Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

October 2018

How we spend, not what we spend, is key

This year’s Budget is something of a Rorschach test: asking people what they think of it will tell you more about them than it does about the Budget itself. The government itself tried to portray the Budget as a pre-Brexit exercise in caution. As Conall MacCoille pointed out, though, any budget where government expenditure grows year-on-year by 6% can hardly be described as cautious.

When it comes to housing, it struck me that a lot of the anger – where there was anger – related to mortgage interest relief for residential landlords being extended to 100%. The optics of this, of course, are not good. But in essence, this is part of a much-needed professionalisation of Ireland’s rental sector.

If you run any other business venture in Ireland, any costs you incur – including costs of capital borrowed – are not counted when the government calculates your income. If your business happened to be renting out residential property, however, that was not the case.

There is no good reason to handicap the rental sector – and by extension, Ireland’s renters – by discouraging professional business through discriminatory measures.

What makes it a bit messier, of course, is that these investors overlap, at least to some extent, with owner-occupier buyers. Thus, any move that affects one group affects the other. But, as it happens, owner-occupiers are already incredibly favoured by the tax system – and remain so despite the latest changes.

If you are an owner-occupier, you do not pay any income tax, for example, on the property you rent out to yourself. This may sound outlandish but there are numerous countries where such imputed income is taxed.

To see why, consider a situation where Mr Murphy and Ms Kelly live in next door to each other. In one version of the world, they own the homes they live in and do not pay any income tax. In another version, they live in the home that the other person owns.

Society should be completely indifferent to these almost identical situations but instead, in this second version, both Mr Murphy and Ms Kelly would be liable for income tax – and indeed for capital gains tax when they finally sell. (Owner occupiers are exempt from CGT too.)

The ideal system for housing would be where all mortgage debt is eligible for tax relief – just as it would be for any other business – but where all income from property, including imputed income enjoyed by owner occupiers, is eligible for income tax.

Viewed from that perspective, the relatively small change to mortgage interest relief is not at all the key Budget measure on housing.

Indeed, I would argue that to judge the Budget on housing, we need to start by looking at health. Gerard Brady, economist at IBEC, outlined during the week the extraordinary increase in public funding of healthcare in recent years.

In 2015, it was planned that the Government would spend €12.7bn on healthcare. The actual figure turned out to be €13.3bn and the 2016 plans were based on growing that higher number. The same pattern has played out each year since and the 2019 healthcare budget is an eye-watering €17bn.

That’s a €4.3bn increase – an increase of one third – at a time of zero inflation. Roughly half that increase has been entirely unbudgeted and the response of policymakers was to reward those overruns, not punish them, with even more public monies in subsequent years.

Language is not our friend here: using the word billion hides the magnitude of this. €4,300 million is probably a better way. That’s almost €1,000 extra for every man, woman and child in the country for a health system that few would describe as one third better now than in 2015.

Perhaps we’re just catching up with our peers? Far from it. Since 1999, despite having one of Europe’s youngest populations, we spend more per capita on healthcare than the OECD average. We spend almost €3,600 per person on healthcare. The average for high-income countries is just €2,000 per person.

What has this got to do with housing? Healthcare and housing are recognised as the two areas most in need of a “fix”. And yet the level of spending in one completely dwarfs the other.

For example, the increase for the Department of Housing in 2019 is €421m. This will be spread principally across a ‘capital’ budget – money to be spent directly on building homes – and the Housing Assistant Payment (HAP). The budget for HAP will increase by €121m. Written as €0.1bn, you can see how this kind of budget would hardly be noticed in healthcare.

Of course, as Ireland’s bloated healthcare budget shows, it is not just about how much you spend –how you spend it is just as important. And here, sadly, Ireland remains some distance from best practice in relation to social housing.

Taxpayer money should never be spent on new houses up-front – rather it should be used to borrow to build what is a long-lived asset. And taxpayer assistance to social tenants should not be tied to market rents, but rather to the cost of building new homes.

Unfortunately, those two features – spent up-front and based on market rents – underpin most of the budget for social housing.

Could you imagine a world where the €2bn over-run in healthcare over the last three years had instead been spent on a cost-rental scheme? Cost-rental works off the basis of linking assistance for social tenants to the cost of providing them with homes (not market rents).

The standard cost-rent system takes a set fraction of disposable income – such as 30% – so that the more you earn, the smaller the subsidy. And when a household’s income rises high enough to cover the rent, they receive no subsidy. This makes cost-rent systems incredibly efficient with taxpayer money.

If the taxpayer had to subsidise the bottom third of the income distribution – roughly 650,000 households – a two-billion euro budget would stretch to an average subsidy of more than €3,000 per household each year. And that budget would be tied to new construction, not to market rents.

Even with high construction costs in Ireland, that subsidy would be enough to cover the cost of adding a whole host of badly needed housing across Ireland – including options for downsizers as well as independent and assisted living complexes.

Many arm-chair pundits talk about what we could do with the Apple money currently tied up in an escrow account. We have actually had a corporate tax windfall of nearly the same amount – €11bn. But instead of spending it on getting the social housing system we need, we have largely spent it on propping up the dysfunctional healthcare system we have.

Downsizing central to our housing solutions

Earlier this week, it was reported that the Independent Alliance TDs – who form part of the Government – are proposing a ‘granny flat grant’, that would help convert family homes into two units, as one of their flagship measures for Budget 2019.

As with all policy measures, the first question should be on what problem this measure is trying to solve. If the problem is real, then the follow-on question is whether this particular solution makes things better or worse, or whether there are better alternatives.

This means that one should not be distracted too much – at first anyway – by the amount. (Newspapers reported that the grant would be €15,000. Given current costs in the construction sector, that would pay for no more than the renovation of a couple of square metres.)

The problem that this proposed measure attempts to address is real. There is a complete mismatch between our housing stock, which is skewed towards family houses, and the current and future make-up of population – which is increasingly made up of one- and two-person households.

The 2016 Census highlights this in stark terms. There are over 900,000 dwellings in this country that would suit a family of 3-5 persons (i.e. with 5-7 principal rooms). But there are only 740,000 families in this country. This means that there are 160,000 more family homes than families.

And this is not a problem of homes in the wrong location: even in the Greater Dublin Area, there are more family homes (225,000) than families (208,000).

This is also not a problem that will go away over time. As we proceed to mid-century, our population will grow to over 6 million – but more and more of the population will be in one- and two-person households. A reasonable estimate of how many family homes we will need by the 2050s is about 930,000.

Instead, the country will need 1.9 million homes for smaller households. Our current stock is a paltry 350,000. Ireland Inc needs to learn – and rapidly – how to build urban apartments.

Consider that for a minute. We need almost no new family homes to be built over the coming decades. But that is precisely what we are building. Just 14% of homes built in the last year were urban apartments.

This is where the Independent Alliance proposal comes in. For as long as Ireland as a country seem entirely unable to meet its housing need the normal way – i.e. by building what it needs – it will need work-arounds. One of those work-arounds is to take the existing housing stock and split it into two – or more – homes.

We know from past experience, of course, that this is far from the first-best solution. Homes built for one family in the 18th century became mini-villages for the poor in the 19th century. And homes built in the 19th century – in places like Rathmines and Stoneybatter – became the bedsits and flats of the 20th century. It seems that, unless and until we learn how to build apartments properly, history is destined to repeat itself.

Many homes of the 20th century are already de facto split into many homes for many people. One quarter of the population growth seen in Ireland between the 2011 and 2016 Censuses was in what I term ‘crammer’ households – households comprising people none of whom are related to each other.

Going back to the two questions asked at the start, the Independents Alliance proposal is most definitely getting to the heart of a real problem. And it is likely to more good, than harm, certainly – even if the proposed amount may seem paltry to a quantity surveyor.

The real solution, of course, would be to provide significantly more options for those with empty nests. Work I was part of in 2016 for the Housing Agency and the Irish Smart Aging Exchange found that older residents love their area, not their dwelling.

This means that housing policy should seek to ensure a ready supply of regular apartments – in 3-5 storey complexes – on infill and corner sites throughout the suburbs. In addition, policy should support the construction of independent living and assisted living complexes as a major part of the country’s housing stock.

For too long, it has been the family home and then nothing until the nursing home or funeral home. Everything in between has been ignored. Hopefully the Independent Alliance proposal is the start of a long-needed change in direction.

No need for hot and cold seasons in property

The figures from today’s Daft Report confirm both that the country’s housing shortage persists but also that – at least for the family home segment in and around Dublin – things are improving steadily.

There was almost no increase in property prices between June and September. And year-on-year, inflation continues to cool, with prices in Dublin 5.9% higher than a year ago. Inflation has been 9.9% this time last year so while a 6% rise is still well above healthy, it is far better than things were.

Having a stable mortgage rules system takes some of the guesswork out of understanding the housing market. The cooling off of inflation relates directly to supply. The total number of homes available in the Dublin market in September was almost 5,000, compared to just 3,400 a year ago.

But those same mortgage rules that pin down the relationship between housing prices and the real economy have also had a secondary effect in the market. The fine print of the rules has meant that market has become an extremely seasonal one.

To see this, it is worth taking a bigger picture. Between 1996 and 2006, housing prices rose steadily – and those increases were more or less the same regardless of the time of year. In the first, second and third quarters of the year, the average three-month increase 1996-2006 was close to 3.5%. Only in the final three months of the year did any kind of seasonal effect kick in.

That market is long gone and what is emerging in its place is a see-saw market, where prices surge forward in the first half of the year and then tread water between July and December. Nationwide, the average quarter-on-quarter increase in the first half of the year since the Central Bank rules were introduced has been 3.3%. In the second half of the year, the increase has been just 0.7%.

The root cause of this is a wrinkle in the mortgage rules. The overall make-up of the rules is not under question. While I have separate reservations about the effect of loan-to-income restrictions, they and their loan-to-value counterparts ensure that Ireland will never again suffer a housing bubble and crash episode like the one seen 1995-2012.

In the fine print, under Central Bank rules, individual banks have exemptions in relation to loan-to-income and loan-to-value caps. Specifically, for first-time buyers, one in five first-time borrowers – technically 20% of the value of new mortgage lending – can be above the LTI cap. For other owner-occupier buyers, the fraction is 10% (since the start of this year).

But, crucially, those exemptions are based on a calendar year. The obvious result is that bank employees, keen to meet their sales targets, frontload their exemptions into the start of the year.

Using overall targets for lending by their bank that year, it is not difficult to estimate how many exempted mortgages they can give that year. Once they know that, it is simply a case of trying to lend out those exemptions as fast as possible once New Year’s Day hits.

And borrowers know this too. Anyone who has a good prospect of an exemption will wait until late in the year, get their paperwork in order, and then make sure they are good to go once January rolls around.

This of course feeds through to the sale side. Estate agents advise their clients that, if at all possible, they should wait until January when the fresh batch of exemptions comes through. (No point in being on the market all that time as, to homebuyers at least, houses “go off” after a couple of viewings.)

All of this is, of course, completely unnecessary. A simple tweak would fix this oddity. The Central Bank merely has to change the basis of their LTI exemptions from being done on a calendar year basis to being done on a rolling 12-month basis. This would move the market away from being a see-saw one without in any way undermining the effectiveness of the mortgage rules.

None of this should take away from the challenges still facing the Irish housing system. The mortgage rules are, by and large, right. And the one segment of Irish housing that is – at least when you compare demographics to the stock of buildings – not under-supplied is starting to show signs of life.

But that still leaves a huge challenge to get the right type of housing built, given how we are going to live in ten, thirty and fifty years time. In particular, we will be living more in cities and more in households of one to two persons. Therefore, the policy priority must remain on increasing the supply of urban apartments, so that our housing stock better matches the likely future path of our accommodation needs.