House builders need incentives to boost supply

Despite its reputation as a dismal science, economics is not immune to new thinking. In recent years, for example, behavioural economics (an approach that brings psychological insights into economic analysis) has taken off in response to the perceived failure of mainstream theory to explain the global financial crisis.

Behavioural economists use the term “negativity bias” to describe people’s tendency to recall unpleasant memories more strongly than positive ones. And this phenomenon may explain why the Irish public is currently so exercised about the re-emergence of rapid house price growth.

According to CSO figures, house prices in Dublin have been increasing in double-digits since last summer. Most commentators agree this is due to tight supply. Simply, we have too few dwellings to meet the demand arising from population growth, declining household sizes and dilapidation of the existing stock. In turn, this has caused competitive bidding on the properties that are available, driving up prices.

While the obvious solution is to build more homes, it is worth considering where this construction is likely to come from. The Government clearly has a role to play in the direct provision of social housing and has recently launched an initiative to deliver 449 additional homes over the next two years.

While this is welcome, it represents less than 1 per cent of the estimated annual requirement for new homes. A €15 million project aimed at refurbishing up to 950 vacant local authority units will also contribute to supply, as will the Government’s continued support of the voluntary housing sector. Again, however, we are talking small numbers – voluntary housing accounted for just 2.5 per cent of total new builds in 2013.

In reality, then, we are relying on the private sector to deliver new homes. But, at present, this is not happening. Last year, just 8,301 housing units were built across Ireland. In Dublin, where an estimated 7,000 units are needed, actual completions reached just 1,360.

Finance thin on ground
One reason may be the scarcity of development finance. Certainly, the banks remain cautious. But, if there was a genuine opportunity for profitable housing development in Dublin, surely private equity should have come in to fill the funding vacuum? This has happened in isolated cases, but it is not widespread. A logical conclusion, therefore, is that it is not viable to build new homes in many locations around Dublin.

How can this be addressed? One option is simply to wait. Strengthening demand in the absence of new construction will eventually drive prices to a point where development is once again viable. This will boost the supply of available properties, leading to more moderate and sustainable price growth. Unfortunately, however, this process could take two years. And in the meantime, rapid price growth may lead to declining affordability, wage inflation, displaced demand and urban sprawl.

An alternative approach is for Government to introduce measures which reduce development costs. In theory this should kick-start private-sector building activity by elevating marginal housing schemes into profitability. Simple measures which have been proposed include:

Reducing VAT on new homes: Currently 13.5 per cent of each new home sale is passed on to the Revenue Commissioners in VAT. If this was reduced to 9 per cent in line with the hospitality sector, the difference would encourage building by directly bolstering development profits;

Reducing development levies: Dublin’s four local authorities last year reduced their charges to developers for infrastructure provision by about 26 per cent. However, with average house prices in Dublin now 50 per cent below peak, there is arguably scope for further cuts to stimulate new development;

Flexible planning: Planners want high-density housing in many parts of Dublin. Paradoxically, however, this is often costlier and more difficult to produce. In particular, the cost of providing basement car parking undermines the viability of many apartment-type schemes. Moreover, indivisibility makes apartment blocks difficult to phase, requiring developers to take on greater levels of peak debt – clearly a problem when funding is scarce. Currently, this is militating against construction activity.

Density criteria
Recently, however, some local authorities have begun to relax density requirements in order to kick-start development. From a policy perspective, the mainstreaming of this approach across all administrative areas of Dublin would help to encourage new development.

The Government will shortly launch its new construction strategy. Hopefully, this will contain measures similar to the above. Given our recent history, the idea of supporting developers' activities through reduced VAT and levies may be unpalatable to some. However, we urgently need houses, and private developers are the only people who are going to build them.

As capitalists, they will do this when – and only when – it is profitable to do so. We have to choose whether this is now or in two years’ time.

Dr John McCartney is director of research at Savills Ireland