The Cost of Estate Densification

The previous chapter of this report set out the indicative potential for densifying London’s largest estates. In this chapter, we look in more detail at the viability of such an approach.

Estate densification is a complex and long-term project. To be viable, the value of the redeveloped estate must exceed the original value of the estate plus the cost of change. If this is not the case, the project will need to justify some form of subsidy.

These costs include the costs of demolition; of compensating and rehousing existing residents; of building new homes, infrastructure and public realm; of providing social infrastructure such as schools and health centres; of meeting other planning obligations; of paying interest on loans; and of providing a return for developers. Final values include the values of new affordable, market-rented and for-sale housing, which will be phased over the lifetime of the project. Other costs and benefits – such as those related to upheaval of people’s lives and improvement of living conditions – are also important, although they are not typically included in viability assessments.

The Viability Model for Estate Densifcation

What follows are the results of a fully costed model of the demolition and rebuild of estates, setting out the key variables determining the costs and benefts of extensive estate densifcation projects involving demolition and rebuilding. This includes the costs and value of emptying, demolishing and rebuilding a London local authority housing estate.

The model is based on the fnancial viability models used by planning authorities to assess developers’ obligations for contributions to infrastructure and affordable housing. The main difference between this model and typical viability models is in the early consultation and decanting phases undertaken by a council before the site and empty buildings are handed over to a developer.

Not all appraisals take account of all of these early costs. These include the substantial costs of rehousing, home loss, and compensation for the original tenants and owners; the real economic cost to the local authority of managing the process, consulting with residents, providing alternative accommodation, and looking after a gradually emptying estate until it is handed over to the developer; and the cost of rebuilding. Table 4 lists the identifed headings in full so that this can act as a checklist for future estate regeneration appraisals.

The model also recognises the long timescale involved from a decision to regenerate through to final occupation of all the new dwellings – in the base case this is estimated at 11 years. In the base case, density has been doubled from the London average estate existing density (90 dpha) to 20 per cent more than the London average density of new residential developments of more than 50 dwellings completed in the last 5 years (153 dpha).

The model uses discounted cash fow techniques to bring all costs and sales values back to a single point in time, thus aiding direct comparisons between schemes of very different (and sometimes very long) timescales. The model also automatically populates the cash fow, primarily based on scheme initiation timescales, leaseholder buy-back rates, rehousing rates, and sales rates.

Our base case is based on London averages for costs and values for a two-hectare estate (or phase of a larger estate) with 180 dwellings remodelled into 360 dwellings, and including a small increase in the number of affordable homes. In all the scenarios we tested, we assumed that the numbers of affordable dwellings after redevelopment always exceeded the original number of affordable homes, in some cases by quite a margin. The new affordable dwellings mix can also be varied in the model. Our base case specified 30 per cent low-rent/social-rent (at 55 per cent of the market rent for those dwellings), 30 per cent Affordable Rent (at 70 per cent of market rents), and 40 per cent shared ownership.

The model assumed that there was no subsidy from central government, from within the council or from the rest of the social housing stock, no grant to housing associations, and no cross-subsidy from the existing stock or market activities of housing associations. The resultant total scheme surplus or deficit for the whole period (from initiation and rehousing to occupancy of the completed redevelopment) is shown is shown in Table 4. This is compared to the residual land value of the developer’s scheme. If the residual land value is sufficient to repay the council its full costs, then the whole scheme is considered viable. If not, then a deficit arises either because the developer’s scheme is not viable (this was rare in our scenarios), or because the council’s upfront costs were high, or both. In these cases, a subsidy might be justified.

Applying the Estates Viability model: the results

In other words, the value of the redeveloped estate must exceed the original value of the estate plus the cost of change. If this is not the case, the project will need to justify some form of subsidy.

In the base case, demolition and rebuilding would result in the following outcomes:

• Double the number of homes on the estate.

• Make better use of scarce land for housing.

• Increase the asset value of the estate by between three and four times.

Table 4: Summary table for base case (£000’s)

The key variables in the Estates Viability model

A sensitivity analysis shows that by far the most significant variables affecting viability are, in decreasing order of magnitude:

• The before- and after-values of the housing stock.

• The potential for increase in density.

• The tenure mix at the beginning and at the completion of the regeneration.

Combinations of changes to these variables have a very significant effect both on viability of the new development and on the ability of the authority to recover its input costs. The model has a high sensitivity to changes in any or all of these variables. Market conditions also impact strongly on final sales values and are almost certainly going to vary during the long development period. Other variables with moderately high sensitivity on viability are in reducing order of impact: build costs, sales rates, rent levels on affordable housing, and rehousing rates. Amongst the low-sensitivity variables are the form of development vehicle used (for example profit sharing joint venture partnerships), the extent of sales into the Private Rented Sector, the extent of challenge from existing owners, and compensation to tenants for upheaval. We explore this last factor in more detail below. It is likely that returns will be maximised with higher density increases on Inner London estates in higher value locations.

Suburban low-density estates

Given that many of Inner London’s estates have recently been redeveloped, there is growing interest in the viability of densifcation in suburban, low-density estates – for example, at levels of 35–50 dwellings per hectare. This is particularly relevant in light of the need to increase the supply of housing, and the fact that little redevelopment activity has been concentrated to date on the suburban low-density housing estates in Outer London. Applying the model to a suburban estate is a good way of highlighting the sensitivities demonstrated by the viability model.

In the cases tested, the key variables were less favourable compared to the base case, for the following reasons:

• Initial values were closer to final values.

• Density increases of more than double were unlikely to be appropriate or acceptable.

• Right-to-Buy sales could represent 70 per cent of the dwellings, far more than the London average.

While the development phases are viable once the scheme is decanted, the gains for the local authority in residual land-value receipt from the new development (and other gains) were far lower than the preparation costs, and in particular the costs of buying out the owners.

Subsidy for gap funding low-density suburban estate regeneration

The difference in recovery of costs by the local authority on these estates could be expressed as a subsidy required, from other sources, for each new affordable dwelling. This could be in the order of an additional £100,000 per affordable dwelling provided. The potential sources of subsidy are considered below:

Source A above looks increasingly unlikely in the future as councils are forced to account for their own housing costs and will need to undertake more comprehensive cost/beneft analysis of regeneration schemes. Councils may, however, be willing to invest in projects which improve the economy in their neighbourhoods.

Source B is no longer available. It is very unlikely that the HRA Settlement will be reversed. A combination of sources C, E and F is more likely to be realistic.

If we are to make the most of the densifcation potential of low-density suburban estates, and the social and economic regeneration associated with these schemes, then there is a strong case for government, councils and housing associations allocating additional resources to these projects. This case is strengthened by the commitment of Mayor Sadiq Khan to a principle of no net loss of social housing through estate regeneration.

Recommendations

We recommend that gap funding for a programme to support densifcation on lowdensity suburban estates could combine some or all of the following: central government grant, housing association cross-subsidy, private fnance through stock transfer, and local authority contribution.

Home Loss Payment for tenants and owners

In addition to demonstrating the variables affecting viability, this model highlights the difference in compensation awarded to tenants and owners, and the impact that this has on the costs of estate densification. The costs of upheaval for residents are met in two ways.

Tenants and owners who have to move are eligible for Disturbance Compensation, and for Home Loss Payments. Home Loss Payments are a statutory compensation to tenants or owner-occupiers who have lived in their property for a minimum of twelve months and are required to move home permanently as a result of redevelopment or demolition of their home. They are a compensation for the upheaval. Disturbance payments are a compensation for the actual direct costs incurred by a displaced household. Items such as reasonable costs for removals, legal services, and disconnection/re-connection of utilities are reimbursed or met by the authority or association.

This study’s financial modelling showed a distinct difference between the amounts received by tenants and owners. Both are entitled to repayment of the direct costs associated with moving – for example, the physical removal, disconnection and reconnection of utilities, and replacement of curtains and carpets. Owners receive more due to the fees, and Stamp Duty, associated with buying their new accommodation.

There are other costs of upheaval which are harder to quantify, such as stress or the effect of moving children to new schools. These are recognised through the Home Loss Payment, which is £5,300 for each tenant household and 10 per cent of dwelling value (up to a maximum of £53,000) for owners who have to move. In London these work out to be very different amounts. In the base case the displaced owner would receive £25,000 by way of Home Loss Payment, whereas the displaced tenant only receives £5,300. We looked further at this discrepancy by identifying all the different impacts that can occur through displacement.

We valued each impact in social value terms, using work by Daniel Fujiwara of the LSE for the Housing Association Charitable Trust (2014) as a base line. We recognised that some aspects of a move can be beneficial – for example, most displaced tenants will benefit from being in better quality homes and some will benefit from moving near to better schools. We then took account of the reduced negative impact of moving to a new dwelling within the estate, which involves far less upheaval.

Finally, we estimated the frequency with which the average household would experience the impact. For example, only a proportion of households will be affected by the need to move schools. The full list and the estimated money value of each social impact is shown in Appendix B. We then made an estimate of how many households might experience each impact. The resultant aggregate figure is a weighted total for an imaginary average household. Not all owners are resident, and some residents are rehoused in a new dwelling on the same estate, thus experiencing much less upheaval. We also made an attempt at scoring positive impacts. One of these will vary considerably, namely the ‘value’ of moving to a better home. Some residents will be rehoused in dwellings with a much greater rent subsidy, refecting the higher cost or value of a newer, better quality dwelling. But many will move into other council or housing association stock of similar quality to their old home with little gain in ‘value’ in this respect. The range is wide but we have tried to be comprehensive. The impact of changing dentist is very low. The impact of earlier death can be a real and unfortunate result of displacement, especially for older people, but is rare.

While no one household will experience the same range of impacts as another, our conclusion is that an assessed impact value of upheaval through rehousing from a London estate due to regeneration is in the order of £15,000 to £20,000 per average resident. Given the current statutory Home Loss Payment for tenants is £5,300, there is a case for Home Loss Payments for tenants to be increased threeor four-fold. There may also be a case for varying the amount depending on the length of time in the dwelling; its value; and whether the move is outside or within the estate.

Home Loss Payments should be increased to ensure the fair treatment of tenants in the demolition and densification process. There may also be a case for varying the amount depending on the length of time in the dwelling; its value; and whether the move is outside or within the estate.

Implications and summary

While discussion of estate densifcation often centres around design and community engagement, understanding the fnancial dynamics of estate densifcation is vital to understanding what the potential for densifcation actually means in practice.

While the consultation process is important, more open dialogue is needed surrounding the fnancial realities which often inform decisions around tenant compensation, estate density, tenure mix and timescale. This is particularly important at a time where local authorities are experiencing severe fnancial constraints. By improving the transparency around these costs, as well as the benefts accrued by unit sales, it is possible to develop more informed consultation and decisions about the viability and desirability of estate renewal. It is particularly important to have a better understanding of how these costs and rewards are shared between the public and private sectors. This understanding is important, not just in improving trust between the various stakeholders involved in estate renewal, but in understanding the variables that affect the costs of projects.

This analysis of costs should be viewed in the context of national and regional housing policy. The commitment of the Mayor of London to achieving no net loss of social housing is one such example. A number of national policies risk further compromising the viability of estate regeneration. This includes the introduction of Starter Homes, and the expansion of Right to Buy.