The debate about taxing vacant homes is happening in a theoretical vacuum that could steer us towards a housing policy own-goal.
The starting point for a reasoned conversation about housing vacancy is to recognise that a certain amount is necessary. To see why, consider a family moving from Dublin to Cork. If there was no vacancy, this family would have to organise a direct swap with a counterparty that wanted to move to Dublin, had a suitable property in the right part of Cork, and would find our original family’s home in Dublin suitable for its needs. Clearly this could take some time.
Now consider another example in which 50 families wanted to move to Cork, and one vacant dwelling existed. In this case, the supply/demand mismatch would cause households to compete for that vacant unit, driving up the price. We remember from the housing crash that too much vacancy can cause major problems. But these examples show that too little creates inefficient and inflationary markets. So what is the optimum vacancy rate?
This is where theory can help. Housing vacancy consists of two elements; involuntary and natural vacancy. When all the owners who want to sell or lease their properties at current market prices can do so, there is no involuntary vacancy. Since everybody is happy, there is no incentive for anyone to raise or cut their price, and the market is in equilibrium.
But this does not mean that housing vacancy will be nil. Because, even in a balanced market, there will be “natural” vacancy. This comes from two sources. Firstly, at any moment, a proportion of dwellings will be empty because their owners are in the process of leasing or selling them. In countries with many big cities like the United States, people are more likely to relocate, so this “frictional vacancy” is higher. Turnover is also higher in rented accommodation, so countries with a big rental sector experience more frictional vacancy. Conversely, frictional vacancy is lower in countries with streamlined conveyancing and probate systems, and in countries with effective online portals for selling and renting property, as these minimise the time that dwellings spend in transactional limbo.
Natural vacancy also arises because of indirect financial incentives for owners to leave their properties empty. Embedded expectations of house price inflation can cause owners to hold on to vacant properties rather than selling today. Similarly, rental growth expectations may dissuade landlords from committing to leases, particularly in countries such as Ireland, where rent controls penalise a “low” starting rent. Other factors such as the Fair Deal scheme historically incentivised nursing home residents in Ireland to hold vacant properties rather than selling or letting them.
The amount of property that owners choose to keep empty for these reasons determines the natural vacancy rate, and this is particular to each market.
Since 1953, hundreds of studies across the world have found that the natural vacancy rate represents a tipping point between rising and falling prices. When the actual vacancy rate exceeds the natural vacancy rate, there must be involuntary vacancy. This means the market is oversupplied and rents and prices will be falling. Conversely, if the actual vacancy rate is below its natural level, the market is undersupplied and rents and prices will be rising.
Choking off inflation
Understanding this provides a valuable perspective on today’s policy challenge. Ireland is currently suffering rampant house-price and rent inflation. This indicates that the market is undersupplied. To be absolutely clear, this means that we have too few vacant units, not too many. In this context, proposals to try to tax vacant property out of existence make no sense and would only exacerbate our inflationary problems.
Instead of taxing vacant property, our focus should be on choking off inflation by narrowing the gap between Ireland’s natural vacancy rate and the actual vacancy rate, which is currently too low. This can happen in two ways. On one hand we can increase the actual vacancy rate by building new homes faster than housing demand is rising. There is already a major policy commitment to ramping up supply, but this is being undermined by construction cost inflation (which we have little control over), and by self-defeating subsidies and schemes which fuel the housing demand that we are trying to out-deliver.
The other approach is to nudge down the natural vacancy rate by reducing the amount of empty property that Irish people voluntarily hold. This can create a less inflationary market at existing vacancy levels. Recent revisions to the Fair Deal scheme disincentivise the hoarding of vacant properties by residents of nursing homes and exemplify reforms that could be explored in other areas such as rent controls, conveyancing and probate.
John McCartney is director of policy at BNP Paribas Real Estate Ireland.