Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

March 2017

The opportunity in downsizers

There are two well-established facts that summarize the Irish housing market in its current state. Firstly, there is a shortage of accommodation. This is particularly true in Dublin – roughly speaking, for every ten new homes needed in the period 2011-2016, only one was built. This was a time of net emigration so, as the country returns to net immigration, the demand will only grow.

The second fact is that it is prohibitively expensive to build apartments in almost all segments of the market. The focus on apartments is not arbitrary – Ireland has Europe’s largest average household size currently. In the 2011 Census, there were 2.7 people in the typical household.

But household size is converging steadily with the rest of the continent, having fallen from over 4 in the early 1970s and over 3 in 2002. As Ireland’s average household size continues to converge to the European average, this will create significant amounts of new housing demand.

The logic behind this is simple, although often forgotten. Suppose Ireland had a fixed population (rather than a growing one) – for round numbers, take 5 million. If the typical household size is 4, the country needs 1.25 million homes (5 million divided by 4). If, however, the typical household size is 2.5, the country needs 2 million homes – 60% more!

A rise in the fraction of one- and two-person households is creating huge demand for a significant number of new dwellings. Let’s take more precise numbers for Ireland’s case currently, which has a population of roughly 4.8m. Relative to a 2.7 average household size, if the same population had an average household size of 2.5, this would mean the country needs 142,000 extra dwellings.

When the numbers are that big, it can be easy to be almost blasé about them. But let’s stop and think about that: 142,000 extra homes is the equivalent of 11 years of what was built in 2015! And if Ireland converges to the EU average (2.3), this would require an additional 300,000 dwellings.

An April 2014 report by Future Analytics for the Housing Agency confirms that these demographic trends have implications for the type of housing stock needed in Ireland and specifically in Dublin. Their findings – for the period 2014-2018 – indicated that three quarters of the new households added in Dublin in that period had at most three persons, with the large majority comprising just one or two persons.

So one- and two-person households comprise the bulk of new households being formed in the capital. You might expect that, in response, accommodation suitable for one- and two-person households would be built.

But that would only happen if costs could be recouped. Those active in the space confirm that the break-even cost of building a two-bedroom apartment currently is roughly €325,000 – excluding any land costs. There are two ways of looking at how affordable this is.

The first is to convert it into a monthly rent – this is what a developer would do if they were thinking of building to rent. An upfront cost of €325,000 converts into a monthly breakeven rent of roughly €1,650. Site costs per apartment of up to €100,000 would add another €500 to that.

It is clear that, with the exception of Dublin 2 and 4 – and a small range of other areas, like the North Docks and some parts of South County Dublin – this is completely unaffordable. Average monthly rents for a two-bed in West Dublin, for example, are just €1,200, well below viability.

One solution might be to build-to-sell, rather than build-to-rent. An upfront cost of €325,000 converts, given current interest rates and deposit rules, into a monthly mortgage of €1,300. However, the first-time buyer market has by and large turned off buying apartments. Such “property ladder” homes, typically bought in the bubble for 2-3 years before being sold, leave the owner open to the risk of a fall.

This is not the case when it comes to downsizers, though. In many parts of the city, the bulk of those over the age of 55 own their homes – and own them mortgage-free. Not only that, this generation have benefitted from a one-off increase in property values. This has happened in Ireland as in other countries: once you strip out inflation, most high-income countries have seen a one-time increase in prices at some point since the 1970s.

This gives them equity – and equity that could be used to downsize and to provide for their future. The average four-bedroom home in South County Dublin is worth €800,000 currently. The average two-bedroom apartment in the same part of the city is worth less than half that.

But currently, there is almost nothing for them to choose form. According to Eurostat, just 14% of households in the region that includes Dublin and Cork live in apartments. This is very low compared to other European city-regions, with almost half of the housing stock in apartments in the equivalent EU region containing Liverpool, two thirds in Copenhagen and over three quarters in Lisbon.

There is, therefore, a clear mismatch. In 2011, 256,000 of Dublin’s 467,000 households, in other words over 55%, had just one or two persons in the household. However, only 170,000 dwellings in Dublin contain four or fewer principal rooms – a two-bedroom apartment would typically have three principal rooms.

What the city needs is the densification of the suburbs: good-quality apartments built close where older people live and thus close to where their networks and amenities are. But time and again local politicians – including Cabinet ministers – object to the development of new apartments in areas where the buyers would disproportionately be older people.

If local authorities want to be age-friendly, they need to take a much firmer stance on objections to the development of apartments, particularly in suburban locations. If there is no supply of homes for people to downsize into, demand for downsizing becomes almost irrelevant.

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An edited version of this post was originally published in my column in the Sunday Independent.

Trusting rules of thumb about housing

There are a few rules of thumb that exist about how expensive housing should be. Three rules – about incomes, yields and affordability – are familiar to many people but what is perhaps less well understood is which are the sturdiest.

One rule of thumb is that the price of a house should be on average between three and three and a half times the income of those living in the house. A second is that the price of the house should be something like 20 times the annual rent for the same home.

And the third is that when renting, or indeed when thinking about a monthly mortgage payment, the amount spent on housing should be no more than a third of all disposable income. It turns out that we can rank these three rules by how useful they are – one is only marginally helpful, one is helpful once caveats are born in mind while one should be at the core of housing policy.

Rules of thumb are – as their names suggests – rough guides, not hard and fast rules. Nonetheless, it is interesting to note that the first of these has, in recent years in Ireland, gone from a rule of thumb to a cornerstone of macroprudential policy.

The mortgage rules introduced by the Central Bank in early 2015 include loan-to-income restrictions, in particular that the size of the mortgage can be no more than 3.5 times the household’s income. On the face of it, this seems sensible. For those of a certain vintage, it reminds them of the building society rules that lasted until the 1990s.

However, scratch at the surface of this rule and the justification is pretty slim. Whether a household on a €50,000 a year can afford a mortgage of €125,000 depends not only on those two numbers but on many other factors too. Two obvious ones include interest rates and tax rates.

Interest rates in Ireland switched from around 10% in the 1980s and early 1990s to around 5% (or indeed mostly below) since entering the Eurozone. Similarly, the tax rates that applied in the 1970s and 1980s would horrify workers today.

Even taking the housing market at a particular point in time, house prices – and thus mortgages – will vary by location far more than incomes do. So, while attractive in its simplicity, there is little foundation to the first rule of thumb.

The second rule of thumb, that what you should pay for a house should be something like 20 times the annual rent, is far more solid. If you think of that ratio the other way around – what percentage of the price is the annual rent – it is a percentage that you can compare to the return on other assets, like a savings account.

If house prices are 20 times the annual rent, the rent gives a yield of 5% of the price (five goes into 100% twenty times). Economists think of the yield of any asset – in this case housing – as being the sum of two bits. The first component is known as the “risk free rate”, the yield on the most secure asset in an economy.

Typically, this is the interest rate on government debt (unless of course there is a risk of the government defaulting). The second component is the specific risk attached to that asset. For example, if there is a risk of a falling rents because of slow economic growth, this should be priced in to the yield.

If the yield goes down to 3% or below – as it did during the Celtic Tiger bubble – this is a sign that the market has taken leave of its senses. The same applies for individual properties. Ultimately, if you paying more than 20 times the annual rent, you need to have a good reason why.

Another way of thinking about this is that if you are the highest bidder on a property, you value that property more than anyone else on the planet. Are you clear why?!

But it is not the case that there is one just one multiple that will hold in all cases. For investors, the yield that they will require will be different to an owner occupier, because they face an income tax bill that an owner occupier doesn’t.

And what a healthy yield is now, for any given buyer of a specific property, will be different to what it was a generation ago. A generation ago, the yield on property was closer to 8% – and a generation before that, it was at least 10%.

So while the link between rents and prices is a very useful barometer of the housing market, it is not set in stone. It varies with the ‘regime’ governing the housing market.

The final rule of thumb is about affordability: a household should not spend more than roughly one third its disposable income on housing. Unlike the rule about prices to incomes, it takes account of taxes and interest rates. If interest rates go up, this will reduce the amount of debt someone can borrow, even if their income stays the same.

But thinking in terms of monthly income and spending gets around this. It also gets around the prices vs. rents argument. It doesn’t really matter what the system is that governs the yield – whatever that system, if you are spending more than a third of your disposable income on housing, you are financial exposed.

This is by far the most robust of the three rules of thumb. It’s not a cliff-edge: going from a third to 35% – or even to 40% – is unlikely to bring financial ruin to a household. But it does increase their vulnerability.

Nonetheless, this rule of thumb should be at the heart of housing policy. Mortgage rules and construction costs should be designed with affordability for the average household in mind. And perhaps most importantly, housing subsidies should be too.

If a household earns enough that one third of their income is adequate to cover the cost of housing on the market, great. But if not, society should step in to top up their income so that they can.

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An edited version of this post was originally published in my column in the Sunday Independent.

Lessons from O’Devaney Gardens

For those who have never been, O’Devaney Gardens is located off the North Circular Road, next to the Phoenix Park and within a five minute walk of Heuston Station and the Luas. Indeed, it is walkable to work – I live next to it and walk to Trinity every morning.

It clearly enjoys a phenomenal location but its history is more potted. It was built in the 1950s as a social housing complex to house almost 300 families moving out of tenements. However, the blocks started becoming deserted in the 1980s and 1990s, as the country switched out of social housing and into private ownership, due to financial liberalisation.

The last of the residents moved out in 2016, although plans for its redevelopment long predated the clearing of the 12-acre site. A plan for regeneration of the site – on a public-private partnership basis – were shelved when the housing market collapsed.

More recently, the site has found fame due to it being used for filming on the series Love/Hate. But the site is really an emblem of what is wrong with the housing system in Ireland at the moment.

For five years, there has been a worsening shortage of residential accommodation in Dublin, with just 5,000 new homes added in the city between the 2011 and 2016 Censuses. By any thorough measure, this is roughly one tenth of the underlying demand, meaning that for every ten dwellings that Dublin needed in the last few years, it got just one.

And all this time, Dublin City Council has had to sit on the O’Devaney Gardens site because neither the public nor private sectors had the appetite to redevelop it. The site captures all three elements of what is wrong with housing in Ireland currently.

The first aspect is construction costs. Even if the public sector didn’t have the money to redevelop the site itself, if the city had a healthy private housing sector, private developers would have made the Council an offer it couldn’t refuse.

There are those who would view this as a loss to the city – and I’m sympathetic to this, as I’ll explain below. But ultimately even if it only private, for-profit housing had been built on the site, at least it would have helped redress some of that severe and chronic imbalance between supply and demand, with 90% of demand going unmet by new homes in Dublin.

However, nobody made an offer – as to do so would have meant building on the site, which would not be viable given just how expensive it is to build in Ireland currently. This is particularly the case for apartments, which are precisely what should be built, in the main, on central sites like O’Devaney Gardens.

Suppose, though, that costs were low enough that private developers did want to buy the site. A second issue that emerges is around land use. If home providers were interested in that site, they would sure be interested in the adjacent 6-acre military hospital or 4-acre derelict site owned by the Department of Defence.

Or indeed in the 35 acres of McKee Barracks, apparently used now mainly to house the army’s horses. But to bring all 60-odd acres into full use, this country needs an about-face on how its land is used.

Currently, we have a system of last use determines next use, with bus depots today in the same locations as tram depots back in the 1890s. What we need is a system where best use determines next use, with policymakers actively reconsidering what the optimal social use of a site is on a regular basis. As I’ve mentioned before, a land value tax internalises this, putting the onus on whoever owns the site currently, be they public or private sector.

But if construction costs were tackled and land use reformed, what would happen is that new homes would be built for those on average to above-average incomes. Nothing would be done for those on the lowest incomes.

A complete housing policy needs to tackle not just construction costs and land use but also housing subsidies too. I think it is reasonable to hope that people on all incomes could expect to afford accommodation on a site like O’Devaney Gardens – with ample green space and good transport facilities.

To do this, we need to drastically reform social housing and simplify it to one key principle: if you do not have the means to meet your accommodation needs, society will bridge that gap.

What this would mean on a site like O’Devaney is that it enables a non-profit Approved Housing Body, like Cluid or Respond, to open talks with a private developer. They would do so, leveraging the fact that they can offer the developer a 25-year lease – or indeed outright purchase – of, say, 200 of the 600 units that could go on the site.

The ‘win’ for the AHB is that by taking such a large quantity over such a long timeframe, the agreed rent is well below the market rent. The ‘win’ for the developer is that with this pre-letting agreement, they can go and raise the funds to build and rent or sell the remainder.

And the ‘win’ for the Council is that sites that they owned but couldn’t use effectively are being used to house people of all incomes, reducing the fear that social housing would create a ghetto of deprivation if unsuccessful.

As it happens, O’Devaney Gardens is a site with too many, rather than too few, plans. The latest is for roughly 600 homes, including 100 houses. But finding a one-off funding solution for the prominent sites is not the same as solving Ireland’s broken housing system.

To do that, construction costs, land use and housing subsidies all need fixing. And given the scale of the mismatch between supply and demand, particularly in Dublin, the sooner the better.

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An edited version of this post was originally published in the Sunday Independent.

Housing and Ireland’s competitiveness jigsaw

Housing should always be primarily a social issue. If the country cannot house its own citizens, this should be disturbing enough for remedial action. However, most people would acknowledge that, with everything the last five years have revealed, when housing is only an issue of social justice, it doesn’t feature high enough on the agenda. What needed to happen was for housing to become an issue of international competitiveness. Unfortunately, this has now happened – but fortunately, this means that it is far more likely to feature on the radar of key Ministers, policymakers and the Cabinet.

Housing has traditionally been regarded as domestic issue. Just as firms based in Britain typically ignored EU bashing in the media, as they didn’t want to meddle in a local issue, so firms based in Ireland typically focused on more obvious inputs to competitiveness, such as corporate tax rates and membership of the European single market. No firm wants to get a reputation for meddling in domestic affairs. However, firms based in both countries have realised that ignoring a political issue can be precisely the worst course of action. In the UK, firms are now scrambling to respond to the referendum result on EU membership last year. The powerhouse of the entire British economy – the hub of financial services centred in the City of London – could have its foundations taken away in coming years.

And in Ireland, large employers here have become increasingly noisy on the issue of accommodation. To see why, you need look no further than the National Competitiveness Council’s ‘Cost of Doing Business’ profiles. The standard FDI project coming to Ireland now is a services, or perhaps R&D, facility and for such projects, labour costs make up three quarters of their overall costs. This is a sea change from the 1980s and 1990s, when the IDA’s main targets were large manufacturing facilities, where half of all costs were imported inputs.

And the single most important item of spending is housing, which typically makes up one third of disposable income in cities. So of the three quarters that relates to wages, one third is down to housing. This means, simply put, that housing is one quarter of Ireland’s competitiveness. Therefore, when rental prices in Dublin rise by 65% in less than six years – or sale prices rise by almost 50% in less than five years – this does not just put pressure on those on lower incomes. It also erodes a key source of wealth for this country: jobs serving foreign customers.

When Irish-based subsidiaries of foreign-owned firms have to take unusual steps, such as offering bonuses to existing employees to temporarily house new ones, while they find their own homes, it is only a matter of time before HQ finds out that Ireland has a problem. In a world where capital is chasing skilled labour, and where skilled labour wants to enjoy all the amenities offered by a vibrant city, it is the cities that can house growth which will win. Irish cities are hopeless at accommodating growth currently. Dublin has now been allowed to grow up and so, since the 1980s, has started to sprawl. Commuting, though, is consistently ranked as people’s least favourite use of time and is not a viable long-term way of life.

But it is not just Dublin that is suffering. Cork and Galway are home to very large employers, with thousands of workers, in particular in pharmaceuticals in Cork and in medical devices in Galway. But both cities are struggling to accommodate the growth. One home was completed in Galway City Council in May last year… and while this is an extreme example, only 52 new homes were started in the city in 2016. In a rapidly growing city of 80,000 people, it should be adding closer to 800 a year – over 15 times the current level of activity. In Cork, just 310 new homes were started. In a city with a population of 200,000 people, it should be adding 2,000 new homes per annum.

And the problem is not limited simply to the building of homes, although it is clearly at the heart of the issues. Access to schooling, childcare, public transport and infrastructure are all related to the decision of where to live and work. Back in Galway, traffic has become such an issue that there are stories of three-hour commutes after work from the east of the city, where most of the business parks are, to the west of city, where much of the housing is. Three hours to cover ten kilometres is not sustainable.

Housing is and always will be first and foremost an issue of human rights. In a modern, high-income country, access to housing should be guaranteed by a system of subsidies that top up a family’s means to meet their need, where appropriate. But housing is also a competitiveness issue. If we don’t figure out how to build enough homes quickly, it will start costing the country jobs.