Part 3: Buying and leasing houses

Housing New Zealand Corporation: Effectiveness of programmes to buy and lease properties for state housing.

In this Part, we discuss:

Our expectations for buying and leasing houses

We expected the Corporation to have robust processes in place to support the effective acquisition of bought or leased houses. We expected:

  • robust guidelines for the buying and leasing process to be provided;
  • those guidelines to be complied with;
  • the Corporation’s quality standards to be met;
  • financial benchmarks to be met and proper approvals given; and
  • the most suitable houses to be acquired, and be made available to tenants without undue delay.

The process for buying and leasing houses

The Corporation’s process for buying and leasing houses from private owners is well defined and met our expectations. Each programme follows similar steps:

  • identifying opportunities;
  • assessing the suitability of the property;
  • seeking approval to lease or buy the property;
  • overseeing the project through to completion; and
  • notifying the tenancy management staff, who are responsible for allocating the house to appropriate tenants.

The specifics of each step can vary, depending on the nature of the property. The biggest differences occur when the Corporation leases properties that are being built as part of a property development. The Corporation assesses these properties in more detail earlier in the process, and they are more closely overseen throughout the life of the project.

We reviewed 48 acquisition files to see whether the actions taken had complied with the relevant policies and procedures.

Identifying opportunities

Corporation staff monitor the local housing market, using newspapers, real estate publications, and local real estate agents to help identify suitable properties. Property developers or private owners who are keen to lease to the Corporation may also approach them.1

Assessing suitability

The Corporation assesses potential properties against its design criteria. Staff seek verification from regional management if the property seems to be marginal in terms of meeting local need. Properties are occasionally offered to the Corporation for leasing before they are built (that is, from a proposal with building plans). In these cases the Corporation may be able to negotiate design changes to better meet regional need.

The Corporation requires due diligence checks to be carried out when it buys properties. The checks include:

  • a title check;
  • obtaining satisfactory reports from the local authority; and
  • undertaking a maintenance assessment.

Checks on properties for leasing involve verifying the property’s ownership, recording its condition, and checking the credit history of the property’s owners.

The Corporation requires valuation reports for bought properties, and for leased properties that have been offered to the Corporation before being built. The valuation reports inform the Corporation’s financial analysis of the likely long-term value of the investment.

Approving acquisitions

All proposals to acquire properties must be approved in keeping with the Corporation’s delegations framework.

The approval of acquisitions includes considering background information, the results of due diligence work and financial analysis, and copies of sale and purchase agreements or an agreement to lease.2

Completing the acquisition

The staff member responsible for a particular purchase or lease will oversee progress with each property through to settlement date, or the date the lease starts. During this process the staff member interacts with other Corporation staff , including tenancy management, and legal and administrative support.

For bought properties, completing the acquisition involves confirming that conditions in the sale and purchase agreement have been met. As the time of settlement approaches, the staff member must conduct a final inspection, and arrange for the vendor to be paid and for the title to be transferred. For leased properties, a lease start date must be agreed with the owner and the lease registered on the property’s title. For both processes, the staff member lists the property as “pending” in the Corporation’s property database.

The Corporation monitors the quality of properties that are being built to be leased. For these projects, the start of the lease depends on the property developer notifying the Corporation that the properties are ready to be lived in. However, the Corporation must satisfy itself that this is the case. It is possible for the start date of a lease to be postponed if the Corporation considers that the property is not ready to be lived in.

Notifying tenancy management staff

Once property settlement has occurred or a lease has begun, a state house is recorded as vacant in the Corporation’s property database. It can now be made available to people on the waiting list. We were told that it is important for tenancy management staff to have at least 10 days’ warning of new properties becoming ready for tenants so that they can arrange for an applicant from the waiting list to move into the house.

Before moving in, applicants need to inspect the property and sign a tenancy agreement. Once an applicant has signed on as a tenant and has taken possession of a house, it is recorded as let in the Corporation’s property database.

Compliance with guidelines

We expected the Corporation to have comprehensive guidelines clearly setting out the process for buying and leasing houses.

Guidelines for buying and leasing are stored in an electronic quality management system (QMS) that is available to all staff. The QMS is kept current and secure, and the responsible general manager must approve updates to the policies and procedures section.

The Corporation has documented the process for buying and leasing houses, and written guidance is provided for each of the important steps. Responsibilities are set out at each stage, and cross-references to other relevant documents are provided. Other relevant documents include:

  • forms that can be used to set up information in the Corporation’s property database;
  • standard conditions to be added to any sale and purchase agreements;
  • codes of conduct for real estate agents and valuers working with the Corporation; and
  • templates for lease documents.

Conflicts of interest

We have a particular interest in the way that public entities manage conflicts of interest. We are satisfied with the way the Corporation has approached this risk.

The Corporation’s policy on managing conflicts of interest is available through the QMS. It sets clear directions about identifying, disclosing, and managing conflicts of interest, the processes to be followed, and who makes decisions.

Staff are required to disclose any conflicts of interest to their manager and agree on actions to manage the conflict. A signed declaration of this agreement is held on the Corporation’s conflicts of interest register.

We obtained examples of conflict of interest declarations that related to the leasing programme. The declarations involved:

  • a family member leasing a house to the Corporation; and
  • a staff member already owning an investment property in the Corporation’s leasing programme.3

The Corporation took appropriate action to manage the conflicts, and the staff involved agreed not to participate in decision-making that might affect the properties.

Managing conflicts of interest has a high profile within the Corporation. Training courses and advice have been provided to staff and managers. Managers must annually certify that they have complied with policies and procedures, including checking with their staff for any conflicts of interest.

The Corporation provides its staff with robust guidelines for buying and leasing houses. Generally, the guidance is being complied with. The Corporation recognises the importance of managing potential conflicts of interest and has adequate arrangements for managing them.

Compliance with guidance

Our review of 48 files showed general compliance with policies and procedures. However, some of the required documentation was missing:

  • There was not always evidence of pre-settlement inspections.
  • The justification for entering into cross-leases was not always documented in the file.
  • There was not always evidence that credit checks had been carried out for leased properties.

Although these were minor omissions, it is important that the Corporation can show through written documentation that it has complied with its policies and procedures. We understand that these matters are being pursued through the Corporation’s internal audit process, and we expect to see an improvement in the documentation.

Recommendation 2
We recommend that Housing New Zealand Corporation include a checklist of the mandatory documentation to be included on each file in its quality management system guidance for buying and leasing.

The Corporation’s investment decisions

It is important that properties bought or leased by the Corporation meet the required financial benchmarks and are approved at the appropriate levels. Our review of files for bought and leased state houses showed that: the required analysis had been undertaken for each property; financial benchmarks had been met or exceeded; and with one exception, all acquisitions had been approved at the appropriate level or higher.4

The Corporation undertakes financial analysis of all proposed purchases or leases. Its modelling software can analyse single properties or groups of properties, and forecast investment performance over time.

The data supporting the analysis comes from valuation reports that are obtained as part of the due diligence process. This includes an assessment of the market rental for the properties, and, in the case of bought properties, an assessment of their market value. Standard assumptions of rates of capital and rental growth5 and likely vacancy rates are also included.

These factors are used to forecast income and expenses for the property, and thus the net cash flow of the investment, over 5, 10, and 15 years for bought properties, or over the term of a lease. From this information, the Corporation can see the internal rate of return that it can expect to receive.6 If this exceeds the cost of capital to the Corporation, then the acquisition is considered an acceptable financial investment.7

To be approved, the Corporation has specified that the internal rate of return for a proposed purchase should exceed the cost of capital to the Corporation at the 15- year benchmark. Where the internal rate of return is less than the cost of capital, the purchase may proceed if the rate is equal to, or greater than, the average rate of return for nearby state houses.

For leased properties, the Corporation’s income is a management fee of between 7% and 10% of the total weekly rent.8 To be approved, a leased property must return a positive net cash flow when discounted to today’s dollars during the term of the lease.

The level of approval sought for purchases and leases is based on the risks associated with the proposal. The managers of staff sourcing acquisitions have approval rights. However, more senior approval must be sought if financial performance is marginal, if more expensive properties are sought, or if leases have non-standard margins or lease terms. More senior approval can be sought from general managers, the Chief Executive, the Property Committee of the Board, or the whole Board.

The quality of bought and leased houses

We are satisfied that, overall, properties sourced through the buying and leasing programmes comply with the Corporation’s specifications and are of high quality.

The Corporation has state housing specifications that set quality requirements. State houses must also comply with local authority district plans, the Building Act 2004, and the Building Code.9 The Corporation’s requirements focus on safety, ease of maintenance, and ensuring that property values are maintained.

Properties sourced from private owners do not always initially comply with the Corporation’s specifications. When buying a property, the Corporation assesses the work needed to bring it up to the necessary standard. The costs of the work are included in the financial analysis supporting the proposal to purchase, and, if approved, the work is undertaken before the property is let.

There is less scope for altering leased properties, because the private owner decides whether to make improvements. The Corporation can require certain changes when negotiating the conditions of the lease. For example, we noted instances of the Corporation requiring dishwashers and garbage disposal units to be disconnected.10 However, property owners may choose not to enter into leases if they find the quality requirements too onerous.

It is possible for the Corporation to influence the design of properties being built for leasing. Proposals to enter into such arrangements must be reviewed by the Corporation’s design experts before they can be approved. Projects underway are monitored to ensure that they adhere to the quality specifications and must be signed off as complying before the lease can start. We saw one example of the Corporation seeking compensation from a property developer under contract penalty clauses for repeatedly missing lease start dates because of problems with the quality of the property.

Acquiring the most suitable properties and making them available to tenants

It is important that newly acquired houses match the housing needs identified in each region. We expected the Corporation to acquire the most suitable properties, and to make them available to tenants as soon as possible.

Acquiring the most suitable properties

The Corporation has had some difficulty matching its most recent acquisitions in Auckland to the priority housing types identified in the Regional Asset Management Plans. However, overall, we consider that the Corporation has been acquiring the most suitable houses, given the challenges that it faces.

Regional Asset Management Plans set out housing targets for the 2 programmes. Supporting this information is a breakdown of targets by required housing type. To assess the Corporation’s most recent acquisitions we compared written statements in the Regional Asset Management Plans about the types of properties required, and the breakdown of targets, to the properties the Corporation had obtained.

The Corporation’s latest Asset Management Strategy states that about 45% of all state houses have 2 bedrooms or fewer, about 45% have 3 bedrooms, and about 10% have 4 bedrooms or more. The Auckland Regional Asset Management Plans for 2005-06 emphasise the need for the Corporation to obtain fewer 3-bedroom houses, and more with 2 or fewer bedrooms and 4 or more bedrooms. Averaged across the 3 Auckland regions, they specify that for newly acquired houses:

  • 42.5% should have 2 or fewer bedrooms;
  • 36.3% should have 3 bedrooms; and
  • 21.2% should have 4 or more bedrooms.

As at February 2006, acquisition performance for the year 2005-06, averaged across Auckland, showed that for newly acquired houses:

  • 30.1% had 2 or fewer bedrooms;
  • 43.8% had 3 bedrooms; and
  • 26.1% had 4 or more bedrooms.

A direct comparison between these 2 sets of figures is of only limited use, because the acquisition programme for 2005-06 was not complete when we wrote this report. However, our analysis has identified that the Corporation is tending towards acquiring more 3-bedroom houses in Auckland than its planning has identified as necessary. We looked at performance for 2004-05 and found that, of all the houses acquired in that year, 33.5% had 2 or fewer bedrooms, 34.8% had 3 bedrooms, and 31.7% had 4 or more bedrooms.

The Corporation has found that, in Auckland, properties with 2 or fewer bedrooms tend to be in apartment blocks that in most cases do not suit the needs of applicants on the waiting list. It has also found that high costs tend to limit the building of non-apartment properties of 2 or fewer bedrooms.

The Corporation does not see this as an urgent problem. The extra number of 3- bedroom houses above the target percentage equates to about 64 houses in the 3 Auckland regions that share a total of 28,382 houses. In addition, many Auckland applicants on the Corporation’s waiting list could make use of the additional 3- bedroom houses.

Acquiring more 3-bedroom houses than necessary creates a long-term risk for the efficiency of the overall housing portfolio. If the Corporation continues acquiring 3-bedroom houses in Auckland in the absence of suitable properties with 2 or fewer bedrooms, it should put a strategy in place to deal with the associated risk.

Recommendation 3
We recommend that Housing New Zealand Corporation prepare a strategy for making the best long-term use of properties acquired in the absence of more suitable properties identified in the Asset Management Strategy and Regional Asset Management Plans.

Preparing houses for tenants

Most bought properties are let within 5 days of being ready for tenants. Leased properties are also let within a reasonable timeframe, but occasionally do experience delays. When delays occur, in our view, they are not unreasonably long.

Bought and leased properties count towards the Corporation’s targets after contracts are signed and are unconditional. In the case of properties built for leasing, they count towards the targets when the developer has given the required 21 days’ or 15 working days’ notice of completion. The properties are recorded as “awaiting settlement” or “pending lease start” in the Corporation’s property database. However, before tenants can move in, the lease must start or settlement must be concluded, and any necessary maintenance must be carried out.

Acquisition staff are required to give other Corporation staff advance warning of state houses becoming available for tenants to move in. This allows suitable tenants to be identified early, and notified to make arrangements for moving in as soon as the house is ready.11

The Corporation’s property database shows the length of time between properties being counted towards targets, being ready for tenants to move in, and being occupied. We accessed the database history of 126 properties that related to the 48 acquisition files we reviewed, and examined the histories of 114 properties that had been tenanted (22 of these properties were bought and 92 were leased).

Most of the 22 bought properties had been recorded in the database as “let” within 5 working days of being ready for tenants. Sixteen had become occupied within 5 days, and the other 6 were occupied within 3 weeks. Five of the latter group had needed maintenance to be completed.

Our examination showed that the 92 leased properties were also tenanted in a reasonable timeframe, but there were longer delays for some properties:

  • 25 had become occupied within 5 working days;
  • 51 took between 5 days and 3 weeks to become occupied; and
  • 16 properties took longer than 3 weeks to become occupied.

Newly built leasing developments that consisted of many individual properties took longer to fill. In these cases, it is reasonable to expect some delays given the logistics required in arranging tenants for large new developments. However, it took between 5 weeks and just over 8 weeks for 9 of the properties to be tenanted, which approaches the limits of what would be reasonable to expect.

1: The Corporation advertises the leasing programme on its website.

2: There may already be a signed sale and purchase agreement, or an agreement to lease, conditional on approval by the Corporation’s management.

3: The Corporation’s policy is that it will not enter into new lease programme agreements with staff.

4: The exception related to a lease mistakenly approved by a staff member who, since shifting from one business team to another, no longer had delegated authority to approve leases. The Corporation has reviewed the files in question and dealt with this exception appropriately.

5: The system uses underlying tables of values that are applied to investment analysis. These tables include central and local government tax rates, rates set centrally by the Corporation’s corporate finance team, and rates specific to the Corporation’s regions. If staff use non-standard assumptions, they must justify why.

6: Internal rate of return is the annual percentage profitability on the initial investment in a project, taking into account that money received later is worth less than money received earlier.

7: The Corporation uses a Weighted Average Cost of Capital, set by its corporate finance team, to represent the assumed interest cost for the capital used in the project.

8: This is intended to cover initial set-up costs, vacancy rates, lease management overheads, reinstatement costs at the end of the lease, and income tax.

9: The Building Act 2004 provides for the regulation of building work, the establishment of a licensing regime for building practitioners, and the setting of performance standards for buildings. The New Zealand Building Code is Schedule 1 of the Building Regulations 1992. All building work must comply with the Building Code. It states how a building is to perform, but does not prescribe detailed requirements for design and construction. The Building Code is currently being reviewed to align it with the 2004 Act.

10: The Corporation does this to prevent any future liabilities for repairing or replacing these appliances.

11: There is typically a delay before applicants can move into state houses because they need to give notice at other properties.

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