Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

May 2017

Complements and substitutes: Housing as a piece in the jigsaw

As a policy area, housing does not stand on its own. It sits in a system full of links and feedback loops. At a very basic level, money spent on housing has to compete with money spent in other areas. In this sense, housing policy – at least where it involves money, not simply regulations – has a number of substitutes.

But it’s not just about competition. Economists see the world in a slightly different way to most people. To an economist, one of the things they are most interested in is how changes in one good – like housing – affect others, and vice versa. And the two key terms are complements and substitutes.

A complement is a good that goes hand in hand with another. Lecturers struggling to come up with imaginative examples often resort to gin and tonic, when explaining the concept to first-year undergraduates. (We can relax for a while, as gin is once again very fashionable!) A substitute is something that, as the name suggests, can fill in for the original good. The same lecturer might give the example of two types of beer, when explaining the concept to first-years: drinking one brand of beer won’t heighten the enjoyment of drinking the other (arguably!).

This may seem very obvious but it has deep implications, as it is applicable to all types of goods and services we enjoy, public and private, including housing. What is concerning at the moment is that the public policy system in Ireland does not yet seem to have connected up housing with its complements and substitutes.

One obvious example is housing and commuting. When choosing a home, these are substitutes: you can live in House A and you walk or cycle to work, or House B, which is further away and cheaper but involves a 30-minute drive each way.

The Central Bank clearly missed this substitutability when devising the mortgage rules. By focusing on the ratio between the mortgage and gross income, they have incentivised further sprawl. People who hit the limit of the mortgage rules can extend themselves by buying further out and paying in fuel, not mortgages.

The Central Bank is not alone. Local authorities too miss the link between housing and other parts of the system. Take housing and office space. These are complements. For society to get full enjoyment out of one, it needs the other too: put simply, all workers need somewhere to live. The current office-building boom in central Dublin, therefore, creates a need for new housing.

It is estimated that there is office space for 60,000 new workers being built in Dublin currently. Almost all of this is taking place in central Dublin, well within the City Council’s limits. And yet, fewer than 1,000 apartments are being built. In fact, in the last seven years, just 3,000 apartments have been built in Dublin – many of those completions of legacy projects from the bubble.

Professional developers, many of them new to Ireland, are adding perhaps 25% to the stock of office in Dublin in just five or six years. This scale of development clearly indicates the demand for offices is there. Therefore, Dublin City Council must connect the dots and see that more offices need more homes.

This is definitely not a call for the Council to limit the development of office space. Nor is it a call for the Council to demand from those developing office space that they develop residential instead.

Rather, it is a call to understand why development of the residential accommodation that is so badly needed in the country – and in particular in Dublin – is not taking place. I suspect that this is because construction costs in Ireland are so high, compared to other countries, but what role does regulation play in this?

Related to this is the need to move beyond “building for families”. Fewer than half of the households in Ireland are family units (one or two parents with children). In Dublin, the fraction is even smaller and the city has more family-sized homes than families.

But without enough apartments or student homes, those without the right kind of homes end up living in imperfect substitutes: family homes. This has led to an artificial shortage of family homes in a city that has too many!

The implications for local authorities are clear. Where there are offers to build, for example, student accommodation, the city – whether it is Dublin or any other Irish city – should take it. Dublin alone needs to approve one hundred blocks with an average of 300 student units by 2024 to meet existing and new demand. That’s one block of student units every month for the next eight years, if demand is to be met.

We currently have the bizarre situation of local authorities looking askance at proposals to build student accommodation or suburban apartments, while welcoming all new office space. It is time for them to revise their Econ101 and the basics of complements and substitutes.

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

Information matters: why we need a public register of rents

With all the commotion of the last decade or so, markets are not very fashionable these days. We forget that markets work a lot of the time and when they work well, they are invaluable. They help identify who has the greatest need for something, as identified by how much they are willing to give up to get it, and transfer it to them.

Obviously, there are many instances where markets are not the solution. In most countries, you are not allowed sell your vital organs, for example, as there is a concern that the vulnerable will be tempted into making short-run decisions with long-run costs.

Less dramatically, we know that not all housing can be left to the market. As different households enjoy very different incomes at any given point in time, if housing was left completely to the market could mean that many households would not be able to afford housing. (Indeed, this has largely been the problem with social housing over the last two decades: it has been left to a market that was never going to provide it.)

For the bulk of people, though, the market is where they source their home. And for markets to work well, certain key ingredients are needed. One of those key ingredients is information. Those active in the housing market a decade ago or more will know all too well the feeling of not knowing whether you have overpaid for a property.

That fear may still exist, as those who buy today worry about overpaying compared to what it might be worth in two or ten years’ time. However, there was a more basic fear that existed: until the Residential Property Price Register was launched nearly five years ago, you had no idea if you were overpaying compared to the person who bought next door, a month or a year previously.

The Price Register helps solve that problem, by publishing information about property transactions in the country on one site. In truth, it is only halfway there. It includes only the most rudimentary information on transactions – the date, price and address. A proper Register would also include the Eircode and information about the dwelling itself, such as size, type, age and energy rating.

But even with it only halfway there, it is world away from the private rented sector. Last week, I wrote about how the system of Rent Pressure Zones will struggle to have any impact on the vast majority of tenants.

This is primarily because the system does nothing to address the lack of new rental homes that are needed – and indeed may make things worse by encouraging existing landlords to sell up.

However, the other reason RPZs are unlikely to work is that they require policing by tenants. Given how difficult it is for a tenant to get “shortlisted” by a landlord currently, it seems very unlikely that one lucky enough to get a home is going to then try to pick a fight with their landlord.

I suspect, though, that we will not see Rent Pressure Zones scrapped in the lifetime of this government. Thus, policymakers should be concerned with how to make them work as best as possible in minimising rent increases both tenants, old and new.

One thing that could help, at least in part, is to do as is done in the sales market: make publicly available information about all rents paid, by address. Some landlords would baulk, I am sure, but many more would be keen themselves to see if they are charging the right amount.

Such a change requires very little new work on anyone’s part: the Residential Tenancies Bureau already collects this information when the tenancy is registered, together with information on the type and size of the property. The one major tweak would be that landlords are required to notify the RTB when they change the rent, as the RTB currently only captures rents when the lease starts.

Again, Eircodes would come in handy here. If they were mandatory on RTB forms, this would allow a published register of rents to be linked up, by address, to online listings. This would bring an element of self-policing into the market. Anyone viewing the property online, on a site like daft.ie, would be able to see the rents paid by the tenant leaving, and previous tenants.

Doing this will not level the playing field. The rental market will still be an insider-outsider one, where sitting tenants are unlikely to move because of the benefits and cheaper rents or staying put. But it will make things a little less unfair, as it would use public information – that is already collected – to establish a common ground for negotiating a rent.

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

Why Rent Pressure Zones can’t work

Earlier this week, the latest Daft.ie Rental Report confirmed that the streak of rising rents continues. In Dublin, rents have now risen for 23 consecutive quarters – nearly six years – and have risen a total of 66% since 2011. Outside Dublin, the increase has been somewhat smaller (40%) and shorter (17 quarters), but the trend is now common across the whole country.

It is important to put those trends in context. Adjusting for general inflation, the longest streak of rising rents that I can find in the post-World War II era in Ireland is at the start of the Celtic Tiger. Rents in Dublin rose by more than 100% in real terms in the seven years between 1995 and 2002. It is now looking likely that, in length if not in the size of the increase, that record will be broken in the very near future.

Ultimately, rents are rising because of the chronic mismatch between strong demand and weak supply. The country needs at least 15,000 and probably closer to 20,000 new rental homes built each year. But currently almost no new rental homes are being built.

The majority of new “completions” each year are either one-off homes (which never come on the market, sales or rental) or properties built during the bubble being inhabited for the first time now. And the bulk of the remaining new homes – perhaps no more than 3,000 in 2016 – are houses built in estates for sale, not apartments and not for rent.

In this kind of market, a system like Rent Pressure Zones could never work. Put yourself in the shoes of a landlord in the current market. You put up a home for rent in a Rent Pressure Zone, for €1,000 per month. You are inundated with enquiries and arrange for an open viewing. Thirty interested parties turn up.

The first prospective tenant says they are interested in the property. Fully aware of their rights, they ask for proof that the €1,000 a month rent is no more than 4% than the rent charged to the previous tenant a year ago. The landlord, new to this Rent Pressure Zone thing, says “OK, well, let me get through this and I’ll get back to you on that.”

Next in the queue says “Look, I don’t really care who was here a year ago or what they paid. I need somewhere to live and I can pay €1,000. I’ll pay €1,050 if needs be.” Who is the landlord going to go with, even with the best of intentions?

Rent Pressure Zones were introduced because rents were rising due a scarcity of supply. But they can never work for precisely the same reason: where tenants have no bargaining power, they are not going to police rent increases.

This is certainly true for new tenants. What is less clear is what has happened rents for sitting tenants. The headline indices of rents – both in the Daft.ie Report and in the RTB’s reports – measure rents for new lease. Until now, neither has been able to say anything about how often and how much rents are increases within a lease.

For this week’s Daft.ie Report, we organised a survey of over 4,000 tenants, asking them the path of rents they have paid in recent years. The findings are noteworthy: “sitting rents” have increased by an average of just 27% in the last five years, compared to over 50% for “market rents”.

This is even more damaging for the Rent Pressure Zones. Not only are they most unlikely to work, it seems that their prime beneficiaries – sitting tenants, who know exactly what the rent was a year ago – are the renters least in need of protection.

Indeed, if rents of sitting tenants were measured accurately, it may be the case that nowhere in the country is a Rent Pressure Zone currently.

Ultimately, the whole system of Rent Pressure Zones was based on a poor understanding of the housing system. It was the equivalent of a Minister for Health banning high human body temperatures, because of the danger they pose to our health.

The level of rents is effectively the temperature of the market. If you don’t like the symptoms, you can’t simply ban them. You have to tackle the underlying disease. The disease here is a lack of rental homes, in particular apartments, due to high construction costs. That is what policy should focus on.

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

Should we fear another property bubble?

In last week’s Sunday Independent, we learned that a substantial fraction of the population – almost two in five – are worried about another housing crash. The public have every right to be concerned about what’s happening in the housing sector. As each year passes with only a small fraction of the 50,000 or so new homes needed being built, we run into more and more bottlenecks.

However, what happened the Irish housing market – and indeed the wider economy – in the period 2001 to 2012 was a bubble, one of epic proportions that will be used in textbooks around the world for decades to come.

It has all the defining hallmarks of a bubble. The first part of a bubble is an initially benign economic boom. In Ireland’s case, this was the start of the Celtic Tiger in the mid-1990s, which brought about rising prices, especially for housing.

It is important to remember that, with two exceptions, house prices had been largely unchanged for twenty years from the 1970s. However, year after year of rapidly increasing prices created a new normal and this convinced both borrowers and lenders that things had changed.

A major driver of Ireland’s economic growth was a very benign global economic environment, following the end of the Cold War. Tied to this was the Single European Market and a period of financialization across the developed world.

Financialization meant in practice the rise of universal banks and, with them, the death of Building Societies. These specialist institutions were not ‘too big to fail’ and so had to lend prudently to survive. Ironically, Building Societies were among the loudest in calling for the deregulation that would see them gobbled up by the new larger banks.

Ireland’s banks, which had existed as banks for the commercial sector since the early 19th century, now had a new business arm – mortgages – and access to almost unlimited capital from overseas. It was partly this lack of experience that led them to scrap the requirement for a substantial down-payment from those taking out a mortgage.

As late as 2000, the typical first-time buyer deposit was over 30%, according to Central Bank figures. But by the mid-2000s, this had fallen to less than 10%. Indeed more than one quarter of first-time buyers in 2006 had no deposit at all.

And this is what was at the heart of the Irish bubble – and indeed all bubbles: a glut of capital. One of the main chapters in my doctorate looks at what drove the Irish bubble and crash and it found that easy lending was at the heart of pushing up house prices between 2001 and 2007. This is in contrast to the period from 1995 to 2001, where a mix of fundamentals drove up house prices.

The fall in house prices after 2007 reflected a combination of expectations realigning and prices finally reflecting all the new supply built in the bubble, particularly outside the main cities.

Probably the single best statistic to spot a bubble is not trends in house prices per se, but rather trends in sale prices relative to rental prices. Investors call this the yield and it can be thought of as the equivalent of an interest rate: what percentage of the value of the property is the annual rent? Or, flipped around, how many years rent do you need to buy a home?

This one measure is hopefully enough to show just how different the housing market is now to 12 or 15 years ago. In 2002, the average Dublin property sold for 20 years rent. This is in line with international norms, where a range of 15-25 years is typically given as normal.

However, by late 2006, the average Dublin property was now selling for 33 years rent. All the extra new homes that were built should have lowered housing prices – and they did have an impact on rents. But the glut of mortgage credit meant that, even when rents fell, price rose.

Since the peak of the market in 2007, though, yields on property in Dublin – and all across Ireland – have normalised. This happened because prices fell by far more (roughly 55%) than rents (roughly 30%). This was a much-needed correction and a much more sensible multiple of annual rents has prevailed in the market over the last five years.

With capital not running riot in the Irish housing market, and with yields at healthy levels, there is little risk of a crash similar to the one we have just seen. But does this mean that there is nothing to worry about when it comes to Irish housing?

Absolutely not! If anything, the problems in the housing sector now are the opposite of those from a decade ago. Instead of a glut of housing, there is a scarcity – an extreme scarcity in the cities.

If the country were at risk of a housing bubble bursting, there would be clear implications for policymakers. In particular, the Central Bank would need to take action. Instead, what we have is an acute lack of homes. I estimate that in Dublin, over the last six years, just one new dwelling has been built for every five new households formed.

Instead of the Central Bank, it is the Department of Housing that must lead the charge in tackling our current housing woes. Moves to control rents or help first-time buyers are really about demand. But the problem is in supply. That should be the focus until the country is building more than 40,000 new homes a year.

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

Ireland’s housing crisis: Is it all the market’s fault?

Ireland’s housing woes can be summarised adequately by the phrase ‘plenty of people, not enough homes’. The country enjoys a rapidly growing population. This is due to a substantial surplus of births over deaths, something that most other high-income countries would love to have. It is also due to net migration, again a symptom of economic success.

That’s why it’s ‘plenty of people’, rather than ‘too many people’. I’m a bit of a demand fundamentalist, when it comes to housing. We shouldn’t have to turn away anyone simply because we don’t have enough property.

This is true not only for permanent residents but also businesses, who need office space, and visitors, whether short-term tourists or longer-term visitors, such as international students. All demand is good demand, in that sense, because this demand for housing goes hand in hand with job creation and thus livelihoods for those of us that call Ireland home.

Why ‘not enough homes’, though? Where have things gone wrong? In recent months, it has become something of a conventional wisdom that the lack of new homes being built is down to the failure of the market. Over-reliance on the market, this line of thought goes, has left us bereft of the full range of homes we need.

The logical conclusion most commentators making this point arrive at is that the State must step in and get building new homes. If we set aside, for the moment, quibbles about housing should be provided by Local Authorities or by Approved Housing Bodies, like Cluid or Tuath, then I agree with the conclusion.

But I think the path to getting there is not only wrong but dangerous in terms of its policy implications. A look at some of the numbers will hopefully explain my point.

Taking into account the various sources of demand, it’s clear that the Greater Dublin Area needs at least 1,200 new homes a month – and probably more if it enjoys sustained net migration. But over the last five years, it has seen about one quarter of this level of activity.

Are those who argue that the problem here is over-reliance on the market honestly suggesting that the State should make up three quarters of all home-building? Of course not.

I personally would favour a situation where about one third of housing is supported by the State, targeted at those in the lowest third of the income distribution. But in a country that needs 50,000 homes per year, this means new social housing provision each year of roughly 17,000. Given that only 13,000 new homes were started in 2016, the majority of which were one-off houses, this leaves a missing market of 20,000 new homes. Why are these not being built?

One argument is that the developers simply don’t have the capital to build. This simply doesn’t stack up against reality. In a world of zero interest rates, capital is on a global hunt for a return. We have seen the fruits of this in Dublin’s office sector, where half a million square metres are currently being built – with the same again ready to be built once the first chunk is occupied. The same is now true for Dublin’s hotel sector, where rising room rates have made it viable again to build. And, while there are clearly issues with the planning system (as I discussed last week), the student accommodation sector also shows no signs of being capital starved.

The final piece of the jigsaw is that the organisations that fund or build offices, hotels and student accommodation are the same ones that fund or build apartments – the single greatest need when it comes to housing in Ireland. So if it’s not a lack of capital, what sort of market failure is it? All good students of economics are taught to look out for two types of failure when considering outcomes: market failure and policy failure.

One clear policy failure is the dereliction of duty on the part of government, both central and local, to provide social housing. It is simply not credible to expect the market to provide housing for people with incomes so low they can’t cover the cost of building their home. And it is simply not fair to expect, as Part V does, that the occupiers of newly built homes should pay for new social housing. The cost of new social housing should be borne by all members of society, not delegated to the inhabitants of new homes.

But this is about the 17,000 or so homes needed each year for social housing. When it comes to the 35,000 or so market-built homes needed in Ireland each year, the evidence from the rest of the construction sector is clear: there is no market failure in getting funds to where building is viable.

The problem is that building is not viable, particularly for apartments – where the need is greatest. From the lack of a land tax to well-intentioned regulations that simply stifle new supply, policymakers at all levels need to stop blaming the market and take a long hard look at their role in creating Ireland’s housing crisis.

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