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					Increasing Affordable Housing Supply
   from Limited Public Resources
– The Proposed National Housing Trust

                             3 November 2009
1.        Introduction

1.1   This paper provides an overview of the proposal for a new housing initiative –
the National Housing Trust (NHT) – which would allow for the delivery of homes for
mid market rents while at the same time stimulating the house building market.

1.2    Changes in economic circumstances and on-going dialogue with public and
private sector stakeholders could result in amendments being made to elements of
the proposal prior to any possible procurement.

Summary of the NHT scheme

         The aim would be to deliver, through an innovative high value-for money
          solution, up to 2000 houses suitable for mid market (intermediate) rent in
          areas where there is a high demand for such housing;
         Target groups would be households on low to moderate incomes who cannot
          afford market rents, but are not currently in a priority group for accessing
          social rented housing (e.g. because they do not have children) and are
          unlikely to be able to afford owner occupation even with the aid of existing
          public subsidies;
         A new legal entity (the NHT) would be set up to procure and acquire
          completed houses, governed by a Board whose membership would include
          participating local authorities;
         The houses would remain available for affordable rent for between five and
          ten years;
         Funding would likely to be split 65% public and 35% private sector;
         Public funding would be secured through the Public Works Loan Board
          (PWLB), and utilise the prudential borrowing powers of participating local
          authorities to fund sites in their area;
         Private funding would come from developers and other site owners, and
          would likely to be split 5% loan note and 30% equity investment;
         The PWLB interest costs are fully serviced by the mid-market rents; and
         On exit, the houses would be sold with PWLB borrowing capital repaid in
          priority to private sector debt and equity.

Communication with stakeholders

1.4   A range of stakeholders including local authorities, Homes for Scotland, the
house building industry, banks, and Scottish Government officials have been
consulted in the development of the proposals set out in this paper.

                                    Page 2
Contents of This paper

1.5    This paper starts by looking at the background to the NHT scheme in Section
2. Section 3 of the paper discusses the need for local authority support and co-
operation to facilitate the NHT scheme. Legal structure, proposed forms of legal
contract associated with delivery of the proposal and state aid considerations are set
out in Section 4, with the acquisition strategy for the housing stock covered in
Section 5. Section 6 discusses management and maintenance arrangements while
Section 7 is concerned with the funding structure, economic considerations and
PWLB borrowing. The future disposal of properties is set out in Section 8 and the
paper concludes with Section 9 detailing next steps.

1.6    Annexes are attached setting out the economic assumptions used in the NHT
financial modelling. A worked cash flow example for a sample site of 50 two bed
homes can also be found at the end of the paper.

1.7   A glossary of terms is included as an additional Annex C.


                                  Page 3
2.     Background

Policy context

2.1     The Scottish Government is committed to increasing the supply of affordable
housing from all sources of funding available for this purpose. The credit crunch and
its effects on public and private finances constitute a very significant challenge for all
those involved in the provision of affordable housing in Scotland. The common
expectation is that the recession will lead to an increase in the demand for affordable
housing. At the same time, the Scottish Government and Local Authorities are
facing increased constraints on the amount of public money at their disposal.

2.2    Whilst the commitment to increasing the supply of affordable housing to meet
demand remains, alternative approaches to the funding of affordable housing are
both essential and being actively considered and progressed. The proposal for an
NHT, closely linking the public and private sectors, will help boost the number of
affordable units at a highly attractive rate of leverage for the public sector input, and
realise wider economic recovery benefits.

2.3    Feedback from the industry suggests that lenders are tightening their debt
covenants and are seeking to reduce their lending exposure to house builders.
Short term projects with assurance on cash flow have increased in importance for
house builders. For some developers the focus has shifted to affordable housing
and partnership with the public sector as a potential option.

Target groups

2.4      The proposed NHT scheme aims to meet housing need in particular areas
and to help to reduce waiting lists. Rent levels would be set initially at 80% of the
relevant Local Housing Allowance levels. This should make rents affordable to
households on low to moderate incomes (generally earning between £15,000 and
£25,000 a year, although this would vary depending on area and household size)
who would struggle to afford private renting or to buy a home, but who are unlikely to
be able to access social housing in the near future. Rents would also be accessible
to those qualifying for Housing Benefit. The scheme could offer a choice to those on
housing waiting lists or be adaptable to house some homeless households (where
appropriate for the individuals concerned) – thereby giving local authorities more
flexibility in discharging their homelessness duties as they move to 2012.

                                    Page 4
Tenancy agreements

2.5   Properties would normally be let on six month short assured tenancy
agreements, which could be renewed. Prospective tenants would therefore need to
be content that they were not being offered a home for life.

                                Page 5
3.       Local authority support and co-operation

3.1    Close engagement with local authorities in areas where there was demand for
mid market rent housing would be critical to the success of the NHT scheme. Initially
it would be for local authorities to:

        determine whether there would be sufficient demand for mid market renting in
         different locations in their area;
        if so, determine the type and quality of properties that would be suitable for
         mid market renting in these locations;
        decide on the target groups for properties;
        agree a methodology for allocating properties; and
        as required, borrow funds from the PWLB to facilitate property purchases
         (local authorities would only be borrowing funds for sites in their area).

Demand for mid market rent

3.2    Under normal circumstances, local authority Local Housing Strategies – and
specifically Strategic Housing Investment Plans – would be the key determinants of
housing development priorities and would guide the application of Scottish
Government (and other) funding. Whilst the importance of these documents cannot
be under-estimated, the current economic climate presents opportunities which may
not be available over the medium to longer term, and which may not have been
taken into account when producing these documents. As a result, a change of
approach to the planning and delivery of housing through the NHT scheme would be
required for the proposal to become a viable proposition in the short term.

3.3    Local authorities would require to use their local knowledge when determining
whether they wish to take part in the NHT scheme. Existing Local Housing
Strategies, Strategic Housing Investment Plans, information arising from housing
need and demand assessments, and waiting list analyses could form part of the
evidence base needed when determining whether there was a demand for mid
market renting. There is a large intermediate market in many high demand areas of
Scotland where it is not currently possible to meet all these households’ housing
needs. In areas that were deemed suitable for mid market renting, properties would
be expected to experience low void levels.

                                    Page 6
Section 75 agreements

3.4    Scottish Planning Policy SPP3: Planning For Homes clarifies the definition of
affordable housing in PAN 74: Affordable Housing; to specifically include mid market
rental. It is hoped that planning authorities and developers will recognise the
potential for the NHT scheme to contribute towards affordable housing requirements
in a deliverable, efficient and cost-effective manner, while offering good value for
money to the public purse. The mid market rent housing provided by the NHT
scheme would, of course, only be available for a defined period and not in perpetuity.

Quality standards

3.5     It would be for local authorities to decide if they wished to insist on Housing
for Varying Needs standards or 2007 building regulations, or whether they would be
willing to consider other homes as well for the NHT scheme.

Allocation of properties

3.6    As noted above, it would be for participating local authorities to determine the
target group(s) for properties. Any local authority taking part in the NHT scheme
would be expected to decide how they would like properties to be allocated and to
agree target income groups with the appointed managing agent. This could involve
consideration as to whether local authorities would wish to work with the managing
agent to discharge their duty to homeless households through the allocation of a
limited number of properties once arrangements are in place to enable discharge of
duty through the private rented sector.

Borrowing capacity

3.7     Local authorities participating in the NHT scheme would require sufficient
borrowing capacity within their prudential limits (see below). This could mean
providing a business case – to be agreed within the authority – to increase prudential
limits. As described in Section 7 of this report, the NHT scheme would have a
funding structure which would insulate local authority borrowing from the PWLB
against commercial risk. The PWLB borrowing would be backed by a Scottish
Government guarantee.

                                   Page 7
Prudential borrowing

3.8   Capital investment by local authorities is largely funded through capital grants
and borrowing.

3.9     The unsupported borrowing element – arranged under the prudential regime –
is financed through local authorities’ own general resources. This is known as
‘prudential borrowing’. Loans taken from PWLB by local authorities for the NHT
scheme would fall within the prudential borrowing regime.

3.10 While local authorities are now free to make their own decisions about capital
investments, in determining the levels of unsupported prudential borrowing, local
authorities must ensure that their plans are affordable, prudent and sustainable
based on prudential indicators as set in the Prudential Code published by the
Chartered Institute of Public Finance and Accountancy (CIPFA). Local authorities
have a duty to keep this under review. They also have a duty to adhere to statutory
guidance on best value, which stresses the importance of good financial
management and project management control and of linking expenditure plans to
effective asset management. The Scottish Government guarantee would ensure that
any additional borrowing for the NHT scheme would not affect prudential borrowing
limits, and would provide a strong backing for any local authority business case
considering the prudential indicators. We have consulted Audit Scotland and they
have informally indicated that they would be content with this approach.

                                  Page 8
    4.          Legal structure, Forms of legal contract, and state aid

    Legal structure

    4.1   The NHT scheme would involve an ongoing, medium term relationship
    between the public and private sectors. The key features of this relationship would
    need to include:

               transparency;
               a clear governance and fund flow process;
               allocation of risk and return; and
               minimising the administrative burden on participating local authorities.

    4.2         The following chart depicts the structure for NHT scheme:

                                PWLB                     SFT
                    [65%] Funding
                                                                    Key Partners

                           Local Authority             NHT                       Developers

                        Majority                             Management
                        holding          ‘Golden              Company
                        and senior       share’


                                                                 [35%] Sub
                                                                 Debt - Loan
                                                                 Note / Equity



                                              Page 9

4.3      A new limited liability company – the NHT – would be set up to direct and
facilitate the operation of the scheme, with participating local authorities becoming
members or shareholders in the NHT. The NHT Board would include directors
appointed by each of the participating local authorities.


4.4     The NHT scheme would consist of a number of separate SPVs, one for each
of the individual sites identified in the procurement process. These would sit below
the NHT in the corporate structure. The SPVs would be companies limited by
shares, whose shareholders would be the local authorities, the NHT and the private
sector stakeholders. Completed properties would be acquired by the SPVs.

4.5  Shareholdings would be split into separate classes and a Shareholders’
Agreement would set out the rights attached to each of these classes:

      the NHT shareholding of ordinary shares would contain the majority voting
       rights and would entitle the NHT to a return in the event that the threshold on
       the private sector return was reached (see Section 7), although the NHT
       Board would agree how any eventual surpluses should be distributed;

      the local authority shareholding would provide the local authority with an asset
       capable of being valued against the amount of the loan to the SPV out of the
       PWLB funds. This shareholding would not include any rights to a return on
       winding up; and

      the private sector stakeholder holding would comprise preference shares
       which would be non-controlling shares, which would enable payment of any
       surplus generated – up to the set threshold on private sector return (see
       Section 7).

4.6    The board of each SPV would be structured to represent the interest of the
investors and to reflect the controlling interest of the public sector. One potential
arrangement would be to have three directors appointed by the NHT, one director
appointed by the local authority and one director appointed by the private sector
stakeholder. There could also be a non-voting Chairperson, appointed with the
unanimous support of all five directors.

                                   Page 10
4.7  Although creating a single SPV for each site could potentially result in a large
number of SPVs this approach would:

         eliminate the risk of cross-contamination of developments, with potential
          returns or surplus on one site being affected by losses on another; and
         ensure that all borrowing by a local authority would result in lending to an SPV
          whose sole purpose was to provide housing within that local authority’s area –
          thus satisfying the ‘well being’ provision of the Local Government in Scotland
          Act 2003.

Transfer of Properties Into Scheme

4.8    Completed properties would be purchased via a take-out agreement with site
owners. Site owners would then be free to complete developments in the knowledge
that properties would be sold at an agreed price (see Section 5) to Special Purpose
Vehicles (SPVs) upon completion.

Proposed forms of legal contract

4.9       The following contracts would be required for the NHT scheme:

Prior to procurement

     Members’ Agreement between the SFT and participating local authorities. This
             o regulate the participation by the SFT and local authorities in the NHT;
             o set out the procurement process to be followed and the role each party
               would play;
             o set out the obligations of the parties (including the NHT) to enter into
               the necessary contracts; and
             o deal with the local authority’s exit from the NHT.

     Project Agreement between the NHT and participating local authorities. This
      would provide the local authorities with the necessary governance in the
      procurement process and ensure that local authorities:
             o provided the PWLB funding as and when required; and
             o entered into the necessary agreements.

     Guarantee Agreement between the local authorities and the Scottish Government
      to provide the guarantees to the local authorities on drawdown of PWLB funding.

                                     Page 11
Following successful procurement

   Project Agreement between the NHT and site owner. This would provide for the
    acquisition of shares in the SPV and for the entering into of the Shareholders’
    Agreements and Take Out Agreements.

   Shareholders’ Agreements between the NHT, local authorities and site owners.
    These would regulate the relationship between the shareholders of the SPVs.
    The Shareholders’ Agreement would:
          o set out the rights to attach to each class of share;
          o the procedure for the transfer of shares and the provision for forced
             sale of shares on default;
          o deal with issues of management;
          o set out the memorandum and articles of the SPV; and
          o deal with the exit of the parties at the end of the NHT scheme.

   Take Out Agreement between the SPV and site owner. This would set out:
          o the price for the site as determined during procurement;
          o timescales;
          o any pre-conditions such as planning permission;
          o development obligations (including the finished specification of the
          o the mechanics for acquisition of houses on completion; and
          o the requirement for a full warranty package with step-in rights.

   Management Agreements between the NHT and procured management
    agencies. These would deal with all property management functions including
    repair and maintenance, rent collection, arrears, common charges, letting,
    administration and so on.

   Management Procurement Agreement between the NHT and the SPV. This
    would provide for the NHT to procure management under the Management

   Agreements between the Scottish Government and relevant local authorities.
    These would ensure that the local authorities receive the necessary statutory
    consents to enable them to borrow from the PWLB to on-lend to the SPVs (see
    paragraph 7.9).

                                  Page 12
On completion of houses and drawdown of funds

   Loan note between the SPV and private sector stakeholder. This would deal
          o the sale of the SPV’s assets or shares; and
          o the provisions for the private sector stakeholder’s entitlement to

   Loan Agreement between the SPV and the local authority.

   Standard Security and Floating Charge granted by the SPV in favour of the local

   Postponed Standard Security granted by the SPV in favour of the private sector

   Inter-creditor Agreement in relation to the loans granted to the SPV between the
    local authority and the private sector stakeholder.

   Scottish Government guarantee. The Scottish Government would secure good
    governance by linking the provision of the guarantees to certain terms and
    conditions around housing remaining affordable for tenants and the delivery of
    acceptable outcomes by the local authorities in relation to outputs by the
    managing agents whose performance would be overseen by the NHT.

State aid

4.10 The State Aid Unit has given preliminary confirmation that the NHT scheme
would constitute a Service of General Economic Interest (SGEI) and that the SGEI
block exemption would apply to the NHT scheme. The relevant EC reporting
requirements would need to be followed

                                  Page 13
5.       Property acquisition strategy

5.1. The following opportunities would exist for procuring homes through the NHT

        acquiring newly completed but unsold properties, or existing second-hand
         unoccupied properties – in both cases it is unlikely that single property
         purchases would be considered under the scheme; and

        kick-starting development on mothballed sites in private sector ownership or
         kick-starting development on sites in public sector ownership – in both cases
         site owners would require to provide completed properties to the NHT
         scheme. The scheme would not fund site construction works.


5.2    The NHT scheme would proceed to procurement under the Scottish Statutory
Instrument 2006 No. 1 the Public Contracts (Scotland) Regulations 2006.

5.3    The intention would be to treat each individual proposal as a separate
procurement opportunity – rather than treating the entire NHT scheme as a single
procurement opportunity. Dealing with them as separate procurement opportunities

        allow each one to proceed without reference to the others;
        minimise the complexity of the procurement process; and
        provide an opportunity for the involvement of small and medium enterprises
         which would in turn deliver greater access to a wider range of suppliers.

5.4     Procurement criteria would be agreed between the NHT and each
participating local authority – this would be expected to include the maximum price of
properties that would be considered under the scheme through a competitive
tendering process.

Due diligence

5.5   Site owners would be expected to undertake their own due diligence to verify
economic and other assumptions before taking part in any possible procurement
process, and would not be entitled to rely on any demand or other assumptions
issued as part of the procurement process.

                                    Page 14
Assessment criteria

5.6    It would be necessary to develop value for money criteria – a combination of
price and match to identified need in a given geography – in order to assess each
individual proposal. These criteria would be integral elements of the evaluation to be
used to select housing units for the scheme within the value for money assessment
and the overall budgetary threshold for the NHT scheme as a whole.

Contracting authority

5.7   The NHT would be the contracting authority for the scheme.

Possible housing stock

5.8    While it is not possible to determine precisely the size of the opportunity in
advance of procurement, it is believed that the scale of the national opportunity could
be reasonably stated at between 1,000 to 2,000 units. The focus would likely be on
one, two and three bedroom flatted properties – with an emphasis on two bedroom

5.9     Over the past year, the number of large scale unsold, completed properties on
the market which would be suitable for mid market renting has reduced significantly.
On this basis, the majority of the opportunities across Scotland would be for sites
that are mothballed. While not all locations or property types would be suitable,
developers have shown interest in the model and – where homes have still to be
built – may be willing to adjust their plans to ensure property type and space
requirements are consistent with the needs of the local authority.

Economic stimulus

5.10 Capital spending through the NHT scheme would inject a short to medium
term stimulus into the economy – boosting jobs and securing economic activity. As a
result, the scheme could both directly and indirectly support workers’ jobs. It is
estimated that around 1,100 jobs could be sustained for every 1,000 new homes
built because of the NHT scheme.

                                  Page 15
6.     Property management and maintenance arrangements

6.1     Properties would be managed and maintained by a managing agent(s) – the
NHT would place a procurement notice in the Official Journal of the European Union
(OJEU) with a view to appointing an agent(s) and would also be responsible for
managing their performance on an ongoing basis. There could in theory be one
agent for all participating areas (such as a registered social landlord subsidiary or a
large letting agent) but there could be several – each covering, for example, a
different geographical area.

6.2    The NHT would be responsible for managing the performance of the
managing agents on an ongoing basis. Governance by the local authorities and
private sector stakeholders through the SPVs would also ensure efficient

6.3     It is not intended to procure both completed sites and managing agents as
part of a single procurement exercise, as this would be unlikely to generate the same
value for money returns as separate procurement processes.

                                   Page 16
7.    Funding structure, economic considerations and PWLB borrowing

7.1   The SPV would pay the site owner around 65% of an agreed purchase price
when it acquired the properties. As noted previously, it is likely that this money
would come from the local authority in whose area the properties were situated
through PWLB borrowing. The Scottish Government would be willing to offer a
guarantee to participating local authorities to underwrite the repayment of any
borrowing in the event that rental or sales income was insufficient to repay the

7.2    The remaining balance of funding (around 35%) would come from the private
sector. Based on current economic assumptions, the private sector monies would
be split between a loan note (5%) and equity (30%).

7.3    The proposed financing structure is predicated on the core principle that
private sector investment in the scheme would be structurally subordinated to the
public sector monies.

7.4    From the modelling completed to date, interest on the PWLB lending would be
serviced by the cash flow generated by the mid market rental income. The residual
cash flow would service the private sector loan note interest.

7.5   A worked example is provided in Annex A.

7.6    When the properties are sold in the future, the sales proceeds would be first
used to repay the local authority PWLB borrowing. Loan note capital is repaid next.
In recognition of the risk being taken by the private sector, private sector
stakeholders holding the equity funding element of the structure would receive
returns on their money (if any) from the sale of the properties (see Section 8). The
public sector would take a share of any proceeds from the sale of properties that
were above a threshold level of an Internal Rate of Return (IRR) to the private sector
of 20%.

7.7   The Scottish Government guarantee would be released when the properties
were sold and the PWLB monies repaid.

7.8    The economic assumptions used in the financial modelling are set out in
Annex B. The outturn result of the model as currently constituted would produce an
IRR to equity of just over 11%. Site owners would need to carry out their own due
diligence on the economic assumptions used in the model.

                                  Page 17
PWLB borrowing

Borrowing to lend

7.9    The Local Government (Scotland) Act 1975 does not confer borrowing powers
on local authorities to borrow to lend to third parties. The Act confers powers on
Scottish Ministers to consent to a local authority borrowing for expenses not
otherwise permissible but only if they consider that such costs should be met from
borrowing. Any such consent for the NHT scheme would:

           require to be issued on a site by site basis and on standardised terms;
           need to have a condition attached requiring local authorities to make the
            on-lending rate the same as the rate at which the funds were borrowed
            (see below);
           include direction in relation to the application of the statutory charge; and
           have any other conditions attached which the Scottish Ministers
            considered appropriate.


7.10 It is understood that local authorities normally operate on the basis of the
‘pooled’ rate applicable on their overall PWLB lending. However, rates applicable to
the NHT scheme borrowing would require to mirror the terms of the underlying
PWLB borrowing.

7.11 Local authorities would need to commit to providing PWLB borrowing to
purchase units under the NHT scheme. In the case of units to be constructed there
would be a time gap between entering the contractual commitment to purchase and
providing the funds. During the construction period PWLB rates would be likely to
move. The solution would be either to borrow funds and then place them on deposit
or attempt to hedge the exposure. As there would be a cost with either of these
solutions, the optimal solution would need to be decided in conjunction with local
authorities and private sector bidders.

Breakage costs/ refinance risk

7.12 Breaking an interest period on PWLB lending through pre paying amounts
outstanding would incur a cost. Care would need to be exercised in allowing
flexibility in the sales process at the end of the NHT’s life – a balance would require
to be struck between flexibility and cost.

                                     Page 18
7.13 The terms of the lending from PWLB would be reflected in the conditions of
the local authority lending to each SPV. This back to back arrangement means that
the financial exposure of a potential interest breakage cost would be borne by the
SPV. It would be important to allow sufficient flexibility to realistically avoid incurring
breakage costs – this could only be achieved by a house sale programme which was
reflected in the term of the lending.

7.14 A similar point would relate to refinancing risk. In the event that house sales
were delayed, lending would need to be rolled over into a new loan. The new
lending terms would reflect prevailing interest rates, which in all likelihood would
differ from the original loan terms. This is a potential cost/ benefit that cannot be
controlled or predicted.

                                    Page 19
8.       Property sales strategy

8.1    As noted in Section 1, the NHT scheme would be intended to last for between
five and ten years. It would be the private sector stakeholder who determined when
a sale could take place between years five and ten after completion of the homes.
Five years would be the minimum period of time that private sector stakeholders
would be required to retain their loan note/ equity investment. This would not
preclude a private sector investor selling their stake during this period provided the
overall funding and contract structure was maintained. The acquiring third party
would require to be a financially stable and reputable entity.

8.2   The intention would be to complete an exit by year ten. The exit from the
scheme relies on sales of the NHT stock and forward planning will be required to
ensure that units are sold prior to the termination date of the NHT scheme.

8.3      The following factors influence the considerations for exit strategy:

     the requirements of the private sector stakeholders to:
         o maximise the return on their equity stake;
         o be able to realise their investment with some degree of freedom over the
             life of the NHT scheme; and
         o ensure repayment of the loan note and service of interest over the duration
             of the NHT scheme;

     the interest of the Scottish Government that no sale of stock triggers a call on the
      guarantee unnecessarily;

     the requirement to minimise disruption to tenants;

     the potential adverse effects on the local or national housing markets should
      large quantities of NHT stock be made available for sale at the same time; and

     the need to consider sales on an SPV by SPV basis.

8.4    There are three main ways in which the exit could take place. Firstly, the
stock could be disposed of by a sale of the entire portfolio of the NHT scheme. This
would require the consent of all parties in the NHT scheme, both public and private,
and could be accomplished by means of a sale of the share capital of the SPVs
themselves or through the sale of the individual properties. Secondly, the stock
could be disposed of by a sale of the entire portfolio of each SPV. This could be
accomplished by means of a sale of the share capital of the SPV itself or through the
sale of the individual properties. Finally, the stock could be disposed of by a sale of
individual properties. This could be accomplished by means of selling a tranche of

                                     Page 20
properties together or by identifying a tranche and then drip-feeding the properties
within that tranche into the market at a chosen or agreed rate to minimise market

8.5      Other considerations in relation to any sale are as follows:

     likely purchasers of large amounts of stock could include existing private
      landlords and companies wishing to enter or expand into the private rented

     likely purchasers of individual dwellings might include the existing mid market
      rent tenants;

     public sector or partial-public sector bodies might seek to purchase NHT stock;

     whether sales would proceed with or without vacant possession.

Public right of pre-emption

8.6   To permit the sale of NHT stock into the public sector without adversely
harming the return of the private sector stakeholders participating local authorities
would be granted the right of pre-emption in relation to any exit from the NHT
scheme taking place within their local authority area.

8.7    The pre-emption would require the NHT to market the interest for sale (share
capital or properties) and to then give the local authority concerned a set period of
time to match the best price obtained. Alternatively, the pre-emption would give a
private sector stakeholder the option of obtaining a market valuation if they preferred.

8.8    This right of pre-emption would not be available however on sales of
individual properties to avoid delays on sales of that nature. The right of pre-emption
would be suited to sales of tranches of properties or to the whole portfolio of an SPV
or the share capital of an SPV.

8.9   A local authority exercising its right of pre-emption would be free to nominate
any public sector body or RSL to take up the right on its behalf.

Timing of sales

8.10 As the NHT scheme would last a minimum of five years, no sale could be
triggered by any party within the first five years of property rental.

                                     Page 21
8.11 To accommodate the private sector stakeholder’s requirements to be able to
realise their investment and to maximise their return (or minimise any losses) the
private sector stakeholder in any SPV would be able to trigger the sale procedure
once per year after the expiry of the initial five year period. This trigger would be
without the consent of the NHT or any other stakeholder. The private sector
stakeholder could not however trigger the sale procedure more than once in any
given year without the express permission of the NHT.

Sale procedure

Private sector

8.12 As there would be a number of exit options available to the NHT scheme, the
private sector stakeholder would be able to select which exit option it wished to
pursue in any given year:

      the sale of the entire portfolio of properties or the SPV itself; or
      the sale of tranches of properties – subject to the agreement of the NHT body
       and the Scottish Government.

8.13 The NHT would be responsible for implementing the preparation, marketing
and sale of any properties on behalf of the owning SPV or – in the case of a share
sale – on behalf of the other shareholders. In both cases the properties or shares
would be exposed to the market on standard terms at arm’s length for a suitable
period of time to permit best and final offers to be made.

8.14 The private sector stakeholder would be free to accept or reject any offers
with the following conditions:

      if the private sector stakeholder accepts any offer it would require to accept
       the most advantageous; and
      the private sector stakeholder would not be able to accept any offer that would
       result on a call on the Scottish Government guarantee without the express
       consent of the Scottish Government.

Public sector

8.15 In circumstances where the rental income was not meeting the interest
payments of the NHT to the relevant local authorities – thereby generating a call on
the Scottish Government guarantee – the NHT could require a sale of the SPV’s
stock in the same manner as the private sector stakeholder.

                                  Page 22
Securing vacant possession

8.16 As tenancies will be let under short assured tenancy agreements, the
recovery of vacant possession (where required) would be achieved by giving the
tenant(s) two months notice to quit.

End of the NHT scheme

8.17 Prior to the end of year ten, the SPV would require to market the properties in
its portfolio for sale. The sale options set out in paragraph 8.12 would need to be
pursued – possibly in turn – with the properties remaining on the market until a sale
is achieved.

                                  Page 23
9.      Next steps

9.1   Given the opportunities offered in the current economic climate, it would be
important for those who wished to participate in the NHT scheme to be in a position
to move forward as quickly as possible. As a result, the SFT is keen to hold further
discussions over the coming weeks with:

    COSLA and local authorities who would like to participate so that they can work
     with SFT to design the criteria for the scheme and undertake preparatory work to
     assist with any call for bids from developers and lenders – procurement notices
     for properties and managing agents could be placed in the OJEU early 2010 with
     contracts being awarded summer 2010; and

    developers to seek their views on the proposal.

                                   Page 24
Annex A – Worked example
50 unit scheme in second year of operation – all two bedroom properties
PWLB debt is serviced in priority to other elements of the funding
Average purchase price – £137,376 per property


PWLB – Lending                   65%        4,464,720

Private sector - Loan note       5%            343,440

Private sector - equity          30%        2,060,640

Total                           100%        6,868,800

Cash flow

Rental income                                            257,342

Variable costs                                           - 54,876

Gross margin                                             202,466

Contingency                                               - 5,147

Operating profit                                         197,319

Tax reserve                                                 - 473

Profit after tax                                         196,846

PWLB interest                                        - 175,396

Cash available to service loan note interest              21,450

   Given the assumptions used, the rental income could drop by over £21,000
   before the PWLB interest payment could not be paid. This is over and above the
   voids and contingency levels already contained within the figures.

                                  Page 25
Annex B – Modelling assumptions used in the base case model1
Inflation assumptions
    Year                        2010      2011       2012      2013       2014       2015       2016        2017       2018        2019       2020       2021

    Retail price index (1)       1.0%       1.0%      2.0%       2.0%       3.0%      3.0%         3.0%       3.0%       3.0%        3.0%        3.0%     3.0%

    Real rent increase           1.0%       1.0%      1.0%       1.0%       1.0%      1.0%         1.0%       1.0%       1.0%        1.0%        1.0%     1.0%

    Rental inflation             2.0%       2.0%      3.0%       3.0%       4.0%      4.0%         4.0%       4.0%       4.0%        4.0%        4.0%     4.0%

 Cost inflation                    2.0%      2.0%        2.0%      2.0%       2.0%      2.0%         2.0%       2.0%       2.0%       2.0%        2.0%    2.0%
 Nominal house price
 inflation (2)                     1.0%      1.5%        5.0%      7.0%       6.5%      5.0%         5.0%       5.0%       5.0%       5.0%        5.0%    5.0%
(1) Indices obtained from Scottish Government sources.
(2) House price inflation assumptions are by their very nature speculative. The assumptions used in the model attempt to draw a prudent line between
competing projections.

  The financial model assumes that 1,000 homes are acquired through the NHT scheme. It is believed that the scale of the national opportunity could be
reasonably stated at between 1,000 to 2,000 units.

                                        Page 26
Modelling assumptions used in the base case model

                          Drawdown       Split of     Average     Minimum     Maximum loan      Annual
                             split       overall      interest    interest      to value     interest rate
                                         surplus       cover       cover
                                                                                                             Returns     Total funding

Local authority funding       65.0%            0.0%        1.33        1.06         62.0%            4.0%        4.00%      88,596,788

Loan note funding              5.0%                        1.17        0.95         66.9%            6.0%        6.00%       6,815,138

Equity funding                30.0%       100.0%                                    95.5%            0.0%       11.25%      40,890,825

Total                        100.0%       100.0%                                                                           136,302,750

                                     Page 27
Modelling assumptions used in the base case model
Housing stock (void levels)

 Number of      void
 bedrooms       level     2010       2011        2012       2013       2014       2015       2016       2017      2018      2019      2020      2021
      1            3%         3%        3%         3%         3%         3%         3%          3%         3%        3%        3%        3%        3%
      2            3%         3%        3%         3%         3%         3%         3%          3%         3%        3%        3%        3%        3%
       3             3%        3%         3%          3%         3%          3%          3%         3%         3%           3%        3%         3%  3%
The standard assumed voids level is 3% of the annual gross rental income, inclusive of any allowance for bad debts. This compares with an assumed voids
level of 1% for newly funded registered social landlord rented stock, as set out in the current Housing Association Grant financial appraisal model.

Property rental income per unit
                                       2010       2011       2012       2013       2014       2015      2016      2017      2018      2019      2020       2021
              LHA -
              rental                    MMR        MMR        MMR        MMR        MMR        MMR       MMR       MMR       MMR       MMR        MMR       MMR
 Number of    per                        per        per        per        per        per        per       per       per       per       per        per       per
 bedrooms     week         MMR %        week       week       week       week       week       week      week      week      week      week       week      week
      1         £99.46      80%         £79.57     £81.16     £83.59     £86.10     £89.55     £93.13    £96.85   £100.73   £104.76   £108.95    £113.30   £114.44
      2       £126.35       80%        £101.08    £103.10    £106.19    £109.38    £113.76    £118.31   £123.04   £127.96   £133.08   £138.40    £143.94   £145.38
     3         £153.35         80%       £122.68 £125.13 £128.89 £132.75 £138.06 £143.59                £149.33   £155.30   £161.52   £167.98    £174.70   £176.44
The average of the top half of the August Local Housing Allowance figures are shown in this table.

                                       Page 28
Modelling assumptions used in the base case model
Annual variable costs per unit
                             2010         2011        2012        2013       2014        2015        2016      2017        2018       2019       2020       2021

               Total       Weekly       Weekly      Weekly      Weekly     Weekly      Weekly      Weekly     Weekly     Weekly      Weekly     Weekly     Weekly
 Number of     variable    variable     variable    variable    variable   variable    variable    variable   variable   variable    variable   variable   variable
 bedrooms      costs       cost         cost        cost        cost       cost        cost        cost       cost       cost        cost       cost       cost
      1           1,076       £20.69       £21.11     £21.53      £21.96     £22.40       £22.85     £23.30    £23.77       £24.24    £24.73     £25.22     £25.73
      2           1,076       £20.69       £21.11     £21.53      £21.96     £22.40       £22.85     £23.30    £23.77       £24.24    £24.73     £25.22     £25.73
      3           1,076       £20.69       £21.11     £21.53      £21.96     £22.40       £22.85     £23.30    £23.77       £24.24    £24.73     £25.22     £25.73

                             Per          Per         Per         Per        Per         Per         Per       Per         Per        Per        Per        Per
 Fixed costs                month        month       month       month      month       month       month     month       month      month      month      month
 Central overhead               1,000      1,020       1,040       1,061       1,082        1,104     1,126    1,149       1,172      1,195      1,219      1,243
The ‘central overhead’ fixed cost provides for an estimate of the central running cost of the NHT scheme.

Note: Variable costs                 £
Maintenance per annum                 464
Insurance                             250
Administration costs                  362
Total                               1,076
The maintenance and administration costs are assumed to be annual operating costs following the construction of housing for rent. They are intended to
meet the cost of reactive and cyclical maintenance and housing management. The variable costs noted above are derived from Scottish Government

                                         Page 29
Modelling assumptions used in the base case model
Property value per unit
                                  2010       2011      2012       2013      2014       2015       2016      2017       2018      2019       2020       2021

                      set up
No of    Purchase     costs*      Total      Total     Total     Total      Total      Total     Total      Total     Total      Total      Total     Total
Beds       Price       (6%)       value      value     value     value      value      value     value      value     value      value      value     value
  1       114,750     121,635    127,500    130,050   133,952   137,970    143,489    149,228   155,198    161,405   167,862    174,576    181,559    188,822
  2       129,600     137,376    144,000    146,880   151,286   155,825    162,058    168,540   175,282    182,293   189,585    197,168    205,055    213,257
   3      140,400     148,824 156,000 159,120 163,894 168,810 175,563 182,585 189,889 197,484 205,384 213,599 222,143                                 231,029
* Assumes inclusion of sums for floor coverings, curtains and white goods.
The purchase prices noted above are derived from Scottish Government sources – the figures presented are a national pan Scotland average.

Housing stock
 Number of       Base level number of
 bedrooms             properties
       1                  250
       2                  500
       3                  250
 Total                   1,000
The base case model used the following breakdown of housing stock. As noted in Section 5 above, the majority of properties provided through the NHT
scheme would be expected to contain two bedrooms.

                                         Page 30
Modelling assumptions used in the base case model
Maintenance/ cost reserve

                    Base level         Weekly                      Total
 Number of          number of          variable       Number      variable      Total
 bedrooms           properties           cost         of weeks     costs       reserve
        1                    250           £20.69                    67,250
        2                    500           £20.69                   134,500
        3                    250           £20.69                    67,250
 Total                       1,000                                    269,000       269,000
A cash reserve is set aside in the NHT structure to provide scope to deal with unforeseen events. This ‘maintenance reserve’ has been set at a level
equivalent to 13 weeks of variable cost expenditure. The cash is set aside from rental income generated as the NHT scheme commences operating. Cash
reserves can be used to smooth unforeseen expenditure or to deal with a loss of income. It is not envisaged at this stage that the reserve is to be used
exclusively to meet major maintenance expenditure.

Corporation Tax
                                                        used in
                                             Actual      base
                                   Limit     rate        case
 Small company                   300,000          21%      28%
 Large company                1,500,000           28%      28%

                                           Page 31
Modelling assumptions used in the base case model

 (% of revenue)                   2.0%

Property Sales Costs per Unit

 Number of           Sales costs per
 bedrooms                  unit
        1                        2.5%
        2                        2.5%
        3                        2.5%
The sales costs per unit are assumed to equate to 2.5% of the agreed selling price .

                                         Page 32
Annex C - Glossary of terms

Affordable housing        Housing of a reasonable quality that is affordable
                          to people on modest incomes. Housing may be in
                          the form of social rented accommodation; mid
                          market rented accommodation; shared ownership;
                          shared equity; discounted low cost housing for
                          sale (including plots for self-build); and housing
                          without subsidy.

Base case                 The base case financial model is the spreadsheet
                          model using the agreed set of parameters or
                          assumptions that build up the economics of the
                          transaction. The base case will show what is
                          considered to be the most likely outcome, based
                          on the economic assumptions input. Such
                          economic assumptions will be subject to due

Due diligence             The investigation work necessary to verify – as far
                          as possible – the veracity of economic

Local Housing Allowance   Housing Benefit for households who pay rent to a
                          private landlord and whose income and capital
                          (savings and investments) are below a certain

Mid Market Rent           Rent at levels between full market and normal
                          social rents.

NHT                       The National Housing Trust – the main NHT entity
                          which is the co-ordinating body of the NHT

OJEU                      Official Journal of the European Union which
                          details notices of contracts to be publically

Scottish Government       A guarantee provided by the Scottish Government
Guarantee                 to each of the participating local authorities for the
                          PWLB lending they inject into SPVs.

                             Page 33
Special Purpose Vehicles   Individual limited companies set up to procure
                           housing on specific sites. It is likely that there will
                           be one SPV for each site.

                              Page 34

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