Supply, finance and the PRS
The week in housing 17/09/21
This week I want to look at a fascinating report by Ronan Lyons published by the IIP during the summer: Institutional Investment and the Private Rental Sector in Ireland. The report’s overall argument is that, given the need to dramatically increase the supply of housing, and the fact that PRS apartments are crucial to that, the growing role of international institutional investment in our housing system is to be welcomed. This is obviously a pretty controversial claim in the current context. It is worth examining the argument in detail for the insights it gives into those arguments which focus mainly on private sector supply in terms of overcoming the housing crisis. This report is one of the most detailed versions of that argument we have thus far seen in the Irish context.
The report estimates housing need to 2050 based on natural population increase, net migration, obsolescence and falling household sizes (based on the very reasonable assumption of convergence with other high income countries). The most likely scenario will see Ireland requiring close to 49,000 units per year. This is obviously significantly more than the targets in Housing for All (33,000 per annum).
Moreover, the report argues that supply is both the cause of the housing crisis in general and the key ingredient for ensuring greater affordability for renters:
"The overwhelming evidence from both sale and rental markets in Dublin, therefore, is that availability is the key determinant of subsequent price changes: supply matters".
The report refers to the pandemic experience here; in the final two quarters of 2020 Dublin experienced the largest number of rental listings in the past five years, and of course rents stagnated/fell in this period. More importantly, the report analyses listings and price changes between 2006 and 2011, looking at both rents and sale prices. High levels of listings (the number of homes available to rent or buy on the first day of a given quarter) are strongly linked to low levels of price increases in the following 12-month period. Does this mean that an increase in supply will automatically see prices fall? No. But it does mean, according to the analysis presented in the report, that inadequate supply is the biggest factor driving price increases.
Based on the same analysis, the report argues that in the capital's rental market 'the level of availability associated with stable rents is about 4,000 homes'.
Another aspect of the argument is the type of supply needed. Given urbanisation and falling household sizes, small apartments (one or two beds) are the most needed type of housing, and also the most expensive to deliver. Based on estimates from the IIP itself, the report assumes average construction costs for a two-bedroom medium-rise apartment of €455,000. Apartments are more suitable for the rental market because it is not viable to deliver them at prices most would-be homeowners can afford. Hence, the report concludes, PRS apartments, AKA Build-to-Rent, are central to meeting the supply challenge.
The next question is where the money will come from. In answering this question, Lyons (along with the IIP itself, as seen in their earlier report which I reviewed here), emphasises the limited role the domestic banking sector will play, due to their 'post-crash restructuring and a continued low-risk appetite'. On this basis, the report assumes that Irish banks will be limited to around €800 million per annum in terms of capital investment in housing.
From the above arguments, it follows (according to the report) that we are extremely reliant on international capital to fund housing delivery between now and 2050. Based on an estimated 45,000 houses needed each year, 'the total capital needed per year for residential and commercial real estate is €15.6 bn.' Only 11% of this will come from domestic sources. This is more or less in keeping with current trends - international capital made up almost 80% of annual investment between 2017 and 2019.
As far as the report is concerned, this reliance on foreign capital need not concern us, however:
"As an economy with significant population growth in coming decades, and thus a net borrower, Ireland is fortunate in that it shares a monetary union with older and wealthy countries that are, on balance, net savers. This means that Ireland can take advantage of an elastic supply of international capital, at low cost, in a way that it simply could not do prior to entry into the eurozone'.
Overall, then, the argument is based on an analysis of changing, long-term housing need, according to which Ireland converges with other high-income countries, combined with the integration of our housing system and international finance, which will link our growing, net-capital importing population, with stable (in population terms), capital exporting economies. This is a view in which the growing role of international institutions as investors in, and owners of, housing stock is not only welcome, but essentially the only way to overcome the supply/demand imbalance that has plagued our housing system in recent years. On this basis, the policy recommendations focus on increasing viability, deregulating rents (especially between tenancies) and tax changes.
The analysis presented in this report is, in my view, of great interest and there is a wealth of empirical evidence here. Although I would draw different conclusions, I share the sense that future demand is likely to be very significant and that there is huge supressed housing demand. Thinking about how our housing system needs to develop in terms of long-term structural trends, and thinking about financing requirements in these terms, is also very welcome. There are, however, some areas where I (and I think a lot of readers) would have some questions to ask. Some of the issues include:
• Some will query the cost of delivery at €450,000 for a small apartment, but this is not an area I am qualified to comment on. The figures in Lyons' report are consistent with the analysis of the Society of Chartered Surveyors Real Cost of New Apartment Delivery report, however;
• The absence of Irish banks as a source of additional domestic finance is taken as a given, rather than something which could be changed. More generally, other potential sources of domestic finance are not considered (e.g. the new Credit Union fund just approved by the Central Bank);
• The state's role in increasing housing supply is somewhat in the background here, and it is not clear why the possibility of a major increase of state investment is not included as a potential way forward.
But my main issues are with a kind of economism evident here. This is relevant to a number of aspects of the analysis. First, the potential downsides of international institutional investment are not considered. For example, the estimated enormous volume of capital required would no doubt lead to asset price inflation in land markets. Others have raised the concern of local monopolies of large landlords leading to inflated rents in some areas, and cited evidence that institutional landlords evict more. But there is also the local and urban politics associated with this level of dominance by institutional capital to consider. The report argues that there are no real land constraints (because Ireland's population density is low) and that there are no concerns about institutional PRS 'squeezing out' other forms of housing. But in reality, where there is a very large volume of one form of investment within a particular neighbourhood (say, Dublin 7) there is very likely to be political contestation from communities who feel they do not benefit from the associated forms of housing. In other words, institutional investment cannot just be analysed 'on aggregate' and over a 30 year period, because investment materialises in local urban contexts with existing inequalities, unmet needs, conflicts etc.
Second, similar issues apply to the critique of rent regulation provided. The report argues that rent increases should not be regulated between tenancies as this disincentivises investment. It points to evidence, mainly from the US, relating to unintended side effects of rent controls. This evidence in itself is in my view not very convincing as contexts vary hugely across jurisdictions and the report focuses on mainly US literature, rather than European. Moreover, it does not weigh up the costs and benefits of rent regulation. For example, deregulating rent increases between tenancies creates an incentive for landlords to evict tenants in order to increase the rent. Similarly, rent regulation may (in some circumstances) suppress investment over the medium and long term, but in their absence many thousands of households will struggle to afford housing (see the recent OECD report on this point). In my view, the challenge of housing policy is precisely to navigate these issues in a specific context.
Finally, and perhaps this is the biggest issue, the report argues for a huge increase in supply, but what do we do in the meantime, given this could take decades to achieve? There is an element here that is reminiscent of Keynes' famous quip:
'Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.'
Between now and when the supply/demand balance is restored how much damage will be done to households and society? Moreover, in my view the hoped for supply/demand equilibrium is unlikely to be met (at least as long as the economy is growing and cities are attracting workers). The report itself notes that "the existing pipeline of build-to-rent apartments is likely to amount to only half the backlog of missing rental homes in Dublin needed to bring rents back to affordable levels". This suggests meeting the supply challenge is virtually insurmountable. So the question to me becomes, what do we given a long term, structural supply/demand imbalance? The answer, I suspect, lies in transitioning away from private market housing in areas of highest demand, ideally via cost rental. But one thing the report makes very clear; any proposed solution needs to take seriously the scale of the challenge.
What I’m reading
This really interesting paper by Ian Mulheirn takes a hatchet to the argument that limited supply is the cause of price increases in the UK context. The ESRI/IHREC report on monitoring adequate housing is out now and this one is definitely a must read (great discussion of the report on the Reboot Republic podcast). The Hooke and McDonald Dublin Residential Investment Market report for H1 2021 was also published this week (it shows investment in PRS up to 55% of all real estate investment in Dublin, from 40% in 2020).
Events
The Harvard Joint Centre of Housing Studies have organised a great series of seminars over the next few months, looking at post-pandemic housing, rent regulation and other fascinating issues. Obviously there is the time difference to contend with but it really looks like a great series. The ICSH Social Housing conference is on 22-24 of September.