Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

October 2017

Lessons from Boston: regulations affect costs

Earlier this week, the Society of Chartered Surveyors of Ireland (SCSI) published a report on the real costs of delivering new apartments. Loyal readers of this column may not have seen too much to surprise – but the figures remain extraordinarily concerning nonetheless.

Building a two-bedroom apartment in Dublin costs a minimum €470,000, according to the report – and can cost as much as €580,000. As if that was not bad enough, these figures, which are based on actual schemes, exclude VAT, which would add another 13.5% to the figure.

Build costs often get mixed up with profitability. But that is not how professional developers work. Developers work off a minimum rate of return. If that return is not there, they will not develop. The reason costs matter is because they convert into higher rents or mortgage payments.

As the SCSI notes, even the cheapest possible two-bedroom apartment would require a salary of at least €87,000 to buy. A more standard urban apartment would require an income of more than €150,000. It is a sorry state of affairs when only the richest 10% can afford a minimum-spec two-bedroom apartment.

This exercise undertaken by the SCSI confirms what many of us active in the housing policy debate have feared for over five years – that the lack of apartment building is nothing to do with the crash. Instead, the hard costs per square metre mean that based on current incomes, our housing shortage will persist.

Many readers may shrug and say that apartments are not for them and that the majority of Irish households live in apartments. This misses the point entirely. The reason that almost 90% of Irish households live in apartments is because we as a society appear unable to keep the cost of apartment building under control.

In fact, the majority of Irish households comprise just 1 or 2 persons and almost all growth in new households over the coming decades will be in similarly-sized households. Given long-run trends in population growth, urbanization and household size, the country does not actually need any more houses for 3-5 people. It needs urban apartments.

The SCSI report is great to have, as it provides data from real live projects. But what it does not do –and what is badly needed – is a full audit of costs and regulations. This is not the job of the SCSI, but it is the job of housing policymakers, in particular the Department of Housing and the Housing Agency.

In particular, we need to know two things. Firstly, what makes up the per-square-metre hard costs of construction? How do these various elements in Ireland compare with elsewhere? From what I can have seen, Ireland is more expensive for each of the various headings of hard costs that professionals use.

But why? Is it the price of nails? Or cement? Or a bricklayer? Until we can open up these top-level figures and look inside, it won’t be possible to answer that question. And thus this cost audit is absolutely critical to solving Ireland’s housing crisis.

Secondly, given we are talking about building the minimum-spec apartment, how does that minimum specification compare with other countries? There was a bit of a fuss about this two years ago, leading to Alan Kelly, then Minister responsible for housing, to approve a reduction in the minimum sizes.

Earlier this week, I visited Boston and took the opportunity to visit some “multifamily developments”, as they’re known there. In meeting some of the professionals involved in the sector there, three related facts stood out.

The first is that there is no problem building apartments in Boston currently. This is easy to miss: there are cities all around the world that have similar pressures to Dublin but are responding to them with the obvious solution, building.

The second thing I noticed is that, while the apartments I saw were definitely aimed at those on higher incomes, even for luxury apartments, the cost of building is well below costs in Dublin. A luxury penthouse apartment might cost $400,000 to build (roughly €350,000).

But when a luxury apartment on the 30th floor overlooking Boston costs less to build than a ground-floor apartment in Beaumount, we need to ask questions.

Two obvious challenges for the viability of Irish apartments are parking and lifts. One development I saw had 40 apartments per floor and 4 lifts. Until recently, Dublin City Council would have demanded 20 lifts on the same floor. Each lift is expensive to install and to maintain and, as it comes with its own staircase, gobbles up floor space.

A second development had set aside part of two lower floors for parking but ultimately parking and accommodation were separate services: many of its residents didn’t want or need a car. In Dublin, the standard is one parking space in the basement – not above ground – for each apartment.

This kind of parking requirement is not only hugely expensive – digging basements is costly – but also limits building up. If you can only fit 50 car parking spaces in the basement, it doesn’t matter how tall the Development Plan says you can build, you won’t be able to do it. And by limiting building up, we are propping up rents and prices.

When informed about the very different requirements for parking and lifts, my Boston hosts responded: “Why? That has to change!” It’s hard to disagree with them.

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

Lessons from Saskatoon: allow people to cluster

A decade ago, I worked with IBM, as an economic consultant as part of their team serving governments and public sector clients around the world. One of my more unusual trips involved a stop-off in the city of Saskatoon. For those who’ve never been, Saskatoon is one of the main cities in the Canadian province of Saskatchewan, which is smack bang in the middle of Canada. It’s a resource-rich part of the world, home to a lot of the planet’s potash and uranium.

One of the reasons I was there was to talk about Ireland’s business model. It being 2007, they were curious about how a country like Ireland – with no natural resources to speak of – was as rich as it was. One of the things I took away, though, was just how powerful our tendency as humans to cluster is.

Canada is a huge and sparsely populated country. At roughly 2.5 billion acres, if the entire human race broke up into families of three, we’d each have an acre. And yet, here in the middle of the vastness of Canada, a classic ‘Central Business District’ rose up into the sky. With no scarcity of land, there was still a cluster of tall buildings in the middle of the city.

This was not some quirk or a vanity project of empty buildings. Instead, it reflected one of the counterintuitive aspects of human nature. If you free us up to move and work wherever, instead of finding our acre away from everyone else, we will instead look to live near others.

The current tally for Saskatoon, a city approximately the same size as Cork, is roughly 50 buildings at least ten storeys tall. Five of these are currently under construction. When it comes to accommodating its own growth, Saskatoon is not putting the brakes on.

Clearly, central to this is regulatory permission to build tall. There are perhaps half a dozen buildings in Ireland more than a dozen storeys tall. This does not reflect a lack of demand. In a city as big as Dublin, without restrictions on heights, there would probably be close to a hundred buildings ten or more storeys tall – and in all likelihood a few of those would have more than thirty storeys.

But Dublin – together with other Irish cities – have local authorities that tend to frown on height. In Dublin City Council, for example, height is proscribed in most of the places where there would be demand for it: the centre of the city. Instead, if you want to build tall, you are encouraged to look in more experimental locations – including Ringsend, North Wall and Ballymun.

Trying to shoehorn demand for height into parts of the city where demand is unproven is not a recipe for success. But this may sound like a victimless crime: city fathers want developers to build tall where there’s no demand – developers don’t build because the demand is not there. Who loses, right?

Unfortunately, these actions have opportunity costs. In fifty years time, Ireland is projected to have an extra 1.5 million residents. Not only that, Ireland will be an 80% urban country by then, the same as its peers, and the bulk of its households will contain just one or two persons.

Add all that up and the prognosis is clear: Ireland needs to densify, rather than sprawl, and central to that is the construction of a large volume of urban apartments, of all kinds, over the coming decade.

But building apartments is a very different activity to building housing estates. In particular, the risk profiles are worlds apart. When building a housing estate, you can build ten or twenty semi-detached homes, test the waters and then use the proceeds to fund the next 30 or 50 homes, if the demand is there.

When building apartments, just like building a hotel or an office block, it’s all or nothing. No apartment is finished and ready to be occupied until they all are. For that reason, policymakers here need to understand how apartments are built, from start to finish, and ensure their rules are future-proof.

In particular, it’s emerging elsewhere as something of a rule of thumb that when developing a build-to-rent apartment block, 500 units is the minimum efficient scale. This means height, not width. But if our main cities have rules that prevent the height needed, then can we really expect to get the homes we need?

It’s time for our local authorities to look around, learn from their peers and future-proof their development plans.

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

A simple Budget can be a good Budget

This was Budget week, the week where fiscal nerds take the day off, stay at home in their pyjamas and shout at the politicians and pundits on TV. I suspect that this kind of person may have been somewhat disappointed by Tuesday’s affair, though.

I’d like to think my interest in Budget Day is a more work than pleasure. In particular, as an economist, a simple Budget can be a good Budget. This is for two reasons. First, ‘Santa Claus’ budgets are an anomaly, not the norm, elsewhere. Good fiscal policy is made by having on-going debates around the best decisions in relation to what is taxed and what is spent.

Secondly, politicians should not always use all fiscal space available to them. The standard rule for fiscal policy is that it should be counter-cyclical: when times are bad, spend more to stimulate the economy. And when times are good, step back.

The last few years have seen Ireland grow faster than any of its European neighbours. Employment has risen so fast that unemployment has fallen by ten percentage points in five years, an astonishing improvement.

And, before all this, Ireland had ‘enjoyed’ massive fiscal stimulus during the Crash when its peers, through the Troika, allowed it to borrow very large deficits, rather than have to balance the books. Looking at this year’s Budget, one might ask the question: if we don’t run a surplus now, when is Ireland ever going to run a surplus again?

But those decisions are of course made at a pay grade higher than mine. Focusing specifically on housing, the construction industry certainly got one of its wishes: this was by and large a simple budget with few substantive changes.

In particular, fears on the part of house-builders that Help-to-Buy would be scrapped did not materialise. My own prediction that it would be tweaked, just so that policymakers could say that had reviewed and ‘fixed’ the scheme was also wide of the mark.

There were a couple of missed tricks, however. In particular, build-to-rent is still treated anomalously for VAT: if you build but never sell something, why should you pay VAT on it? If this had been changed, viability of urban rental apartments would have improved significantly – and this is where the shortage of housing is most acute.

But by far the biggest headline from the Budget, when it came to property, was the change in commercial stamp duty. Commercial real estate transactions are now subject to a 6% stamp duty rate, compared to a 2% rate before the Budget.

Bizarrely, the Minister justified this decision by saying it had been even higher in the mid-2000s. I would have hoped that we can all agree with hindsight that fiscally policy in the second half of the Celtic Tiger was extraordinarily reckless.

It is a relatively fundamental rule of fiscal policy, for example, that you don’t make permanent spending commitments – such as ‘benchmarked’ public sector pay increases – on the back of temporary revenue sources. And taxing transactions, aka stamp duty, is the ultimate temporary revenue source.

I have no doubt that there is every chance this will look a smart move in 12 or 24 months. The Budget also tweaked the Capital Gains Tax exemption, which meant that someone who bought certain forms of commercial property (including sites) between 2011 and 2014 could pay no CGT as long as they held it for at least seven years. That has been cut to four years.

This means that those who bought in 2012 or 2013 expecting to have to hold until 2019 or 2020 can now get out. With Brexit increasingly looking like an economic car-crash, foreign investors may well be tempted to realise existing gains rather than hope for more. A 6% stamp duty rate may look small if your site has trebled in value since 2012.

But this is finite stock of revenues. Commercial stamp duty returns are likely to increase dramatically – probably more than three-fold – next year and the year after. But we should not expect that to continue, in the same way that we should not have expected the €10bn or so in revenues associated with a housing bubble to continue ad infinitum,

Policymakers should look to tax stocks, not transactions. This means reforming commercial rates, not hiking stamp duty. In particular, there are anomalies with the rates system that exclude public bodies and encourage vacancy. Replacing rates – and commercial stamp duty and developer contributions – with a land value tax on all forms of land, other than private homes and farms, would generate more revenues but without the dangers.

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

No free lunch when it comes to property tax

Property tax has – after something of a hiatus of a couple of years – all of a sudden become a hot political potato. Since the end of summer, a string of politicians have been on the airwaves and in the newspapers saying that they will protect homeowners from higher Local Property Tax (LPT) bills.

There has long been a split between civil servants – who want to protect their sources of revenue – and politicians, who would happily promise both higher spending and lower taxation if they could square the numbers.

Still, the speed which with politicians have moved to distance themselves from what is, in most other high-income countries a major source of revenue, is somewhat surprising. It is even more surprising that this is something on which both left and right agree.

To the bewilderment of their peers in the rest of Europe, Ireland’s left-wing politicians have been to the forefront of campaigning against LPT. What is confusing about this is that residential property is the single largest chunk of wealth in the country.

Therefore, it is effectively impossible to be in favour of a wealth tax but against a property tax. There is roughly €500 billion of wealth in Irish housing. If – as many of our high-income peers do – we had a tax of 1% per year, this would provide Irish local authorities with €5bn in funding every year.

This could be used to fund social housing. This, in fact, is more or less a description of what Irish local authorities did before property tax abolished in 1977.

On the face of it, it is easy to see why politicians are saying what they are: they have to get re-elected. Property prices have – according to the latest Daft.ie Report, covered elsewhere in today’s paper – risen by an average of almost 50% since they bottomed out a few years ago.

Indeed, it is perhaps typical of the luck of the Irish policymaker that they fixed the valuation date at 1 May 2013, as close to the bottom of the market nationally as makes no difference. There’s quite a bit of difference around the country in terms of how much prices have changed since then. In Dublin 1, prices have risen by almost 80% from their lowest point. In Ballyfermot (Dublin 10) and Crumlin (Dublin 12), prices have risen by roughly 70%.

Meanwhile, prices in Tipperary and Limerick (outside the city) have risen by just 20%. In Donegal, Sligo and Mayo, prices have risen by just 15%.

The debate now about revaluations echoes a debate had by policy analysts such as myself when the tax was being first designed in 2011 and 2012. It is best practice that property tax valuations are updated regularly. Instead, Ireland chose the opposite: a frozen valuation with an option to renew that freeze.

This is, for want of a better name, the British option. There, no politician has had the guts to update the valuation since 1991. A cottage industry has since arisen where valuers come up with a hypothetical valuation of what a newly-built property now would have been worth if it existed in over a generation ago.

The obvious reaction by homeowners to this is that it will be very difficult for Dublin households to deal with a 70% or 80% increase in the property tax bill. As a homeowner in Dublin, I find it easy to agree.

But that is a far cry from saying we should not revalue LPT. Firstly, imagine this attitude applied to other taxes, like VAT. When was the last time you heard a Minister for Finance stand up at the Budget and say: “Look, the general price level has gone up by 10% in the last few years, so we’re going to cut VAT by the same to balance things out.”

If this seems an odd counter-example, it is worth bearing in mind that VAT is very regressive – it hits poorer households much harder than richer households. LPT, on the other hand, is an incredible progressive tax: most of Ireland’s poorest households own no property. Ireland’s richest households own a lot.

The argument is perhaps more about ability to pay. But there, homeowners – and politicians – want to have their cake and eat it. The reason that LPT is supposed to be going up in 2019 is because they will be wealthier then than in 2013.

Fine, you may say, but property wealth and income or ability to pay are not the same thing. That is true. In some countries, this argument will gain you little ground, as it is seen as a good thing for people to downsize once their nests empty out.

I am not so naïve to think that such an argument would win the day here, though. Nonetheless, if a homeowner makes the argument that they shouldn’t have to pay a higher LPT, based on a lack of income, this can’t be the end of it.

Instead, government should offer those paying LPT the option to pay the higher LPT upfront or else to roll it up and pay (with interest) when they crystallise the wealth. This is, as it happens, similar to the system that operates in some countries, where those below a certain income can opt to defer all property tax payments until the property is sold.

Otherwise, you are just offering people free wealth from owning their own home. If this sounds reasonable, we have short memories indeed. No other asset is so tax-exempt as the family home. The OECD concluded in 2006 that this extraordinarily generous tax treatment was one of the principal factors behind our housing bubble.

Barely a decade on, our politicians have a test to see how much they’ve learned. Will they pass the test?

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

Are we seeing the first effects of Brexit in the housing market?

Today sees the launch of the latest Daft.ie House Price Report. The report, which covers the period from June to September this year, found that inflation in that three-month period was modest, after a pretty hectic first six months.

During those six months, house prices jumped by almost 10%, as the market reacted to the relaxation of the Central Bank’s mortgage rules for first-time buyers. In the most recent three-month period, however, prices rose by just 0.3%. This is the smallest three-month increase outside of the final three months of the year – when prices recently have tended to ease back – since prices bottomed out in 2013.

Prices are now roughly 9% on average than this time a year ago and, taking a step further back, prices are almost 47% higher than when they reached their lowest point. These are the headlines of the report – but the devil of course is in the detail.

Drilling down into the figures, a few things jump out. Unsurprisingly, Dublin has seen far bigger increases than more rural markets: whereas prices are 61% higher in the capital than when they bottomed out, in Munster, Connacht and Ulster – outside the main cities – prices have risen by 37%.

Perhaps the most noteworthy contrast, though, is between Dublin 1 and Donegal. These are, of course, the epicentres of all that’s good and bad about Brexit for Ireland. Dublin 1 is home to the IFSC. If any one housing market stands to benefit from Brexit, it is the one next to where many of the Brexit refugee firms will end up.

On the other hand, Donegal will lose more than any other part of the Republic if a hard Brexit does indeed happen. Letterkenny is three hours from Dublin and almost six hours from Cork – but just two hours from Belfast and 30 minutes from Derry.

The county, therefore, is at risk of losing access to the two urban hubs closest to it. Prices in Donegal have risen by just 1.9% in the last 12 months and are just one quarter higher than their lowest point. This is in stark contrast to Dublin 1, where prices have risen by almost 90% since they bottomed out in late 2011.

The opportunities and threats of Brexit are confirmed by looking through the prices trends for each of nearly 400 “micro-markets” that make up the foundation of the Daft.ie Reports. Two of the three markets closest to the 2007 peak are the IFSC part of Dublin 1 and the Grand Canal Docks part of Dublin 4.

Both micro-markets are less than 20% from their peak a decade ago. This suggests that – with the current lack of supply set to persist for at least the next three years – they will be among the first to reach those peaks again. The other market closest to the Celtic Tiger peak is Sandycove, the country’s most expensive micro-market and likely target for upper management in the Brexodus.

While Dublin – and the other main cities – have markets where prices look less than two years off their Celtic Tiger peaks, there are many others around the country that are years, if not decades, from the peak. Once again, Donegal looms large.

At the opposite end of the recovery is Bundoran. The coastal town in Donegal is heavily dependent on Northern Irish tourists, among others. Prices in the town are still two thirds below their peak – further away than any other market in the country.

Killybegs, another Donegal town, is the market that has seen the smallest increase in prices since bottoming out. Prices have risen by just 9% in the fishing port, well below the national average increase of 47%.

Often, people speak of a two-tier market but the reality is closer to a 400-tier market. Each area has its own amenities and attractions, drawbacks and idiosyncrasies. But the huge variety doesn’t hide some obvious trends.

Ireland’s cities did not build too many homes in the final stages of the Celtic Tiger bubble – this was the preserve of the country’s smaller towns and rural areas, which were dotted with ghost estates and empty one-offs respectively.

Overlaid on top of this mismatch in oversupply was an urge to urbanize. Urbanization is a much misunderstood phenomenon, particularly in Ireland, it seems. In this country, it appears to have been conflated with sprawl. True urbanization is the opposite: more people living on the same amount of land, an environmentally friendly process that also allows a cheaper standard of living and more variety.

It is this combination of strong demand in the cities and excess supply elsewhere that has driven much of the difference in housing market trends over the last few years. And then on top of that, along came Brexit.

For the moment, we must assume that Brexit happens, in the sense of the UK (including Northern Ireland) leaving the single market and customs union. That process will create significant economic changes for Ireland.

There is little doubt that, in net terms, Ireland losing easy access to its main trading and migration partner will be a negative on balance. However, there was always the possibility that some sectors and some locations would gain, while others lost out.

If the evidence of the housing market over the last few quarters is anything to go by, Donegal has recognised it will be badly affected by Brexit. For Dublin’s docks, however, Brexit appears to herald even more demand. Whether these expectations of the market are borne out remains to be seen.

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