Financialisation of housing
Everyone has a right to a home. I was one of the lucky ones – buying my first home in Cork in 1972 when I was a 22-year-old junior bank clerk. The home I bought was in Meadowbrook, Riverstown. Meadowbrook was then a very young community but otherwise socially very balanced. The other new residents came from very diverse backgrounds. Like most people back then, my first home was a three-bed semi and of course like most of our neighbours my new home was painted one room at a time.
In euro terms my new home cost me about €6,000 and I received a first-time buyers’ grant of €500. At the time, as a young bank clerk, my annual salary was €900. As a bank employee, I was lucky. I had a preferential borrowing rate of 3 per cent – when the normal mortgage rate was 9 per cent. In addition, I was able to use the first-time buyers’ grant for my deposit.
Today, my house in Meadowbrook would cost over €250,000 – a multiple of about eight times salary for the equivalent position versus the six times salary I had to pay. That same house in Dublin would cost a minimum of €350,000 – a multiple of over 11 times salary and completely unaffordable for someone starting out.
Obviously there has been substantial inflation since 1972. Based on the consumer price index what you bought for €100 in mid-1972 would cost you about €1,100 today. However, while general prices have increased 11-fold my equivalent salary has increased over 30-fold, from €900 to about €30,000. In theory we should therefore be much better off. Unfortunately, the price of my first home has increased over 40-fold. So despite lower interest rates my first home is now not affordable to most people.
Under any analysis Ireland is much wealthier now than it was in 1972. Many more people are at work, real incomes are higher and interest rates are at historic lows. Yet, we take it for granted that most households will require two incomes to meet the mortgage payments and even then, double income households on the average wage cannot afford a starter home in Dublin. At a societal level that is unacceptable. The State needs to pro- actively intervene.
Why has our housing become unaffordable?
I am not an expert in housing but a quick analysis of what happened in 2019 illustrates the complete failure of our housing policies. My focus is on the financial aspects. It is for others, more expert in social structures, to ensure that housing needs are provided in a fashion which avoids the socially destructive mistakes of the past.
Under any reasonable assessment our housing crisis is not being effectively dealt with. According to recent industry reports in 2019 there were 21,000 homes constructed, of which only 8,000 were available for sale. Contrast this number with the level of job creation in 2019 of about 80,000 and the rate of new household formation of about 46,000 and ask yourself if our housing problem is being solved or getting worse.
The following snapshot of 2019 highlights our flawed approach to housing.
– 5 per cent of apartments built were available for purchase; 95 per cent were sold to institutions.
– A total of 8,000 new houses/apartments were available for sale, though the Government focus was on the 21,000 or so houses/apartments built. The median price of new homes nationally was more than €350,000 and in Co Dublin it was €409,000.
– Dublin is the most expensive city in the European Union in which to rent an apartment.
– Despite the housing crisis in some new apartment buildings in prime locations less than half the apartments are occupied.
– Dublin City Council, under ministerial pressure, approved a deal which effectively gifted more than 10 acres of land in Dublin city worth more than €50m to a developer. (O'Devaney Gardens)
– Dún Laoghaire Rathdown County Council (DRCC) entered into a 25-year lease for social housing in Dundrum at twice the cost of building on State land, effectively borrowing money for rented housing at an effective cost of 5 per cent when the State could have borrowed to build it at almost nil cost. Following a better strategy, the DRCC could have housed four times as many families for the same outlay.
Forcing people into inflated rental accommodation, whether subsidised or not, is permanently destroying the savings of those people
In the Taoiseach’s address to the Construction Industry Federation in November 2019 he recognised the general desire of people to own their own home.
“More than 20,000 new houses were built in the past year. The Government’s policy is to ensure there is a greater supply of housing:
“– Social housing for people on housing lists.
“– Private housing for people who want to buy because most people want to buy their own home.
“– And places available for people to rent,”
Despite the platitudes, the provision of social housing is inefficient, with more than 70 per cent being provided in the private rental sector, and overall policies are forcing potential owners into the rental market. This is coupled with the State squeezing out the small builders, promoting a quasi-monopoly power among the large developers, and promoting policies destined to line the pocket of the developers, increase rents and increase land values.
Forcing people into inflated rental accommodation, whether subsidised or not, is permanently destroying the savings of those people and in addition is forcing at least some of them to be permanent dependants of the State.
All of this is being done at a time when the State is sitting on enormous land banks, where well master-planned affordable homes could be built for less than €250,000 each. In contrast, the average price in Dublin that the authorities are paying for such homes is about €450,000 and in the case of the Herbert Hill, Dundrum deal are paying an average of over €550,000 per home in rent and will not even own the apartments at the end of their lease.
Financialisation of housing – causes and implications
As noted above, in 2019 about 95 per cent of the apartments built were sold to institutions. Only 5 per cent of the new apartments were available for purchase. This trend has continued into 2020 in predominantly small, high-rise, minimum standard blocks. In fact, thousands are being fast-tracked through planning, even though Dublin already has a five-year pipeline of planning permissions for homes.
Why has this happened and what are the implications? I will focus on the financial reasons.
Given the very low rates of interest available, institutions are searching for investments that give a positive yield. Irish apartment blocks represent one such opportunity.
Currently institutional investors can acquire apartment blocks in Dublin with an initial return of about 3.6 per cent. Given that the current return on deposits is at best zero, the institution receives a substantial premium to cover any risk of delayed occupancy. The institution will borrow at less than 0.5 per cent. Depending on the amount of debt the institution is prepared to use, the institution can readily earn 12 per cent to 15 per cent on its equity
The acquiring institution, in addition to its immediate interest arbitrage has every incentive to maximise the long-term rental from the apartment building. Given the shortage of housing in Dublin most vacancies arise because the rental price is set above the immediate market price and in the expectation that by delaying higher rental incomes will be achieved. As currently about 80,000 jobs are being created annually and new housing units are about a quarter of that level the rent pressure is only going one way.
The acquiring institution will want to maximise its efficiency in operating its new financial asset. Accordingly, it will prefer to own 100 per cent of the building. This also suits the developer who can substantially eliminate his risk by turning the planned apartment building into a financial asset. This is simply achieved by estimating the potential rental income from the apartment building and financial buyers will then be willing to acquire the apartment building based on the expected yield once the apartment building is complete. That is what is happening in Dublin today
The individual potential owner-occupier cannot compete against the combined forces of the institution. Consequently, the individual is forced into being a permanent renter.
Along with the financialisation of housing, the introduction of Strategic Housing Development legislation (SHD) together with ministerial guidelines on planning policy favouring investors and the abolition from the end of 2014 of the windfall tax have coupled to generate massive gains for the developers and in turn put upward pressure on land prices.
The SHD has created benefits for the developers by effectively eliminating the requirement of the Part V obligation to include social housing, the mandating of smaller housing units and encouraging additional height and density.
The windfall tax provisions, which were removed by government in 2014, applied an 80 per cent rate of tax to certain profits or gains from land disposals or land development where those gains were attributable to a relevant planning decision. Surely that is precisely the type of tax the State should be imposing where it is gifting enhanced profits to private sector developers and landowners through reducing standards, eliminating social obligations and increasing densities.
Currently the State is paying double the necessary price for housing because of poor policy and poor management
The wider implications of the financialisation of the apartment stock are obvious:
1. Apartment blocks will be designed solely to maximise income for the acquiring institution. They will not be designed to meet any social policy objectives.
2. Decisions on when to rent will be taken on commercial grounds notwithstanding that apartments may remain empty for a protracted period. With a scarcity of accommodation and developers/institutions focussed solely on profit is anyone surprised that many apartments remain vacant while the developer/institution seeks higher and higher rents.
3. In a low interest rate environment, the cost of land for apartments will continue to escalate rapidly.
4. There will be continuing upward pressure on rents. It should be noted that given;
a. the relative shortage of housing, and;
b. the relatively large stock of existing housing;
constructing an additional 20,000 homes per year, less than 1 per cent of stock, will on its own have no noticeable impact on prices or rents.
5. There will be continuing upward pressure on the cost of suitable development land. As apartment buildings are financialised the value of the underlying land is ultimately determined by the yield at which the institution is prepared to acquire the apartment building. The cost of the construction is simply deducted from the final selling price to get the price that someone will pay for the underlying development land. The lower the yield the institution will accept and the greater the rental income the higher the underlying price for the land. Similar price pressures also apply to commercial land.
Financial absurdity and housing policy
The lack of coherence in our public housing policy will be readily apparent to anyone who examines the decisions in relation to Herbert Hill and O’Devaney Gardens which I referenced earlier.
Currently the State is paying double the necessary price for housing because of poor policy and poor management. In addition, it is locking itself in to perpetual rental supports of about €1,000 million each year to private sector landlords without improving its own stock of housing. The clear implications of these two examples is that if the State is serious about efficiently dealing with the housing crisis then central government and local councils should be taking a leading role in the master-planning of new communities, together with their financing and construction on publicly owned lands.
The State is the largest property hoarder. One expert has estimated that the combined property holdings of Dublin local authorities are about 420 hectares of vacant residential land with a capacity for more than 30,000 dwellings aside from other public land owned by semi-state bodies. The State also has the powers to rezone other more significant land banks currently in their ownership as required.
Families on average wages should be able to afford at least a starter home in a properly serviced community with schools and adequate transport
As with any large-scale landowner, the sites owned by the State should be master-planned by the State and local councils to meet all of the required social and amenity objectives. Then a separate decision can be made as to whether individual elements of the masterplan would be constructed by contractors directly employed by the State and whether some elements, particularly of the non-public housing, should be sold to private sector developers.
However, State master-planning and funding of construction on State-owned lands results in:
– Properly planned communities with the necessary infrastructure
– No land premium
– No gifts to developers
– Economies of scale and lower cost for the same product.
– Certainty about the quality, price and speed of building
Part II: Solutions
In Part I, I set out the problems in the housing market as I see them. Below I have set out a number of solutions which would at least alleviate our problem.
Our objective as a nation should be to ensure that everyone who wants a permanent home should have one. Housing is a social right and Ireland has been criticised by the United Nations for not delivering on this right.
Some have warned on the dangers of the downward pressure on rents and housing costs if the State were to build 100,000 public sector houses over the next five years. Surely that downward pressure on prices and rents is precisely what, as a community, we should absolutely strive for. How can anyone justify having Dublin as the most expensive city in the EU to rent an apartment?
Families on average wages should be able to afford at least a starter home in a properly serviced community with schools and adequate transport. This requires bringing down the cost of housing and deflating the bubble in land costs.
My suggested solutions come under three headings:
1. Make housing affordable – remove the rent to interest arbitrage
2. The State should direct and control policies for affordable housing.
3. Accelerate the use of existing space and avoid hoarding for expected higher future prices.
I have dealt with each of these below.
1. Make housing affordable – remove the rent to interest arbitrage
Institutions are the main purchasers of new apartments – acquiring 95 per cent of them in 2019. The prices that the institutions will be prepared to pay will depend on their after tax yield. Currently institutions earn nothing on deposits whereas they earn about. 3.6 per cent from rented apartment buildings. With appropriate gearing the institutions can earn up to 15 per cent on their own money. To drive down the price institutions will be prepared to pay and indirectly the price developers will pay for land I recommend that the State:
a. Charge a withholding tax of 50 per cent on all apartment rental income above €500,000 and eliminate the tax deductibility of interest where the rent exceeds this level. This would approximately equate to the effective tax and other deductions payable by individuals with that level of income. The immediate impact of this tax will be to reduce the advantage rents have over deposit interest and make it less attractive for funds to gear up to fund investment in apartments
i. This will lower the price institutions will be prepared to pay.
ii. It will make it attractive for institutions to sell the apartments to owners.
iii. From an institutional perspective - subject to approval, it may become attractive for them to both sell the apartments to potential owner occupiers and to provide mortgages to the owner occupiers to fund the purchase of the apartments.
iv. The increased supply of 'available for sale' apartments will drive down prices at the margin.
b. Reinstate the 80 per cent windfall tax so that the State captures a substantial portion of the gift that the State is currently giving to land-owners and developers. This gift arises whenever land values are enhanced as a result of the rezoning of land or the grant of planning or the grant of increased planning. In the case of the SHD it happens by facilitating material contraventions of the local development plans and the mandating of smaller units and lower standards by ministerial order. The windfall tax collected should be re-invested by the State in social and affordable public housing.
c. To decrease the financialisation of the apartment stock and further increase the supply of apartments available for sale, the State/planning authorities should restrict the number of apartments in any one building which an investor/institution can acquire.
As with all recommendations appropriate anti-avoidance measures will be required to ensure the spirit of the proposals is achieved.
2. The State should direct and control policies for affordable housing.
In October 2018 the Government announced the formation of the Land Development Agency (LDA) with €1.25 billion of permanent capital and a target to develop 150,000 houses over the 20-year period to 2040. The LDA is subject to a government policy that all public land disposals must deliver a return for the taxpayer, rather than affordability for the residents.
The LDA could be an important intervention though arguably not sufficiently ambitious in terms of social objective. Equally the Rebuilding Ireland loans and the affordable purchase schemes go some way to alleviate problems.
The Government can borrow long-term money at an interest rate of 00.10 per cent. The Government should make an additional €4 billion available through the LDA to fund local authority housing needs. Nama – the National Asset Management Agency – alone is likely to generate an unexpected €4 billion for the Government. Local authorities should be given specific annual targets, be required to masterplan and be funded to provide second mortgages to people working in essential services as set out below.
There will be those who will argue that State intervention is equivalent to State aid and contrary to EU policy. Currently the State is providing substantial amounts of aid. However, this aid is going to a small number of large developers rather than promoting competition and efficiently providing housing.
As a nation we are being convinced that we should be importing London/New York densities into Ireland – ignoring the totally different scale. How have we so quickly forgotten the failed tower blocks in Ballymun. What are the long term social consequences of co-living? How many ministers will plan to bring up their families in the structures being promoted? Housing is a long-term asset – it should be designed to ensure long-term sustainable communities. While the private sector may focus on profit, the public sector should focus on social sustainability.
Rather than buying homes from private-sector developers, at institutionally determined prices, the State as the largest landowner should:
a. Build about 1,000 homes per month. These houses should be designed as 1,000/1,250 sq ft with a maximum cost of €250,000, including a €50,000 payment to the local authority for the site value. These houses must have a minimum of two bedrooms. At this price point these houses should be affordable by any householder with a combined income of circa €65,000. Equally the local authority can utilise the €50,000 they receive to pay for social housing with every four affordable houses able to at least fund one social home
i. The relevant authority, be it State or local, should masterplan the site and ensure proper infrastructure including community infrastructure, transport and schools.
ii. The relevant authority should then control directly the construction of the houses – potentially, providing competition among small builders who are prepared to tender for small lots. Competition creates value and promotes entrepreneurship.
This approach to building has the secondary benefit of ensuring a steady flow of business opportunity for small builders and rewards those who efficiently deliver a quality product. In addition, the larger building programme has the knock-on effect of additional employment.
Following the LDA guidelines, all master-plans should be for mixed development and include a percentage of social housing. The SHD should not be capable of being used as a mechanism to avoid the Part V commitments to social housing. All new housing should be properly vetted to ensure compliance with all building codes.
b. To the extent that approved occupiers do not have the required deposit – as is likely to be the case given the high level of rents they are currently paying – the State would provide a second mortgage interest free of between €10k and €50k per household depending on their income and occupation. The maximum €50k second mortgage should be provided to people that provide essential services e.g. teachers, gardaí, firemen and hospital workers. This second mortgage should also be available to those buying homes from the private sector, provided the homes meet the criteria set out above.
i. This second mortgage would only be repayable on the sale of the house.
ii. The homeowner would pay about €900 per month on their bank mortgage – assuming a 25-year mortgage of €200,000 at a rate of 2.55 per cent. On a full mortgage of €250,000, this would be €1,125 per month. This repayment is substantially less than they would paying in rent for similar accommodation. At the same time these owners will be acquiring an asset/savings.
iii. To incentivise renters to purchase, the first €500 of interest per month would get double tax relief.
While previously we thought of homes as being a social right, we have allowed homes to become a globally traded financial asset. This has inflated the price of those homes
The cost of such a scheme to the State would be minimal.
(i) For a €50,000 mortgage the actual cost to the State at current interest rates would be €50 per annum. In contrast it will save the new homeowner €2,700 per annum and make acquiring the home achievable.
(ii) If 20,000 affordable houses were built and each of the owners received a €50,000 second mortgage from the State, the annual cost to the State would be one billion euro.
(iii) The State has a long-term asset in the form of the 2nd mortgages and will be repaid when the homes are sold.
(iv) The State will gain directly from both the direct and indirect taxes at the time of building.
(v) In the long term, the purchasers of the houses will be less dependent on the public purse to meet their housing need. There is particularly likely to be a saving to the State when the purchasers come to retirement and would be less able to afford rent and may well have to fall back on the public purse.
(vi) Based on the local authorities building 20,000 new affordable homes annually and being paid €50,000 for each site, the local authorities would receive in aggregate one billion euro annually towards the cost of social housing and infrastructure. This focus on social housing, though reduced in the SDH, is essential. The Economic and Social Research Institute (ESRI) has said: "Long-term investment in, and expansion of, local government housing stock for rent, should provide suitably priced accommodation to shield many lower income households from market pricing."
3. Accelerate the use of existing space and avoid hoarding for expected higher future prices
To help accelerate the use of existing space and existing planning permissions the following measures should be taken:
a. To incentivise the use of vacant urban spaces, particularly over shops etc, all new rented accommodation provided in designated buildings should attract a zero tax on that rent up to an aggregate of €50,000 per annum for the first five years. (It is estimated that there are about 4,000 empty spaces above shops in the Dublin area.)
b. All empty apartments should be deemed to be rented out at 50 per cent of the asking rent and tax should be chargeable based on that deemed income. This would provide a strong incentive to adjust rents to market clearing levels rather speculative hoarding.
c. To stop land hoarding by developers all sites should be deemed to be vacant for tax purposes if not completed and substantially occupied within four years of the initial grant of planning.
Everyone agrees that we have a serious and urgent need to deal with our housing crisis. However, while previously we thought of homes as being a social right, we have allowed homes to become a globally traded financial asset. This has inflated the price of those homes, inflated the profits of the developers and inflated the value of the underlying land.
Proper State intervention and targeted taxation, including the re-introduction of the windfall tax, can be utilised to drive property and land prices down and to increase the supply of accommodation available.
The State is the largest landowner and the Land Development Agency should be required to get directly involved in providing via the local authorities or otherwise about 1,000 starter houses per month on State-owned land at a price-point of €250,000. At that level most families will be able to afford the repayments and the State, at no effective cost, should be able to fund any deposit shortfall by means of a second mortgage.
Author: Financier Dermot Desmond, estimated by Forbes to be worth $2.1 billion (€1.9 billion), founded stockbrokers NCB in 1981 and was a driving force behind then taoiseach Charles Haughey’s setting up of the International Financial Services Centre (IFSC) in 1987. He would go on to sell his brokerage to Ulster Bank in 1994 and use the proceeds to set up his own investment firm, International Investment & Underwriting (IIU). IIU’s most successful investment was the purchase of London City Airport in 1995 for £23.5 million (€27 million). He sold it just over a decade later for an estimated £750 million.