AHBs, cost rental and interest rates
The Week in Housing 20/01/23
Happy New Year! I hope everyone had a restful break. In the last issue of the Week in Housing, Fiona Dunkin’s guest post looked at the challenges debt-financed social housing delivery poses for the AHB sector. Here, I return to this issue and discuss how these kinds of issues are addressed in other countries, specifically Denmark.
As Fiona notes, one of the biggest challenges associated with Ireland’s new cost rental sector is around managing the level of borrowing associated with this form of housing. This is in part to do with our particular situation. In Ireland, AHBs have only relatively recently started using borrowing to finance housing provision, and have expanded rapidly, meaning that organizations which are relatively inexperienced in managing financial risk have acquired a quite high volume of debt over a short period. On the other hand, managing debt is one of the key challenges of any cost rental sector, as most rely primarily on private borrowing. In the Austrian case, around 60% of new cost rental developments are bank financed, while in Denmark around 90% of finance comes from the ‘mortgage bond’ sector, also a form of private finance.
There are a lot of elements to managing debt, and I certainly don’t claim to be an expert on risk management, but perhaps the key issue is interest rates. Interest rates are crucial for two reasons. First, they play a key role in determining the cost of providing housing, and therefore (in the cost rental sector) in determining rent levels. Second, interest rates change over time and, because housing is a long term investment, ‘interest rate risk’ can pose challenge.
There are many ways that cost rental housing in different countries seeks to sustain low interest rates. These include:
Government guarantees for Housing Association borrowing
Treating the public borrowing associated with cost rental as ‘subordinated debt’ (meaning if things go bely up, the Government takes the first hit)
Robust auditing and regulation to reduce potential defaults
But something that has been given less attention in Irish debates is the issue of interest rate volatility. This may be in part because the sector has grown up in the context of ultra low interest rates, or because it has thus far relied on the Housing Finance Agency (rather than private institutions), to complement direct Government funding.
Nevertheless, we are now in a cycle of interest rate increases and, although we have no idea how long it will last, this has put interest rates on the top of the agenda for many people concerned with housing.
Apropos of this, I was reminded of an interesting feature of the Danish cost rental model (which I have written about here). In Denmark, housing associations receive an ‘interest rate subsidy’ from central Government which means that the interest rates they pay are essentially fixed and stable over time. The last time I looked into it (a few years ago), Danish Housing Associations’ contribution to the cost of finance was fixed at 2.8% per annum. This means that if interest rates go higher than this, the Government picks up the additional interest rate costs. In other words, the ce interest rate subsidy covers the difference between the contribution from Housing Associations and the actual cost of finance for each project (i.e. the interest rate charged by banks for lending to the cost rental sector).
Interestingly, where financing costs are below 2.8% there is in effect a ‘negative subsidy’; i.e. Housing Associations continue to pay the 2.8% fixed rate contribution and the difference between that rate and actual financing costs becomes a source of revenue for central government.
The rate at which the subsidy is set has been changed periodically by central government - until 2008 it was 3.4% for example – it is also indexed to inflation.
The financing burden shouldered by Housing Associations is thus determined by central government and not by the market. This ensures that Housing Associations are not exposed to interest rate volatility and that increases in the cost of finance do not render new projects non-viable. This is one reason for the stable supply of cost rental over time.
Importantly, given that the cost is ultimately borne by tenants, fixing the cost of finance means that tenants’ rents are also not determined by the market cost of finance, nor are they subject to fluctuations due to changing interest rates. In addition, the fact that Housing Associations are not exposed to interest rate risk lowers their risk profile and therefor facilitates low cost finance.
One crucial point to note here is that the cost of bank finance is also politically determined. The interest rate charged by banks for cost rental housing is negotiated between the Danish Government and the banking sector. This is very important because otherwise the banks would likely simply absorb the interest subsidy in the form of higher interest rates, and the benefit would not be felt by housing associations and their tenants.
The Danish interest rate subsidy is no doubt complex and has been developed in the very specific financial and governance context of Denmark. But it is an interesting example to reflect on as we think about how to ensure the Irish cost rental sector remains sustainable and resilient given that, in the long term, it will likely have a growing reliance on private finance, and that it will have to weather recessions, financial crises, and interest rate volatility. An interest rate subsidy is an attractive policy tool because, by eliminating interest rate risk, it reduces the cost of finance for the cost rental sector and therefore helps to stabilize supply, while also reducing rents.
Events
Next Tuesday the Housing Agency will host a seminar on Land Value Tax. Don’t forget, if you are organising a housing related event, let me know and I will share the details here.
What I’m reading
As this is the first issue of The Week in Housing for 2023, I thought I’d share the most read issues of 2022:
Is cost rental making a difference? (Guest post by Fiona Dunkin)
Why we need a political economy of housing: Part I (and see Part II here)
Shrink the PRS: Part I (and see Part II here)