PR

O
AC
TI
VE
LY
R
EL
EA
SE
D
BN 22 015
17 June 2022

Hon Dr Megan Woods, Minister of Housing

Hon Grant Robertson, Minister of Finance
cc: Vui Mark Gosche, Board Chair

Update on Kāinga Ora Financial Sustainability

Recommendations

D
1. I recommend that you:

SE
a) note that Kāinga Ora – Homes and Communities has inherited an Noted
ageing public housing portfolio with 45,000 of our state homes
requiring significant capital reinvestment in the next 20 years in

EA
order to enable them to meet the needs of our customers.
b) note that due to COVID related delays, we are hitting a peak Noted
construction period at exactly the same time as construction costs

c)
have surged and interest costs have increased.
EL
note that as Kāinga Ora borrows to cover all costs associated
with building new public homes, increases in our costs will mean
R

y
it will take longer for the rents we receive over the life of the Noted
homes to pay off the cost of building them – leaving less to go
Y

towards future renewal, maintenanc and other activities such as

providing increased service levels and covering our operating
L

costs.
VE

d) note the Kāinga Ora FY22-26 draft budget: Noted

 incorporates existing public and supported housing growth
commitments, healthy homes compliance requirements and
TI

commitments to deliver the large-scale projects business

cases.
AC

 reflects the government’s current commitment to public

housing growth ceasing after FY24, and as a consequence
shows a shift in focus to the renewal of the existing ageing
O

public housing assets.

 reflects a significant shift in a number of key assumptions
PR

since previous versions, reflecting headwinds across the

construction sector, pronounced cost inflation relative to
income, and broadened demands on the organisation.

e) note that the Kāinga Ora financial metrics will be stressed in the
Noted
near term and our funding model is being significantly challenged.
f) note that the Kāinga Ora Board is focussed on the prudent
financial management of our operations and stewardship of our
balance sheet to ensure long-term sustainability and is taking a Noted
number of mitigations to improve our resilience.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 2

PR
O
AC
TI
VE
LY
R
EL
EA
SE
D
Executive Summary
2. Kāinga Ora has inherited an ageing public housing portfolio. Over the next 20 years
around 45,000 of our state homes will reach the end of their economic life and
require significant capital renewal to enable them to meet the needs of our
customers in a cost-effective manner. This means we need to make a decision for
each of these assets on the interventions required to provide the functionality and
thermal performance necessary for modern public housing, and improve the
typology match to our customer needs.

D
SE
EA
EL
R

y
Y

3. This renewal challenge is coming through in our maintenance costs with our CPI
adjusted spend on repairs and maintenan e doubling over the last ten years. This
L

spend is on an upward trajectory. In addition, research has shown that a high

VE

proportion of our customers feel that their homes are cold or damp, and research
shows cold damp homes impact health outcomes.
TI
AC
O
PR

4. Generally, most landlords in this situation would:

 Be able to draw on rent set aside through the life of the asset to manage these
renewal costs, however previous settings which required Housing New Zealand
to provide a dividend to the Crown mean we do not have these reserves; or

BN 22 015 – Update on Kāinga Ora Financial Sustainability 1

  Run assets down until they reach the point of failure before selling them ‘as is’
to avoid expensive refurbishment costs. However, this is not financially sensible
if you want to hold the assets in the long-term and would have adverse
outcomes for our customers and communities.

5. Given this context of ageing homes at the end of their life, we need to fund the
management, maintenance and renewal of our assets from:

 the rent we receive from our existing assets (based on market rents)

 sales revenues from release of surplus and/or high value homes, and

 selling land where we have enabled intensification, particularly the super lots

D
within our large-scale projects.

SE
6. These income streams are normally received after our capital investment, so some
new debt is required to pay for the upfront investment. This is repaid through income
from renting those homes over their life, as well as the proceeds from house and
land sales.

EA
7. The significant renewal requirement and cost of development means there is no
surplus cash left over to contribute towards public housing growth. As a result,

EL
growth in the number of public and supported housing is all financed through debt.
This means that the rents and operating supplement we receive for these new
homes need to cover the costs associated with the future management,
R
maintenance and renewal costs of the homes, as well as the costs of servicing that

y
debt. This model is also reliant on inflation in rental levels to make it work for us.
Y

8. We have based our revenue requirem nt for new homes on cost recovery. This
means we have targeted a level of rental evenue (primarily from the Crown) to meet
L

our costs but no more.

VE

9. Our long-term modelling had previously shown that we were able to pay off the debt
we would borrow within the life of the assets, and have some remaining free cash
flows to enable us absorb some of the broader expectations or respond to shocks.
TI

10. The shifts we are now seeing in construction and maintenance costs as well as
interest rate increases are now challenging this model, with expenses outgrowing
AC

our revenue streams at an accelerating speed from FY22. As can be seen in the
below diagram this is reflective of broader movements being seen across New
Zealand (refer figure below), and we are anticipating that over the next few years
O

our surpluses (EBITDA) will not completely cover our interest costs. It should be
noted that the majority of our labour costs outside of core staff are maintenance
PR

contractors which have seen much higher levels of inflation - this is discussed in
further detail in the body of the paper.

11. In addition, growing expectations to deliver improvements to our public housing

service levels and the quality of our homes has put further pressure on our financial
metrics.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 2

 D
SE
EA
12. The table below summarises the key drivers behind the shifts in our assumptions,
and the effect this has had on core financial sustainability metrics. In particular:

 Scenario A reflects our draft budget and shows the key financial impacts from

EL
delivering our renewal investment pathway. It shows that the changes to our
economic and cost settings are challenging our financial sustainability. Cash
surpluses will be challenged in meeting financing costs across the next
R
10 years, likely impacting our stand-alone credit profile. Future renewal

y
requirements will not be fully met through free cash flow, requiring further debt
financing.
Y

 Scenario’s B-E display the increment l change of each setting change. In

L

particular:
VE

o Scenario B shows that the escalation in build costs is having the greatest
impact on our long-term financials due to the significant investment in new
homes across the next 10 years, adding circa $8b to our forecast financing
TI

requirements. Build costs under previous settings would have resulted in

most sustainability measures being met.
o Scenario C shows that relative to build cost escalation, maintenance cost
AC

increases have a lesser medium-term impact but remain material long term.
The portfolio’s future renewal requirements are negatively impacted, as
future free cash flow will diminish should ongoing maintenance costs
O

remain elevated.
o Scenario D shows that the impact of quality improvements including
PR

delivering Homestar 6 version 4 in all new builds, 15 percent universal

design requirements for newly built homes, and the additional cost of
adding accessibility enhancements through our retrofit programme (around
15 percent of total programme cost). These changes have had a similar
impact to maintenance cost increases.
o Scenario E shows that movements in interest rates in the last eight months,
have had a pronounced effect financing costs. Higher debt requirements
from increased investment results in us being more vulnerable to
movements in bond markets. Previous financing settings ensured
compliance with most metrics as we had sufficient cash surplus to cover
interest expenses.

 Scenario F shows the overall impact of these movements in assumptions,

illustrating that under previous economic and cost settings, the delivery of the

BN 22 015 – Update on Kāinga Ora Financial Sustainability 3

 preferred investment pathway would likely have met key financial sustainability
tests, and ensured we could meet future asset renewal requirements.
s 9(2)(f)(iv)

D
SE
EA
13. Reflecting the challenging external environment, we are already driving efficiencies
into our organisation, including incorporating into our draft budget a 10 percent

EL
savings target in our corporate area which will yield savings of approximately $28m
per annum. We have also asked management to investigate options for further
savings through efficiencies in corporate, maintenance and construction costs. It is
R

y
expected that these will be reflected in our quarterly budget updates as appropriate.

14. We have also asked management to pro ide advice on the cost impact of different
Y

service level and quality options relating t our public housing portfolio. We strongly
L

believe that the current service levels and quality standards are appropriate given
our customer base and align with government policy direction, but given they move
VE

our portfolio well beyond the service levels and quality standards of a typical rental
portfolio, they may no longer be viable for us to absorb within our income streams.
TI

15. In particular, we have asked management to provide advice on:

 Suspending the whole of home heating programme which seeks to ensure the
AC

whole house can be heated rather than just the living space as is required by
the building code and Healthy Homes.

 Removing accessibility improvements from the retrofit programme (currently

O

~15 percent of our programme costs) pending discussions around alternative

funding arrangements for this.
PR

 Exiting high-cost remote locations and/or uneconomic assets (those assets that
cost more than the rent we receive to run them).

16. There are also a number of options to reduce costs further including:

 revisiting decisions relating to HomeStar 6 version 4

 initiatives based around standards or service quality e.g. community rooms,

customer programme, accessibility improvements (15 percent universal design)
as part of new build homes etc.

17. At this stage we are not investigating these last two areas further, but should we
need to we will seek your guidance on how we should proceed.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 4

18. We are also actively investigating funding streams to support decisions around:

 moving to Homestar 6 version 5 noting that current income streams prohibit this

 the delivery of further accessibility improvements as part of our new public

homes beyond the current 15 percent commitment.

19. As is highlighted in the table above, while we are pulling those levers within our
control, the impact of these changes is dwarfed by the broader economic challenges
we are facing. Without changes to our current funding model our ability to invest in
further public housing growth and meet the expectations set out for us both in the
Government Policy Statement on Housing and Urban Development (GPS - HUD)
and in our legislation around public housing and urban development delivery will be
significantly constrained.

D
20. In addition, you should be aware that our modelling is now showing that with the

SE
changes to our assumptions indicated above, by FY24 our Community Group
Housing (CGH) funding streams will no longer be sufficient to cover interest costs
and tax. This means decisions around stopping or deferring growth where there is

EA
not a sufficient lease or rental income to meet costs, or divestment may need to be
considered. Ultimately a lot of the costs associated with CGH are paid for by other
government departments, in particular Ministry of Health (which funds over half).

21.
EL
Your support to secure a more reliable funding stream for this service from these
government departments would help improve the model for this critical service.

Given this context, this paper seeks your support for us to work with HUD and the
R

y
Treasury to review our current funding and financing settings to ensure that our
service provision aligns to your expectations for public and supported housing; and
Y

enables our broader urban developme t remit in line with government direction with
a particular focus on:
L

s 9(2)(f)(iv)
VE
TI
AC
O
PR

BN 22 015 – Update on Kāinga Ora Financial Sustainability 5

Purpose
22. This briefing note provides you with an update on the short and long-term financial
projections for Kāinga Ora, in particular the impact of cost pressures and inflation
and the implications of this on our funding settings (including the operating
supplement), projected debt and our associated financing strategy.

Background
23. As part of our April 2022 update on key delivery commitments (BN 22 033 refers) we
committed to providing you with further information on our long-term financial
projections, in particular the impact of cost pressures and inflation and the
implications of this on our funding settings (including the operating supplement),
projected debt and our associated financing strategy.

D
24. We are currently in the process of finalising our FY22-26 internal Kāinga Ora budget

SE
and expect to receive the final budget in late June for approval. This budget will set
a baseline for the organisation for the next four years.

EA
25. As part of the budget development process, we have undertaken long-term financial
projections (out to 60 years) to help frame the four-year budget and budget
decisions, and to understand their implications over time.

26.
EL
The FY22-26 draft budget shows a significant shift in a number of our key
assumptions from previous versions, reflecting headwinds across the construction
sector, and pronounced cost inflation relative to rental levels and operating
R
supplement settings that have implications on the ability of the current funding

y
model for capital spend on additional homes.
Y

27. We received clear direction from your 2022 Letter of Expectation to:
L

 Be particularly focused on, and clear about, our core activities and functions as a
VE

public housing landlord, provider of new public and transitional housing, and
enabler of much needed urban development;

 Focus on prudent stewardship of our balance sheet and financial leveraging to

TI

ensure our long-term financial sustainability and continued ability to deliver the
core functions and operations; and
AC

 Have a disciplined focus on ‘core’ roles and functions and consider what is
critical, what could be deprioritised, or better enabled through others. In
particular, you have asked that we ensure policy and funding settings are fully
O

established before implementing any new initiatives.

PR

28. This direction has framed the approach we have taken to this budget.

Kāinga Ora’s Existing Funding and Financing Model

29. Our financial modelling reflects a number of key investment principles, which were
agreed as part of our current Long-term Investment Plan. These are as follows (in
no particular order):

 Our investment intentions reflect  We run the portfolio from the rental
Kāinga Ora strategic and legislative cash flows of the business.
priorities.  Debt is only used to finance our
 We meet our legal requirements first. capital programme – renewal, growth
and urban development – from clearly

BN 22 015 – Update on Kāinga Ora Financial Sustainability 6

PR
O
AC
TI
VE
LY
R
EL
EA
SE
D
 D
SE
EA
EL
R
32.

y
While the tables set out a broad range of organisational activities proportionality
Y

87 percent of Kāinga Ora’s funding is cur ently linked to both the maintenance and
L

renewal associated with our existing ~68,800 public and supported homes and the
growth of these portfolios. This activity is funded through proceeds from rental
VE

revenue, unit sales and debt financing (directed towards capital programme – which
ultimately will be recovered through rents or unit sales).
TI
AC
O
PR

33. The renewal requirement for our portfolio is significant. Over the next 20 years
around 45,000 of our state homes will reach the end of their economic life and
require significant capital renewal to enable them to meet the needs of our
customers in a cost-effective manner. This means we need to make a decision for

BN 22 015 – Update on Kāinga Ora Financial Sustainability 8

 each of these assets on the interventions required to provide the functionality and
thermal performance necessary for modern public housing, and improve the
typology match to our customer needs.
34. This renewal challenge is coming through in our maintenance costs with our CPI
adjusted spend on repairs and maintenance doubling over the last ten years. This
spend is on an upward trajectory. In addition, research has shown that a high
proportion of our customers feel that their homes are cold or damp, and research
shows cold damp homes impact health outcomes.
35. Previous government requirements for Housing New Zealand to provide a dividend
to the Crown have meant that we have not been able to draw on reserves set aside
during the life of these assets to fund renewal. Sweating the assets further would
also have adverse outcomes for our customers and communities and significant

D
reputational risks from an all of government perspective.

SE
36. Given this context, we are currently funding the management, maintenance and
renewal of our assets from the rent we are still receiving from these existing assets
(based on market rents), sales revenues from release of surplus and/or high value

EA
homes, and the current market value of assets used for land development realised
from super lot sales. Some debt financing is required to pay for this upfront
investment, which is repaid through the rental and sales proceeds mentioned
previously over time.

37. EL
The significant renewal requirement and cost of development means there is no
surplus cash left over to contribute towards public housing growth. As a result,
R
growth in the number of public and supported housing is all financed through debt.

y
This means that the rents and operating supplement we receive for these new
homes needs to cover the costs associat d with the future management,
Y

maintenance and renewal costs of the homes, as well as the costs of servicing that
debt. This model is also reliant on inflation n rental levels to make it work for us.
L
VE

38. We have based our revenue requirement for new homes on cost recovery. This
means we have targeted a level of rental revenue (primarily from the Crown) to meet
our costs but no more.
TI

39. Refer to Attachment 1 for the cash flow and income statement at a portfolio level.

Kāinga Ora Budget 2022-2026

AC

Our draft budget is focussed on meeting our commitments...

40. Given the context set out above, our 2022-2026 budget sets a baseline for the
O

organisation incorporating our existing commitments around:

PR

 Growth of approximately 6,000 net additional homes in FY23 and FY24 and nil
growth thereafter reflecting current government budget commitments to public
housing growth

 Completion of the healthy homes programme by June 2023

 Delivery of the large-scale project business cases (being the first five years of
investment in these programmes for Mangere, Mt Roskill, Tamaki and Porirua
which enable land for up to 17,000 homes).

41. Our financial projections also incorporate direction in relation to higher service levels
for our homes and customers including responding to:

 the Healthy Homes Guarantee Act by June 2023

BN 22 015 – Update on Kāinga Ora Financial Sustainability 9

  the Kāinga Ora - Homes and Communities Act which set new and expanded
expectations around how we work partner and engage, and which sets
obligations in relation to community and individual wellbeing, including
supporting tenants to be well connected to their communities and to lead lives
with dignity and independence

 The Disability Action Plan through setting accessibility requirements in new

homes; and

 Emerging direction in relation to climate change, including through the Carbon

Neutral Government Programme, which we have reflected through adopting
Homestar 6 version 4.

D
....it also provides direction to the business in the absence of a current commitment
to public housing growth beyond FY24.

SE
42. In order to meet our FY24 housing delivery commitments we are building capacity
internally and within the private market to undertake approximately 5,000

EA
construction interventions each year. A key part of our ability to do this is our
commitment to the construction sector that we will have ongoing pipeline of work.

43. With Government commitment to funding new public homes currently ceasing in

EL
FY24, as a Board we currently are unable to commit to growth beyond this point. As
such our 2022-26 budget modelling switches the capacity we have built in the
market to a renewal, rather than growth, focus post FY24.
R
44. Based on current asset data and initial analysis around what we anticipate will be
the most financially optimised approach, we would expect an approximate
Y

combination of renewed homes of:

L

 retrofit of assets in locations which we wish to maintain a presence on land

VE

holdings that are not able to be redeveloped (~11,000 homes)

 replacement (~17,000 homes via sale of an older home offset by a new home
through redeveloping Kāinga Ora land or on land we don’t currently own) and
TI

 redevelopment (~17,000 homes through demolition and intensification of our

AC

existing land holdings).

45. With a single focus on asset renewal post FY24, we would be able to renew our
stock (~45,000 homes which are coming due or are past due for renewal) over an
O

approximately 10 year window extending their lifecycle and making them fit for
purpose for our customers. This is much quicker than was previously planned
PR

(which was estimated at 20 years). This approach will:

 Deliver warmer, drier, better-quality homes earlier improving the health and
wellbeing of our customers;

 Result in higher performing assets in the right locations;

 Help to address escalating operating costs;

 Be less reliant on debt for future asset renewal; and

 Release many more homes into the market.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 10

46. On the basis that we currently have no access to funding for additional public
housing post FY24, to offset home and land packages we may acquire (through the
replace programme) or additional homes created through uplifts in density (through
the redevelopment programme), our budget also reflects the sale of ~24,500 homes
to the market including:

 High-value homes with limited redevelopment potential,

 Existing older homes.

47. This would mean that while there will be a net-zero impact on public housing
numbers, there will be a net increase in housing overall for New Zealand. There is
also an opportunity that some of these older homes could be released as an

D
affordable housing product.

SE
48. The approach we have taken to renewal in the budget is necessary from an
organisational perspective, as with lead-in times for our more complex projects of
two or more years we are already starting to see projects for post FY24 coming
through for approval, and without this or a commitment to growth we would need to

EA
consider dialling back capacity.

49. This approach also means the organisation will be able to respond more quickly

EL
should funding be provided post FY24 for public housing growth (i.e. we will be able
to quickly dial back proposed sales programmes which will offset growth under a
renewal approach). Your support to get certainty on public housing growth
R
expectations through Budget 23 will be necessary for us to be able to readjust our
approach.
Y

Financial impact of this decision

L

50. Our renewal activity is primarily funded from ongoing rentals (which are based on
independently assessed market rents) and the net proceeds from surplus asset and
VE

land sales. These activities leave Kāinga Ora with an efficient modern portfolio
capable of generating strong operating surpluses into the future allowing it to:


TI

Cover the costs of its debt associated with renewal, if any;

 Repay the debt; and

AC

 Remain within prudent debt limits.

51. While retrofits increase individual property rents, a key aim of the programme is to
O

offset the depreciating values and rents across the wider portfolio i.e. Kāinga Ora is
endeavouring to maintain its rental stream relative to the market (which our rental
PR

stream is assessed against). As such, the increased rents at a property level do not
entirely translate as increased rents at the portfolio level, with any additional rent
requirement likely to be absorbed within current Income-Related Rent Subsidy
(IRRS) provisions, which are adjusted in line with market.
52. The properties identified for renewal are reaching the end of their functional life,
making them costly to maintain and impacting the financial sustainability of the
portfolio. These homes also require significant capital investment in order to enable
them to meet the needs of our customers. The costs therefore will not go away and
will need to be funded one way or another, irrespective of whether the properties are
renewed via retrofit, redevelopment or replacement, or as a result of an increased
maintenance requirement should we not intervene at all.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 11

The construction sector headwinds have coincided with high public housing
growth requirements and increased interest rates and together these pressures
have had a significant impact on our assumptions
53. Significant increases in demand for additional public housing, alongside increasing
expectations to deliver improvements to our public housing service levels and the
quality of our homes, has put pressure on our metrics. Our long-term modelling had
previously shown that we were able to pay off the debt we would borrow within the
life of the assets and have some remaining free cash flows to enable us to absorb
some of the broader expectations or respond to shocks.

54. The shifts we are now seeing in construction and maintenance costs as well as
interest rate increases are now challenging this model, with expenses outgrowing

D
our revenue streams at an accelerating speed from FY22. As can be seen in the
below diagram this is reflective of broader movements being seen across New

SE
Zealand (refer figure below), and we are anticipating that over the next few years
our surpluses (EBITDA) will not completely cover our interest costs. It should be
noted that the majority of our labour costs outside of core staff are maintenance

EA
contractors which have seen much higher levels of inflation - this is discussed in
further detail in para 61.

55. In addition, growing expectations to deliver improvements to our public housing

EL
service levels and the quality of our homes has put further pressure on our financial
metrics.
R
L Y
VE
TI
AC
O
PR

56. The sections below outline these key shifts in our assumptions, including:
construction cost prices, maintenance costs, interest/financing costs, scope and
people costs and the effect this has had on financial sustainability metrics.

Increased construction costs

57. Prior to the significant construction price escalation from Covid-19, we were
delivering homes in line with the previous sustainable construction price benchmark.
An overall 15 percent savings target was established, with an increasing number of
our deliveries achieving efficiency savings prior to 2020.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 12

58. As is illustrated in the below figure, construction prices from 2020 have risen
significantly above the previous sustainable benchmark, with future contracted
builds almost 50 percent higher driven by:

 Accelerated cost escalation (35 percent for new builds) - due to labour and
material shortages and inflation.

 Changes in bedroom mix (9 percent) - the business has identified a greater

need for larger homes via its redevelopment programme as we move existing
customers than is anticipated through the housing register. These larger homes
cost more but do generate higher rents offsetting this additional cost.

 Scope changes (5 percent) - increases to the quality of the homes we are

D
developing beyond building code standards.

SE
59. As a result we have updated the cost benchmark to reflect these sustained
pressures in the construction sector. We are also actively pursuing construction
opportunities through Project Velocity, lifting build delivery efficiency, and increasing

EA
our capacity to meet public housing commitments.

EL
R
L Y
VE
TI

60. However, due to the significant investment in new homes across the next 10 years
AC

this escalation in build costs is having the greatest impact on our long-term
financials, adding circa $8b to our forecast financing requirements.
O
PR

61. Consequently, with increases in construction costs driven by material and labour
costs we have also seen our maintenance costs increasing from on average $7,500
per home to $8,500 per home and retrofit costs (costs of bringing an older home up
to standard) increasing by approximately 25 percent. The following table outlines the

BN 22 015 – Update on Kāinga Ora Financial Sustainability 13

 increases in labour rates between 2019 and 2022, and the subsequent graph
models the impact this has had on the long-term financial outlook.

Category Increase
CARPENTRY 45%
DECORATING 27%
ELECTRICAL 42%
FLOORING 30%
GLAZING 28%
HEATER 18%
CLEANING 17%
PLUMBING 36%
ROOFING 44%

D
GAS 34%

SE
OVERALL 33%

EA
EL
R
Y

62. If cost inflation were to continue to increase faster than expectations, this would
L

further erode our financial projections, extending the horizon over which associated
VE

financing could be repaid, including the risk of deriving a ROI insufficient to cover
repayment obligations. As context the escalated construction and maintenance
prices we now face significantly extend the time frame in which financing
requirements could be repaid, challenging the ability for future renewal requirements
TI

to be funded by portfolio reinvestment.

AC

Financing costs
63. Movements in interest rates have also had a significant effect, with previous
projections ensuring compliance with financial sustainability metrics (stand-alone
O

credit profile rating).

64. Our most recent modelling however which reflects updated interest cost projections
PR

over the budget term to June 2026 shows higher interest rates on our financing
activities are an immediate cost pressure to us – adding in an additional $680m over
the next four years relative to last year's budget, although this becomes more
noticeable later in the period given the level of pre-financing already undertaken at
lower rates.
65. This is an issue impacting any financing activities across all organisations (including
the Crown) and is not unique to Kāinga Ora.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 14

 D
SE
66. Relative to construction costs and financing changes, scope changes and people

EA
costs have a smaller, but still material impact by constraining our ability to meet our
portfolio’s future renewal requirements from free cash flow. These are discussed in
the following section.

EL
Increasing costs associated with delivering enhanced service levels in response to
Government direction and legislation
R
67. We are currently delivering a number of service level and scope increases in
response to government direction and legislation, the costs of which are not directly
catered for by our current funding mechanisms nor will result in increased rents.
Y

These include:
L

 A move away from historical direction to provide a service comparable to a

VE

market landlord to one that has a greater focus on sustaining tenancies

(previously over half of our tenancy managers had more than 250 or more
households in their portfolio whereas now they are managing on average
between ~100-220 households) and ensuring the quiet enjoyment of tenants
TI

and their neighbours (~$30m annual costs).

AC

 Healthy Homes legislation - $7,370 per home (~60,000 homes) includes an

estimated increase of $60m ($48m capex and $12m opex) due to COVID
delays and to meet legislative compliance timeframes- total cost ~$0.5 billion.
O

 Direction (GPS HUD, NZ Disability Strategy and Action Plan) to increase the
accessibility of our homes (~$8,100 per home to ensure 15 percent of our new
PR

homes meet universal design standard)

 Improvements in the quality of our homes to drive better health and

environmental sustainability outcomes (GPS HUD and Carbon Neutral
Government Programme). These changes have been integrated into SPE
targets based on 100% of new homes being delivered to a Homestar 6 standard
or higher. Based on the current version (version 4) of Homestar 6 this is adding
~ $9,500 per home.

68. The draft budget incorporated a forecasted additional 485 FTEs by June 2023,
driven by:

BN 22 015 – Update on Kāinga Ora Financial Sustainability 15

  Growing front-line services and customer base, especially as a result of the
customer programme

 Increasing housing supply and land development activity

 Increasing support services and people to support growth in other areas.

69. As the proposed increase in our people numbers will draw down further rental
income in the next couple of years with limited funding and capitalisable costs we
have already taken steps to reduce this projected cost by 10 percent which is now
reflected in our baseline draft budget – this is discussed further in the sections
below. As the below figure illustrates it should also be noted that our current net
people cost projections fall as a percentage of cash spend.

D
People costs (net) falls as percentage of cash spend

SE
EA
EL
R
L Y
VE

Due to COVID related delays, we are hitting a peak construction period at exactly
the same time as construction costs have surged and interest costs have
increased. As we borrow to cover all costs associated with building new public
homes, this means that it takes longer for the rents we receive over the life of the
TI

homes to pay off the cost of building them – leaving less to go towards future
renewal, maintenance and other activities such as providing increased service
AC

levels and covering our operating costs. Increased interest rates exacerbate this
issue.
O

Implications on our financial sustainability

PR

70. The cost pressures outlined above have significantly challenged our ability to absorb
further shocks, resulting in our balance sheet carrying a higher level of risk exposure
for longer. The current approach of 100 percent debt financing is projected to result
in core financial sustainability metrics remaining challenged for at least the next
decade.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 16

 s 9(2)(f)(iv)

D
SE
EA
71. As part of our normal practice, we model the financial implications of current policy

EL
settings and commitments on our organisation’s longer-term sustainability to ensure
it can remain agile and able to respond to changes in our external environment,
demand, the cost of construction, and the cost of debt. In order to understand the
R
potential impact of our choices, a number of assumptions have needed to be made
which have been drawn from Treasury data. Short term assumptions reflect latest
economic forecasts from The Treasury (Dec 21). Long term assumptions utilise The
Y

Treasury’s Long-Term Fiscal Model and are based on a sustainably functioning

L

economy and housing market. Key assumptions are detailed in Attachment 2.

VE

72. Our updated modelling shows that the current direction is tracking towards
sustainability within existing commitments, however a further improvement in
financial settings is required to confidently achieve true financial sustainability and
TI

improve our resilience. With debt estimated to peak at $28.9b in 2033 (refer to the
figure below), under current settings debt is not projected to be completely repaid
across the 60-year horizon.
AC

73. Across the next 10 years our surpluses (EBITDA) will largely be directed towards
covering financing costs, with limited free cash flows for reinvestment in the renewal
O

of the portfolio. This contributes to the need for further debt financing beyond the
current public housing growth commitments, as free cash flow during this period is
PR

insufficient to complete the full renewal of our existing portfolio.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 17

74. The debt projection at 2081 of $8.9b is equivalent to the Crown increasing equity
holdings in Kāinga Ora by $2b in today's dollars.

75. A key driver of the gradual improvement in free cash flow is from a higher
performing asset portfolio (newer/younger homes driver higher rents and lower
maintenance costs). The ageing effect of assets which would lead to diminished
operating margins is mitigated by implementing a renewal strategy. This focuses on
renewing assets at around the 60-year point before yields start to degrade
significantly.

76. The modelling also highlights that while until recently we have been able to leverage
our balance sheet to deliver additional housing, begin the renewal of its ageing
portfolio, and increase its levels of service to some of New Zealand’s most

D
vulnerable, this approach is no longer viable and additional activity needs to be fully
funded or be constrained to live within the current funding model.

SE
Sensitivities
77. Our long-term financial outlook is underpinned by a sustainable economy and

EA
housing market, with sustained growth in rental income equal to cost escalation.
Small variances from this pathway will have a significant impact on financial
sustainability. The figure below models the relative impact of sustained deviations in

78. EL
key economic settings impacting the financial outlook.

A lower inflationary environment assists in constraining debt growth during our

investment phase, however if this were to continue debt repayment would slow due
R
to lower growth in our operating margin. High inflation grows the capex requirement
further but leads to greater margin growth in the sustaining phase of our investment
Y

cycle.
L
VE
TI
AC
O
PR

79. Our ability to absorb current economic conditions has been assisted by a strong
balance sheet with low levels of leveraging. As we continue the pathway towards
delivering current public housing and urban development commitments, and focus
on the renewal of the existing portfolio, debt financing requirements will increase.
Without a change to funding settings, we will have a diminished ability to handle
economic shocks.

Cost of Additional Public Housing growth (post FY24)

80. The current level of operating supplement being applied to our current contribution
to the Public Housing Plan will be insufficient to cover the whole of life cost of us

BN 22 015 – Update on Kāinga Ora Financial Sustainability 18

 supplying additional homes beyond FY24. We have seen two key trends
contributing to this;

 The upfront cost of delivering new homes has increased by 37 percent over the
last two years (from $467k to $638k per new home). This cost will continue to
escalate with inflation current at circa 18 percent per annum, with a current
estimated 2025 build price of $750k

 Interest costs have shifted upward recently from 2.3 percent in mid-2021 to
4.5 percent today, and are forecast to further increase. Interest costs alone to
finance new homes, at the new costs, now surpasses income under current
settings.

D
81. Interest expense on $750,000 new build would be $34,000 per annum, while market
rent plus a 50 percent operating supplement if forecast at $45,000. The $11,000

SE
margin would fall short of covering property expenses (e.g. maintenance, rates,
tenancy support) and overhead expenses (e.g. back office support)

82. Our initial estimates suggest we may need upward of 80 percent operating

EA
supplement on additional new supply, or commensurate equity injections to cover
these increased costs. We will work in the coming months with HUD develop an
appropriate funding model for additional state homes.

Improving financial sustainability

83.
EL
Given the challenges facing our balance sheet, we have already applied a 10
R
percent corporate efficiency saving to our draft budget (from FY 23) and an
improved occupancy efficiency of 0.5 percent (from FY 27 reflecting the move
Y

towards a renewal programme and a smaller retrofit programme).

84. The following sections set out additional proposed mitigations to improve our
L

financial resilience. These are all currently not incorporated in our FY22-26 draft
VE

budget and can be summarised broadly as:

 Capital cost efficiencies (changes we can make by improving how we deliver)

TI

 Operational efficiencies (changes we can make to how we deliver)

 Service and quality level reductions (areas where we could reduce unfunded
AC

activity but will create misalignment with broader government direction and
priorities).
We have already made changes to improve our sustainability within our current
O

settings and we will be making more

PR

85. We are focussed on the prudent financial management of our operations and
stewardship of our balance sheet. Given this we are already progressing with a
number of actions to improve our resilience. These include:

 Capital cost savings through build efficiencies

 Construction productivity initiatives such as Project Velocity which will bring

about efficiencies, cost savings and support wider sector transformation.

 Targeting further efficiencies around build cost savings e.g. we are considering
a target of a 10 percent efficiency saving (note: benchmarks have been updated
to reflect recent & current accelerated cost inflation)

 Operational efficiencies

BN 22 015 – Update on Kāinga Ora Financial Sustainability 19

  Maintenance – longer-term review of the operating model for maintenance to
look at more systemic change to our delivery approach

 Maintenance savings – efficiency savings, additional to savings derived through

lower age of new properties e.g. we are considering a target of a
10 percent efficiency saving

 Increased prioritisation of activity. This includes:

o More extensive moderation processes through the annual plan cycle.

o Review of the priorities set within the change programme.

 Corporate review – further assessment of the level of corporate costs in the

D
business, including analysis around whether further efficiencies can be made
around people costs. This would be informed through benchmarking and value

SE
for money assessments.
86. The table and figure below provide an indication around the potential impact that
each of these levers may have.

EA
EL
R
L Y
VE
TI

87. The implementation of levers such as construction and maintenance cost savings of
10 percent respectively, would result $2b less debt in the next decade and set us on
AC

a pathway towards financial sustainability (shown in the figure below). These are
additional to increased occupancy of 0.5 percent and 10 percent corporate cost
efficiency.
O
PR

BN 22 015 – Update on Kāinga Ora Financial Sustainability 20

88. These changes would improve our resilience and ability to respond to future
economic uncertainties and have the ability to fully fund future renewal
requirements. Without efficiencies a proportion of future renewals would require debt
financing. The below figure shows the ability to finance future renewal requirements
from free cash flow improves through cost efficiencies.

D
SE
EA
We can make further choices but these will impact service and quality levels and
we will be seeking your advice on these where appropriate

89.
EL
This paper also seeks to make you aware of some of the harder choices now facing
R
us outside of these commitments. These include considering options to reduce
quality and service levels relating to our different housing portfolios. It should be
Y

noted that we strongly believe that service level increases are appropriate given our
customer base and align with government policy direction, but given they move our
L

portfolio beyond the legal minimums set within the building code they are no longer
VE

viable for us to absorb within our income streams. These include:

 Suspending the whole of home heating programme which currently seeks to

ensure the whole house can be heated rather than just the living space as
TI

required by the building code and Healthy Homes. Noting that the scale of this
programme is expected to reduce as our renewal programme increases.
AC

 Removing accessibility improvements from the retrofit programme (currently

~15 percent of our programme costs) until alternative funding sources can be
identified given these interventions are costly and do not result in a subsequent
O

uplift in rent. Noting that the scale of this programme as a portion of our broader
renewal programme is forecasted to reduce with the proportion of new builds
PR

through redevelopment (which will require a percentage of accessibility

improvements) expected to increase.

 Investigating a focused exit from high-cost remote locations and/or uneconomic

assets (those assets that cost more than the rent we receive for them to run)
e.g., by shifting to local trusts or providers.
90. There are also a number of options to reduce costs further including:

 Revising decisions relating to HomeStar 6 version 4.

 Initiatives based around standards or service quality e.g. community rooms,

customer programme, accessibility improvements (15 percent universal design)
as part of new build homes etc.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 21

91. At this stage however, we are not investigating these last two areas further, but
should we need to we will seek your guidance on how we should proceed. We are
also actively investigating funding streams to support decisions around:

 Moving to HomeStar 6 version 5 noting that current income streams prohibit

this.

 The delivery of further accessibility improvements as part of our new public

homes beyond the current 15 percent commitments.
92. In addition, you should be aware that our modelling is now showing that with the
changes to our assumptions indicated above, by FY24 our Community Group
Housing (CGH) funding streams will no longer be sufficient to cover interest costs

D
and tax. This means decisions around stopping or deferring growth where there is
not a sufficient lease or rental income to meet costs, or divestment may need to be

SE
considered. Ultimately a lot of the costs associated with CGH are paid for by other
government departments, in particular Ministry of Health (which funds over half).
Your support to secure a more reliable funding stream for this service from these

EA
government departments would help improve the model for this critical service.

93. We are also investigating whether there are opportunities for some of these
activities to be funded from other portfolios such as ACC and Health where the

EL
financial benefits from us undertaking these interventions will be more directly seen.

One emerging pressure is the cost associated with improving the environmental
sustainability of our homes in line with Government direction
R
94. We are currently working through our response to the Carbon Neutral Government
Programme which requires Kāinga Ora to develop an emissions reduction plan
Y

consistent with a 1.5 degree climate change scenario. This is generally accepted to
L

be a 50 percent reduction in emissions by 2030.

VE

95. The Green Building Council (who administer the Homestar system) have recognised
this and the proposed new Building Code standards (H1) and have responded by
introducing a new version of Homestar (Homestar 6 version 5). Transition to
TI

Homestar 6 version 5 will be required to meet our SPE targets and is a critical
pathway to Kāinga Ora achieving sufficient emission reductions by 2030. These
AC

changes will result in:

 Improved wellbeing and economic outcomes for our customers by improving
customer health and comfort and reducing customer energy costs:
O

o Reducing annual hot water heating bills by ~$700 - $1,000 per year
o Reducing the energy required to heat a home to healthy standards, resulting
PR

in potential energy savings of ~$300 - $1,600 per household (dependent

upon location and energy use patterns)

 Contribution to government emissions reductions by significantly reducing

carbon emissions associated with Kāinga Ora housing (43-46 percent reduction
each year over each home’s life). This is equivalent to a 100t reduction in whole
of life emissions per house or a 302,000t reduction in emissions associated to
our construction programme between now and 2050 and ~13,000t per year
reduction thereafter.

 Savings associated with emissions reductions of around 77,000t by 2050

compared with continuing our current approach.

BN 22 015 – Update on Kāinga Ora Financial Sustainability 22

96. We believe that this investment is in the best in interests of New Zealand from a
wellbeing perspective. However, we do not presently have an adequate funding
source.

97. The resulting cost is estimated to be an increase on our construction cost of around
5.4 percent across the programme ($21-25k per townhouse/ standalone units or
$21k per apartment and walk-up units) with costs varying by region due to different
climatic conditions across the country and the interventions required to meet energy
performance standards.

98. At this stage we have made the decision not to proceed with a move to Homestar
version 5 due to the costs at this time however we would be keen to discuss this
further with you, noting that:

D
 Given the extent of our build programme over the coming year bringing the

SE
transition forward by six months would avoid a further 58,000t of emissions and
brings the reduction up to 24 percent.

 We expect any emissions reductions not delivered through this transition will

EA
need to be met elsewhere in the Kāinga Ora programme of offset through the
purchase of carbon credits.

EL
The need to review our funding model is more pressing than ever
99. Our modelling has shown that given current headwinds, the organisations decisions
will need to be primarily focused on constraining activity to live within the current
R
funding model. This is likely to mean that we will not be able to achieve the delivery
expectations and wider ambition that has been set for Kāinga Ora through the
Kāinga Ora - Homes and Communities Act and the GPS HUD.
Y

100. While the organisation will make decisions to ensure its long-term sustainability, this
L

paper also seeks your support for us to restart work initiated through your 2019
VE

Letter of Expectation (but paused in early 2020 as a result of COVID) which

requested that we work with HUD to ‘undertake a comprehensive review of our
medium to long term funding and financing model.’ Given current headwinds we
TI

believe this is more necessary than ever to ensure that our service provision aligns
to your expectations for public and supported housing and enables our broader
urban development remit in line with government direction ahead of Budget 2023.
AC

101. In particular, we seek your support for us to work with HUD and the Treasury to
review our current funding and financing settings to ensure that our service provision
O

aligns to your expectations for public and supported housing; and enables our
broader urban development remit in line with government direction with a particular
PR

focus on:

Short-term (Budget 2023 initiatives):

 The development of a cost pressure bid to align revenue streams with costs

 Confirming growth requirements for public housing beyond FY24

 Options for service level funding which could include funding to enable
HomeStar 6 version 5.

 An extension of current operational funding for urban development planning,

sustainability and Māori functions which currently cease in FY23

BN 22 015 – Update on Kāinga Ora Financial Sustainability 23

  Consideration of funding for delivery of urban development outcomes. The
Growing Local Places briefing note which seeks your support for the
development of a 2023 budget bid to enable Kāinga Ora to undertake mid-scale
urban redevelopment interventions in neighbourhoods where Kāinga Ora has
substantial land holdings and there are high levels of existing deprivation
coupled with significant housing pressures (refer BN 22 022) is an example of
this.

Medium-term Initiatives:

 Review our current funding and financing settings to ensure that our service
provision aligns to your expectations for public and supported housing and
enables our broader urban development remit in line with government direction.

D
These could include but are not limited to:

SE
o General recapitalisation (equity injection) to support organisational activities
and reducing financing requirements

o Embedding a rent premium across the full portfolio to better represent the

EA
costs of public housing provision, to enable greater ability to generate
cashflow to complete the portfolio renewal required

o
EL
Greater crown contributions to specific activities – additional funding to
support public housing growth or specific significant programmes of work.
Ensuring these recognise the longer-term economic impact of the
R
investments, not just the shorter-term cash implications

o Move the revenue model away form a market rent/IRRS model to one that
Y

moves more directly in line with the underlying cost structure.

L

102. The below figure is illustrative but shows how a 10 percent increase to public
VE

housing market rents (reflecting cost drivers associated with the provision of
increased levels of service for our complex customers) in addition to the mitigations
we are already undertaking would have a significant impact on the financial outlook
of Kāinga Ora. This would provide us with the ability to fully fund future renewal
TI

requirements from operational surpluses and mitigate against the risk of further
economic shocks. Cash surpluses would also be generated to provide future
AC

investment options.
O
PR

BN 22 015 – Update on Kāinga Ora Financial Sustainability 24

103. The organisation’s ability to deliver to public housing growth targets beyond FY24
and be sustainable, will require changes to the existing funding model. This could
include complementing operating supplements with equity, or the introduction of a
cost-based model that better reflects both the cost of delivering and managing the
public housing portfolio.

Next Steps
104. The Kāinga Ora Board will receive the final version of the organisations FY22-26
budget for approval in June alongside a draft Long-term Investment Plan.

105. Subject to your agreement officials will work HUD and the Treasury to review our
current funding and financing settings and report back to with recommendations as

D
appropriate ahead of Budget 23.

SE
EA
EL
R
L Y
VE
TI
AC
O
PR

BN 22 015 – Update on Kāinga Ora Financial Sustainability 25

PR
O
AC
TI
VE
LY
R
EL
EA
SE
D
s 9(2)(f)(iv), s 9(2)(i)

D
SE
EA
EL
R
L Y
VE
TI
AC
O
PR

BN 22 015 – Update on Kāinga Ora Financial Sustainability 27

PR
O
AC
TI
VE
LY
R
EL
EA
SE
D