The landlord exodus
The Week in Housing 03/06/22
This week I want to take an in-depth look at a recent report on the private rental sector, written by Jim Power and published by the Irish Property Owners Association and the Institute of Professional Auctioneers and Valuers (it doesn’t appear to be available to download). It’s worth getting into the weeds on this one for two reasons. First, the report had a significant impact in the media. The Irish Times had an article summarising the report’s findings, and so did the RTE website. It also featured quite widely on various Radio programmes. Second, the report echoes an agenda for the rental sector that has been around for quite some time. It boils down to an argument for returning to a deregulated PRS to incentivise investment by small-scale landlords.
The main argument of the report is that small-scale investment in the PRS has declined, that this is a significant problem from a supply point of view, and that the main drivers here are the tax treatment of small-scale landlords (as opposed to the funds) and the RPZs.
The argument that small-scale investment is falling is based on two sets of data. The first is Buy-to-Let mortgage data. This data comes from the Banking and Payments Federation. BTL mortgages are described in that data as ‘Residential Investment Letting’. The data shows that RIL mortgages accounted for 19.9% of total mortgage lending in 2006, but just 1.4% in 2021. The report concludes that ‘the collapse in private investment participation in the market is symptomatic of the manner in which the private residential rental market has evolved in recent years’. The second data is registered tenancies. It notes that registrations grew consistently and quite rapidly up to 2016, but have declined by an average of annual rate of 1.75% between 2016 and 2020.
There is an internal contradiction in the way this data is presented. All of the decline in RIL mortgages took place between 2006 and 2010, and they have remained very low since then. But registered tenancies increased between 2010 and 2016. This is because mortgages drawdowns are a very poor indicator of investment in rental properties. Indeed, research from the Central Bank during this period shows a very large increase in the proportion of cash buyers, who are obviously not reflected in the mortgage data.
Moreover, the collapse of RIL mortgages was driven by a number of issues that have nothing to do with regulation in the PRS – as mentioned all of the collapse took place prior to increased regulation from 2016. In particular, arrears in the sector were extremely high (much higher than for normal mortgages) in the wake of the crash, banks have been reluctant to issue RIL mortgages, and the Central Bank’s macro-prudential rules are stricter for these mortgages than for standard ones.
Nevertheless, there does appear to have been a decline in small-scale landlords between 2016 and today, and this has been found in a number of studies which the report draws on. Sherry Fitzgerald’s research from last year, the report notes, suggests the decline in small investors has reduced the number of available tenancies by almost 22,000 between 2016 and 2020.
Next let’s look at the issue of why small-scale landlords are leaving. The report sets out three main reasons:
• “Rent Pressure Zones have not succeeded in controlling rents and have had the unintended consequence of preventing rents from falling and reducing the supply of rental properties in the market.
• The taxation treatment of private landlords compared to institutional landlords acts as a serious disincentive for private landlord participation in the market. Private landlords need to be treated fairly as they are a vital component of the rental property market.
• The regulatory and taxation environment facing private landlords is constantly changing. There is no certainty or continuity and this prevents private landlords from engaging in long-term financial planning and management.”
I have no issue with the third of these, but the first two are an example of muddled thinking on this issue.
On taxation, it is not clear why small-scale landlords would leave the sector due to the advantageous tax treatment of institutional landlords. Obviously, if a market actor feels another market actor is getting a better deal, they are likely to be unhappy about this. But if we assume small-scale landlords are rational market actors, than surely their key criteria would be the costs and benefits of retaining their asset versus selling it. It is not clear that the profits that other market actors are making has much to do with this.
It could be argued that institutional landlords are able to out-bid small-scale landlords when it comes to purchasing properties, due to their advantageous tax treatment. But in practice the market segment that that institutions focus on is new apartments, most of which don’t come to the market to begin with, and which are acquired in bulk purchases anyway. It can still be argued that the tax treatment of small landlords is overly onerous, but to my mind the comparison with institutional landlords is less relevant than is recognised in much of the debate.
On the RPZ issue, again the argument is problematic. First, the report claims that the RPZs have not worked and rent levels of new tenancies have continued to rise. Unfortunately, the report does not engage with or even reference the empirical evidence we have on the impact of the RPZs (which I discussed last week). Indeed, it is somewhat frustrating that the report does not refer to any existing research, with the exception of some recent surveys of landlords, despite the fact that there have been three recent international reviews of empirical evidence around rent controls (see here, here and here).
Moreover, if RPZs have not worked and rent levels are continuing to rise, surely this favours new investment by small-scale landlords?
Second, in terms of existing landlords within RPZs, their ability to increase rents has obviously been constrained. Here, again, the report leaves out two important points. First, non-compliance appears to be quite widespread and so the RPZs are not necessarily relevant to the non-compliant section of the market. Second, it would be irrational for a landlord to leave the market purely out of frustration that they can’t raise the rent to market levels if there is not an available alternative asset with higher yields, less risk, or both. Again, this is what we need to be considering if we are making an analysis on the basis that small-scale investors are rational market actors, as opposed to treating them as irrationally (in the economistic sense) reacting to aspects of the PRS they find frustrating or unfair.
There is also a bit of a twisted logic at play here that appears to argue that RPZs don’t work and so rents keep increasing, and this is somehow bad for landlord investment, but also at the same time as not working, RPZs do in fact limit rent increases for existing properties (which is their objective), and this is also bad for landlords. This is reminiscent of Freud’s ‘kettle logic’, which describes three arguments put forward by a man accused of returning a borrowed kettle in a damaged condition: ‘I returned the kettle undamaged; it was damaged when I borrowed it; and anyway I never borrowed your kettle’.
A further argument put forward in the report is that the RPZ legislation incentivises landlords to sell to owner occupiers rather than other landlords. The reason is that if an investor purchases an existing rental property, future rent increases are constrained by the RPZ legislation (assuming the new landlord complies with the RPZ legislation). This would effect the price they would be willing to pay for the property, such that higher prices can be obtained by selling into the owner occupier segment. This is an interesting point and an aspect of the RPZs I hadn’t considered.
The report makes the important point that this may reduce the stock of PRS properties. However, a full analysis needs to take account of how the PRS and owner occupier segments interact. In this case, it is obvious that when a property moves from the PRS to the owner occupier sector it reduces the supply of PRS properties, but also reduces demand for PRS properties by effectively creating a new homeowner. As such, this aspect of the RPZs can be seen as supporting homeownership. Conversely, if the RPZ legislation was abolished and the tax treatment of landlords changed, this would allow landlords to bid up house prices, thus reducing access to homeownership, as indeed happened during the Celtic Tiger bubble (see Norris and Coates, 2014).
There is a wider point here about how small-scale landlords are framed in the report, and often in the wider media discourse. Attention tends to focus on the factors that might push landlords out of the sector, such as RPZs. Certainly this is an important part of the discussion. But any meaningful assessment must look at the wider context, for example available yields on comparable assets and asset prices. If a landlord sells a property, assuming it is not entirely to finance their personal consumption, they have to do something with that money, whether it is savings or some form of investment. The available returns and the risk profile of alternative assets should thus be central to any analysis.
Similarly, the report pays very little attention to the wider context of the PRS market. Some of this context is provided by a last week’s ESRI report on rent subsidies. The report estimates that the share of households renting has increased from 18% in 2000 to 29% in 2022 (although this covers both social and private renters), and that ‘combined, the Housing Assistance Payment (HAP), Rental Accommodation Scheme (RAS), Rent Supplement and Rent Allowance assist around one-third of supported renters (95,535 households) today, compared to just one-fifth (29,594) in the early 1990s’. So demand has grown very rapidly and is also massively subsidized through government intervention - factors which must surely be taken into account when assessing rental properties as an investment.
For all these reasons, there is a lot to be gained from the ‘systems thinking’ approach advocated by Gibbs and Marsh, i.e. to acknowledge ‘that the different elements [of the housing system] interact in complex ways: change in one has consequences for the system as a whole and for other components. It also suggests that understanding the perspectives, incentives and goals of different parties involved is important to developing credible and sustainable system or policy change’.
In my view, in addressing the issue of small-scale landlord investment, we need to take an approach which recognises the following:
We do not have comprehensive data on small-scale landlord investment. The closest we have is the Property Price Register data on ‘household non-occupier’ purchases, but this includes holiday homes and other instances where a household purchases a property they do not intend to occupy. The annual registration of tenancies with the RTB may help to fill this data gap.
We do not have an adequate, empirically informed theoretical model of the investment behaviour of small-scale landlords in Ireland, or indeed internationally.
In particular, we need to be wary of approaches which appear to treat landlords as rational, market actors, but which in fact treat them as irrationally reacting to policy developments, and which fail to consider the wider set of relevant factors, such as the performance of comparable assets, asset prices, the nature of demand etc.
Investment in the PRS interacts in a dynamic fashion with the other tenures, especially owner occupation. Creating a favourable investment environment for small-scale landlords has implications for the ability of other actors to purchase residential properties. This may be a good or bad thing depending on the relevant context and policy objectives. The exit of small-scale landlords from the PRS cannot necessarily be treated as a straightforward decline in supply, but rather as a reorganisation of the housing stock and part of a process of tenure change.
Investment in the PRS also interacts with a wider set of factors which need to be considered, in particular the concentration of ownership of residential property and wealth inequality.
This does not mean that the exit of small-scale landlords from the market is nothing to be concerned about: sale of rental properties is one of the main drivers of homelessness. The point is that the issue needs to be considered in a holistic and evidence-informed fashion.
On the subject of renting, the Housing Agency are kicking off their summer seminar series with a session on ‘experiences of renting’, register here, and I understand Threshold will be launching their annual tenant sentiment survey on the morning of June 23rd, details TBC. A recent EVICT project seminar on the relationship between the right to housing and health is now available to watch.
What I’m reading
Social Justice Ireland have an important new publication which I am very much looking forward to reading, Housing Costs and Poverty 2022. On the subject of rent controls, Gibb and Marsh have a new briefing paper on ‘principles, practices and international experience’, following on from the publication of their report last month, which I wrote about here. Another UK report looks at how to tackle tenant insecurity in the PRS. Closer to home, the Oireachtas Housing Committee published a report on Urban Regeneration.
Great piece Michael, and yes, felt there was a lot missing from the IPOA report. There is significant non compliance in the sector and a lack of real data about who is renting and why. There's also a dearth of long term studies of tenants, especially long term tenants. I did study Systems Thinking & practice with the OU, so delighted to hear whole system analysis is being doing by someone.
I think a missing point in the paper was the tax treatment on small investor sales, which in context of large sales prior to 2006 is extremely favourable. If anything, one of the issues at the moment is that. It would be nice to get more in depth study of landlord who bought prior to 2006 in particular. The point on investment arrears is a critical one. It's another area for deep study perhaps.
Many small landlords are not 'utility maximising' as per the neoclassical model. They may sell because they regard the system or its outcomes as unfair, even if it means cutting off their nose to spite their face. I write from some personal knowledge.
In some cases tenants have benefited from low rents that were voluntarily introduced or maintained by the landlord following the GR that then became the base from which rent increases were limited to 2% per year. It is not unusual for properties held by small investors to be let 20-50% under 'market' (even recognising that the 'market' price is skewed by the predominance of new lettings). Some such tenants have improved their economic situation over the years, potentially enjoying more income than their landlord. Under the current system, such tenants are strongly incentivised not to relinquish their tenancy (even if they come to own a separate property) to facilitate a family with greater need to benefit from the capped tenancy. On the other hand, were the landlord to sell the property, a genuinely needy first time buyer could benefit. This is a strong motivation for many to sell that is not included in your economic universe.
I predict that the decreasing value of residential investments (due to higher interest rates, inflation, and improved return from government bonds) will shortly accelerate their sale, not by small landlords, instead by large 'professional' investors ie REITs who are indeed 'utility maximisers'. Now that will be interesting !