Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

June 2017

A housing boom needs housing!

There has been talk this week – following Minister Murphy’s comments about Help-to-Buy – that July will be a bumper month for the housing market. In particular, the new Minister talked about Help-to-Buy being reviewed and potentially scrapped if it is found that the scheme is pushing housing prices.

The scheme lowers the minimum deposit required by first-time buyers of newly built property. Therefore, some agents believe that first-time buyers will move now, rather than wait and gamble on it still being there in six months time.

Certainly, if it were to be wound down, it would be an ignominious end to the scheme first mooted less than a year ago and only in existence since the start of the year. And there is precedent for this kind of boost.

The end of mortgage interest relief and the imminent introduction of Central Bank rules both had this kind of effect in the market. Mortgage interest relief was ended in December 2012 and, with this well flagged, there were over 9,000 transactions in the housing market in the final three months of 2012, compared to fewer than 5,000 in the first three months of 2013.

The final three months of 2012 actually made up 36% of all transactions that year, compared to the 25% you might expect if transactions were spread out evenly. Similarly, when the Central Bank announced in September 2014 that it would introduce mortgage rules in early 2015, this led to a similar rush in the market. The final three months of 2014 made up 37% of transactions that year.

Both these show that policy changes – and announcements that policy will change in the future – can have a real effect on the day-to-day housing market. But there are two reasons to think that what the Minister said will not have the same kind of effect.

Firstly, what the Minister said is actually in line with his predecessor and general government policy. In February, the Department of Finance issued a request for tenders, looking for an independent assessment of the impact of the Help-to-Buy scheme.

Now, being honest, it’s hard to understand the timing of such a review. Normally, policymakers under “ex ante” and “ex post” reviews of policy measures. This means you make a rigorous assessment ahead of time of the likely impact of a new policy. And then, once it has had its effect, you review and assess that and learn for future policy measures.

The review being undertaken is neither ex ante or ex post. It is taking place just as the measure is finding its feet. What a review of Help-to-Buy could achieve, based on perhaps three or four months of data, is hard to see.

This is particularly so given the second reason why it’s unlikely the Minister’s comments will lead to a bumper summer: there are very few homes eligible. If people do want to take advantage of Help-to-Buy, newly built homes need to exist!

In January and February of this year, the first months of the scheme, 2,175 new homes were started around the country, according to the Department of Housing. This was actually 3% below the total for the same two months in 2016.

A similar picture emerges if you look at the figures from the Property Price Register. There were approximately 2,800 new homes sold in the first half of 2017. This figure may rise slightly as more transactions are registered for the quarter. Granted, this exceeds the 2,600 new homes sold in the first half of 2016 – but is well short of the 3,700 sold in the second half of last year.

Given the country needs roughly 4,000 new homes every month, it is hard to see how a “housing boom” could take place without the housing.

As for the scheme itself, it is an attempt to address a supply-side issue – the high cost of construction in this country – by further stimulating demand.

My doctorate was on the Irish bubble and crash of the 1990s and 2000s and one of its main findings was that the typical deposit asked of first-time buyers was a crucial factor determining housing prices: the smaller the deposit, the higher house prices went.

If the new Minister wants to tackle the chronic lack of supply of new homes, it makes sense to focus on supply, rather than further fuelling demand.

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

Future-proofing our housing regulations

Last week’s column discussed some recent history, in particular the regulatory backlash to the building boom that took place between 2000 and 2007. Its main point was that many believe that the volume and quality of building was a result of the lack of regulation, rather than the wrong regulations (in particular tax incentives).

If you believe this, you are more likely to believe that the answer lies in lots more regulations, rather than simply enforcing the regulations that were there all along (and removing the tax incentives that distorted the market).

This is what most local authorities believe and we have seen the implications in a raft of new requirements for building, especially when it comes to apartments. Almost all of these new regulations come from good intentions, like the requirement in Dun Laoghaire Rathdown that all new homes are passive (i.e. they produce at least as much energy as they consume) or the requirement for all apartments to be fully accessible to those with limited mobility.

Who could argue with these regulations, you might ask? Take the analogy of a car. Suppose one of Ireland’s local authorities decided that any new car sold in its area had to be battery powered, rather than petrol-powered and, on top of this, all new cars had to fully wheelchair accessible.

A moment’s thought would reveal that these new regulations, while probably well meant, would clearly discriminate against those on lower incomes – and probably against everyone except those on highest incomes. The very same principle holds true in housing.

All the new regulations, specifications and minimum requirements that have been brought in in the last ten years are all things that would improve the quality of accommodation. However, they also increase the cost of new housing, putting it further out of the reach of ordinary households.

For example, a newly built two-bedroom apartment in central Dublin would cost at least €1,700 a month to rent – and that’s without any site costs. Allowing for reasonable city-centre site costs, the breakeven monthly rent is between €2,000 and €2,200.

To put that in perspective, suppose a couple with one child wanted to live in a newly built two-bedroom apartment. What income would they need to earn so that their rent accounted for no more than one third of their spending, as is recommended? With a rent of €2,000, their take-home pay would need to be €6,000 and thus their gross income would need to be over €100,000… just to afford a minimum-spec two-bedroom apartment!

When seen in this light, it is clear that local authorities have got things backwards with minimum standards. You don’t start with your list of desirables and make them the minimum allowable, regardless of the cost implications. You start with the spread of incomes in society and figure out what a reasonable breakeven rent is – and then what standards match that.

This is bad enough – but it gets worse if the regulations are forcing things to be built that aren’t needed anyway. One example relates to fire doors and corridors, which are typically mandatory in new Irish apartment buildings. These are expensive and more dangerous than sprinkler systems – and they also preclude the open-plan style of apartments that modern urbanites prefer. Why do we have these requirements?

Another example – and perhaps more responsible than any other factor for delaying the apartment boom that Dublin and Ireland’s other cities need – is basement car-parks. It is mandatory, with some exceptions, that any new apartment have an underground car-parking space. These cost €30,000 to build – digging deep is expensive – and thus add an extra €150 to the breakeven monthly rent.

There are two problems here. The first is the cost: such a regulation prices out poorer households. The second is the questionable benefit. If you go to a recently built apartment block – granted, there are few enough of them – you’ll see lots of empty spaces semi-permanently.

Who would want to own a car, if you live close to town or the Luas or DART? With groceries delivered, car-clubs like Go Car and on-demand taxis if the need arises, car ownership is increasingly viewed by younger generations as a burden.

So they are foregoing car ownership – but as they move into the 21st century, our local authorities are still stuck in the 20th. The same holds for the cookie-cutter approach to the layout of apartments. Increasingly, apartments are going to be built with shared facilities – similar to the new generation of student homes.

And yet our planners have introduced a byzantine set of requirements for the relative and absolute size of particular rooms in an apartment, as if the rooms we lived in forty years ago are sacrosanct. Have local authorities thought about how those requirements will change for every ancillary facility, from swimming pool and gym to office and cinema facilities, included in the development?

The country’s biggest housing need is not family homes. It is the need for roughly 250,000 apartments in Dublin and all other major urban centres. The current set of regulations for apartments are costly, making the small number of newly built ones the preserve of the wealthy. But they are also outdated, designed to fix the policy-driven deficiencies of a building boom that ended over a decade ago.

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

Diagnosing the problem with housing supply: too much regulation?

The dramatic housing bubble and crash that took place between 1995 and 2012 has left its footprint on Irish policymaking. One of the obvious signs of this is that the Central Bank has introduced macroprudential rules about how much households can borrow.

In part, this is just formalising the systems the Irish building societies had in places for over a century, from their establishment in the 1860s to the 1990s. The building societies, however, wanted to be more like banks and got their way in the late 1980s.

As the old saying goes, though, “Be careful what you wish for.” And less than a generation later, they are all gone. Most were gobbled up by the banks in the 1990s but the few that weren’t converted to become banks before disappearing when the bubble burst.

The banks that took over the mortgage market had – and perhaps one could argue still have – very little experience in sustainable mortgage lending. Thus, the Central Bank took the step of putting in place rules to make them act like the Building Societies of old.

This was how the system responded to the problems with credit supply that emerged in the bubble. A different problem emerged with housing supply. Whereas there is general agreement that the problem with credit with loose lending, there is less consensus on what happened construction.

To some, the principal problem in housing supply was a simple lack of regulation – allowing developers to build whatever they wanted wherever they wanted. If this is your preferred diagnosis, then the solution is to regulate more strictly what is built and where.

A closer examination, however, reveals that much of the problem of excess was not to do with allowing the free market to build what it wanted. Rather, it was skewing the tax system, through for example Section 23, to get the market to build what would never have been built otherwise.

How else, for example, can you explain the fact that more homes were built in Connacht and Ulster 2000-2008 than in Dublin – despite Connacht-Ulster having half the population of Dublin?

It is inconceivable that the parts of the country currently blighted with unfinished developments would be so badly affected if Section 23 had not been extended from its origins in urban renewal to a “one for every constituency” bonanza.

If you subscribe more to this diagnosis than the first, then the problem was government interference, skewing the market, rather than a lack of government interference and leaving the market to its down devices. This choice matters because it affects housing supply today.

The Irish housing policy system has, by and large, bought in to the former story. It believes that the State was not involved enough in the housing system in the 2000s and therefore needs to become more involved in what gets built are where.

In fact, and of central importance today, the same problem and diagnosis extends to Dublin and the cities too. If you look at the poor quality of apartments built in the late 1990s and early 2000s, it is easy to sit back and think: “This is what happens when developers are allowed to build unfettered by planners and the State.”

This is a complete misdiagnosis of the problem, however. The only reason construction took place, for example along Dublin’s quays, was the presence of tax reliefs. If you give people tax breaks to “rack ‘em and stack ‘em”, that is what they’ll do. If you want them to stop doing this, stop giving them the tax breaks.

Why does this matter? What harm can a few extra regulations do? The Irish housing market, where sale and rental prices have risen by up to 75% in the last six years, are living proof of the potential consequences.

Clearly, the fact that rents and prices have risen is first and foremost about demand. Between income growth, employment growth and population growth, the country needs more homes. But unless you want to stop people from having families or hiring workers, the focus has to be not on why there is so much demand but where there isn’t enough supply.

Currently, Dublin alone has a shortfall of at least 125,000 apartments and, being realistic about the next five years, closer to 150,000 apartments. This is astounding, when you think that the city has only roughly half a million households.

But to build an apartment in Dublin today means complying with what has become effectively a cookie-cutter specification. Regulations today cover everything from ceiling heights, window orientations and balcony depths to basement car parking, lifts per floor and – of course – the overall height of the building.

All these specifications bring benefits but also costs. To take just one example, the cheapest a basement car parking space can be built is roughly €30,000. For context, a city centre apartment would have a site cost of between €50,000 and €100,000. One regulation alone adds an extra 50% to site costs.

To make it even more concrete – if you’ll pardon the pun – every extra €1,000 in costs adds €50 to the breakeven monthly rent. So a basement car parking space adds €150 to the monthly rent. This is, of course, not a problem if you both can afford an extra €150 a month and need the space.

But many households cannot afford such a luxury. And more importantly, many more not need it in the first place. We are moving past the age of car ownership, in particular for those living in urban cores. Next week – the last before a summer break for this column – will look at how we can future-proof our regulations around housing.

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

Property tax is too low: the myth of the squeezed middle

Here’s a heresy for you: taxes in Ireland are too low. My guess is that most readers didn’t agree with that sentence. But, while it may jar with our sense of reality, it is undeniably true. Take income tax. The 2017 “Taxing Wages” report by the OECD compares the average tax paid by the same kinds of households in different countries.

Take a family, with one earner on the average wage and two children. In Ireland, once tax credits and cash benefits are accounted for, such a family pays just 8.3% of its income in tax (and USC). In the boom times, we actually had the crazy situation where such a family was a net recipient from the tax system. Things have improved since then, although only a bit.

As you can imagine, this is not how other countries operate. Across the OECD group of high-income countries, 27% of income is paid in tax by the average-earning family. Ireland’s low figure is nothing to do with a Boston vs. Berlin view of the world. There is a gap between these models, but it’s at a much higher level. In the US, the average-earning family pays 21% of its income in tax, while in the UK it’s 26%. In Germany, it’s 34% and in France it’s 40%.

How can that be, you might ask – particularly if you regularly read that Ireland has some of the highest marginal rates of taxation in the EU. Well, the key is the difference between average and marginal. Ireland’s very high marginal rates of taxation – you pay roughly half of your last euro over in tax, if you earn €35,000 a year – are needed to compensate for very generous tax credits.

What’s this got to do with property? There are three types of tax: income taxes, consumption taxes (like VAT) and wealth tax. Income tax, when done well, are very progressive – everyone pays something but richer households pay a bigger fraction.

Consumption taxes such as VAT are extremely regressive: they hit poorer households hardest. And Ireland’s VAT rate is one of the highest in the world.

When it comes to the last category – wealth tax – Ireland once again sticks out. By far the single biggest chunk of wealth in the economy, at least €400bn and probably closer to €500bn, is residential property. And, until recently, Ireland didn’t tax this at all!

Since 2013, though, Ireland has an annual Local Property Tax. This is set at a rate of 0.18% of the value of the property, although local authorities have some discretion and can vary it from 0.15% to 0.21%. Many authorities have already taken the chance to lower the rate as much as possible.

This week, Fine Gael leadership frontrunner – and thus, very likely Ireland’s next Taoiseach – Leo Varadkar proposed allowing local authorities to cut property tax further. To be fair, he couched it in terms of giving them greater freedom to set the rate.

However, the implication was clear – greater freedom for local authorities means greater freedom to lower property taxes. Unfortunately, this is precisely the wrong thing to do, if we want “strong and stable” local authorities, to borrow a phrase from across the water.

Compared to pretty much every other high-income country – including far smaller ones, like Cyprus and Malta – Ireland has the weakest local authorities. They lack financial autonomy and are thus hugely dependent on handouts from central government, who then dictate the terms.

In order to enable them to stand on their own two feet financially, Irish local authorities need to build up a far longer track record of a number of revenue source, with property tax chief among them. As it stands, the temptation will be far too great for local authorities to cut and wait for national government to fund a service instead.

In most other countries, property tax is at least four or five times the rate it is in Ireland. Having a property tax of 1% of the value of a home not only provides funds for local authorities, it also places a cap on property values – an in-built stabiliser on house prices.

It is obvious that Leo has one eye on 2019, when property tax bills are set to change as properties are revalued. They are currently frozen at 2013 values, almost exactly the bottom of the market, and market values have risen by 50% or more in and near Dublin, Cork and Galway cities.

This shows the obvious drawback to freezing tax bills – it creates an incentive to keep them frozen. The other drawback is that property tax can’t act as the brake on prices as it does in other countries. Dangling the carrot of lowering property tax runs the risk of 1970s auction politics, where various bits of government revenues are sold off.

We need to broaden and deepen the tax base – in particular when it comes to residential property, which makes up so much of all private wealth.

I am under no illusions that a “Tax Is Too Damn Low” Party will take off any time soon. But we as a country need to understand where our tax system is deficient and as a result both why our local authorities don’t have the funds they need and why our housing market will continue to swing more than most.

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