welfare. Around one in every 200 Australians is homeless.
According to Professor Kristy Muir, chief executive officer of the Centre for Social Impact at the University of New South Wales and lead author of the AHURI report, social impact investing involves three core characteristics. These are a purposeful intention to make a specific social impact through the investment, the intention to derive both a social and a financial return on the investment and outcomes which are measurable from both a social and financial perspective.
“First, it needs to intentionally aim to achieve a social impact and has to specifically chase a social outcome (in order to be considered SII),” Muir said. “Second, it needs to provide a social and a financial return. Third, you need to be able to measure the social and the financial return.”
According to Muir, SII can be used in both building and maintaining affordable housing stock as well as delivering services necessary to support vulnerable households to maintain their tenancy.
Across these two groups, three types of investments are common.
First, there are schemes which promote direct investment in affordable housing construction. As well as the US program mentioned above, an important example in Australia has been the National Rental Affordability Scheme (NRAS). Commencing in 2008, NRAS enabled landlords to receive a 10-year tax credit in exchange for rents being applied at 20 per cent below the market rate. To ensure the scheme delivered greater housing supply, only new developments were eligible. Unfortunately, the program is no longer accepting new investments. Including dwellings for which construction is still to be finished, it is expected that 37,155 dwellings will have been delivered under this program.
Next, there are social enterprises – not-for-profit enterprises which are led by an economic, social or environmental mission which fund a substantial proportion of their mission through trading activities and reinvest a large proportion of their profits toward the fulfillment of their mission. These can include credit unions, community enterprises, intermediate labour market companies, CDFIs, cooperatives and mutual, social firms and charitable business ventures.
A common form of social enterprise in housing is community housing providers. These work with governments and private sector partners to build and manage properties. Many lease properties from state governments, whilst others develop and maintain their own housing stock. An advantage of CHPs is that their structure associated with dealing with a range of other parties from the government and for-profit sector promotes transparency whilst the ‘enterprise’ nature of their model encourages innovation.
This is one area where potential for growth exists. Whereas CHPs currently manage only around one per cent of the housing stock in Australia, that figure is 10 per cent in the United Kingdom. In the 2017 Budget, the Federal Government announced an initiative to assist CHPs to raise money more cheaply through the creation of a bond aggregation scheme.
A third area is social impact bonds – a type of government bond through which private investors earn a return on investment provided that agreed social outcomes are delivered. According to the Social Finance Impact Bond database, 60 such bonds were in effect as of June last year having raised $US29.5 million and assisted 3,670 beneficiaries.
Whereas property funds and CHPs are primarily focused around affordable housing provision, social impact bonds tend to centre around providing support services which assist households to maintain their occupancy. Whilst most social impact bonds to date have focused on non-housing areas such as child protection and out-of-home care, South Australia earlier this year entered into the first bond to target housing and homelessness. Using funding raised through these bonds, homelessness service provider Hutt Street Centre in conjunction with community housing providers Common Ground Adelaide and Unity Housing will deliver a problem through which around 600 homeless adults will be provided with stable accommodation as well as job readiness training, pathways to employment and life skills development. The idea is to provide not only housing but to equip participants with life skills and employment outcomes which are necessary to hold down a housing tenancy.
Through the bonds, around $9 million in private investment was raised to pay for the program.
Essentially, this model works something like that of a regular government bond except for the fact that its return on investment varies according to the social outcomes achieved. This the state will repay the bond over the 7.5-year life of the bond but returns will vary according to the degree to which targets are met across areas of housing, justice and health. If all outcomes are met, investors expect to earn an effective return of 8.5 per cent per annum.
One effect of this type of arrangement is to transfer the ‘risk’ in respect of outcomes being achieved from taxpayers to the private sector. Under a normal government funded housing support program, taxpayers bear the entire burden for programs or initiatives which are not successful. Under a social bond, that risk is largely transferred to private sector investors. These arrangements also deliver long-term funding.
Due to their bespoke nature, however, the bonds are relatively complicated to set up.
Overall, Muir says Australia has an opportunity to increase the supply of affordable housing provision through SII by unlocking funding from non-government sources. Governments, she said, cannot shoulder the entire burden for the affordable housing needed; it requires a partnership with the private market. The burden for addressing affordable housing, she said, needs to be shared more widely.
SII will also be able to supply funds for support services to assist vulnerable households to maintain their tenancy through mechanisms such as social impact bonds, Muir said.
Nevertheless, she says several conditions need to be addressed before the potential of SII can be realised.
For one thing, there is the finance ‘gap’ which exists between what a CHP might earn through rental payments to vulnerable tenants and the costs they incur in providing that housing.
To overcome this, Muir says one of two things must happen. First, private sector investors will need to be persuaded to accept a lower than market return in exchange for the knowledge that their investment will achieve a socially beneficial outcome. Alternately, the government may have to bridge this gap.
Second, Muir says it is imperative to ensure that beneficiaries are not impacted in cases where the investment does not deliver upon its full anticipated return from a financial perspective.
In addition, she cautions that SII is one of several possible solutions and is not in itself an ultimate panacea to the affordable housing shortage.
Australia faces a shortage of housing which is affordable to low income families.
If it can unlock private sector finance in affordable housing, social impact investment could form at least part of the solution going forward.