The week in housing 21/05/21
Do we need vulture funds?
This week it was once again all about institutional investment and the dreaded “Vulture funds”. The Government’s new policies were perhaps not too surprising. From the Government point of view, the new regulations reflect a pragmatic balance between protecting first-time buyers and supporting the continued investment of funds in Dublin apartments. From the opposition point of view, the new measures are simply a sell-out and give a green light to institutional investors to continue their monopolisation of the property market.
As is often the case, as the debate continued it became more confusing. To some extent this is not surprising, in reality we know very little about the activity of institutional investors in the Irish real estate market. It is even more difficult to assess their overall impact on the housing market, for example on land and property prices or the amount of housing available to first-time buyers.
This week I want to try and shed a little bit of light by focusing on two reports, one new and one old. The old report, which I look at first, is a Department of Finance paper published in July 2019, with the catchy title Real Estate Investment Trusts, Irish Real Estate Funds and Section 110 Companies as they invest in the Irish Property Market. The new report, published just last week, is from Irish Institutional Property, the industry body representing the sector.
The Department of Finance paper is useful in clarifying the different types of property funds and their role in the Irish housing system. They were set up by the Government in 2013 (via legislation), and the rationale for this was to ‘facilitate collective investment …This in turn brings new sources of capital into the Irish property market and contributes to reducing dependence on bank financing". In short, because banks where not in a position to lend into the property market after the crash, REITs were set up as a mechanism to bring international capital in. An argument has also been made that REITs could have benefits for the rental sector in particular. We have seen this mentioned by various Ministers over recent years. The Department of Finance paper puts it like this:
“REITs can also be beneficial through the promotion of professional management in a residential property market which has traditionally been dominated by small, individual landlords, often with high mortgage borrowings against the property. REIT regimes are also intended to be beneficial to tenants by improving stability of tenure as REITs are designed for long-term property investment, which should reduce the likelihood of a tenancy being terminated as a result of the landlord choosing (or needing) to sell the property”.
Anyway, in practice there is only one REIT which is actually involved in housing (the others are focused on commercial property like offices and retail). The total value of property held by REITs in the Irish market is €3.7 billion, 28% of which is residential, i.e. housing, and almost entirely apartments in Dublin. IRES REIT is now the largest landlord in Ireland, so it is an important player, but the focus on REITs in trying to understand the impact of institutional investment in Irish housing is somewhat misplaced. Specifically, the argument that the tax advantages enjoyed by REITs is the main driver of the problems such as the bulk buying of housing estates does not appear to be supported by the evidence.
Another type of fund is what is known as IREFs (Irish Real Estate Funds). These were introduced under Section 23 of the Finance Act 2016. They were introduced due to concerns that international funds were using different types of vehicles to avoid paying tax in Ireland (although opposition politicians, especially Pearse Doherty, have recently been arguing that they still provide very favourable taxation for property investors). IREFs cover a bunch of different investment structures including ICAVs (Irish Collective Asset-management Vehicles), investment companies (PLCs), and unit trusts.
The Department of Finance report estimates they have about €1.7 billion in housing assets (this is just 10% of their total assets, again they are mostly involved in commercial real estate).
Although both REITs and IREFs are primarily involved in commercial real estate, taken together they do amount to a significant impact on housing, especially the private rental sector and apartment construction and purchase. However, we also need to be aware that there are a number of other types of structures/companies including, for example, the likes of Kennedy Wilson (a shareholding company listed on the London stock exchange) and Hines (a family-owned business based in Texas). In other words, even what the Department of Finance knows is limited. It is therefore very hard to say with any certainty what the overall relationship is between taxation and international investment in Irish residential property, and it is obvious that much greater research is needed if we are to avoid policy-making in the dark.
The other main bone of contention in the debate around institutional funds is the question of supply. I think this is the most interesting question because it is likely that the Government’s defence of institutional funds, will continue to focus on the idea that they are crucial to the supply of apartments in Dublin.
Yet again, what we know is limited. In fact, the public debate might be a lot more useful if we were able to acknowledge what we don’t know. Nevertheless, a new report from Irish Institutional Property does provide some interesting insights.
So what do they say about the role of institutional investment?
The main argument of the report is that the role of international capital will need to expand if we are to reach a situation in which we are producing 30,000 new housing units per annum. Most commentators agree that this is what we should be aiming for (although this may be an underestimate).
Between 2017 and 2019, domestic capital provided 22% of development finance, or about €1.2 billion per annum. The remainder, €4.2 billion, came from international providers. Of the €1.2 billion in domestic finance, €582 million came from private finance, presumably mostly banks, and €786 million came from the public sector (i.e. social housing).
They examine what would be required to achieve 30,000 units. They look at a scenario in which public investment increases to €1.7 billion (at the moment it’s about €1.2 billion, so this seems realistic enough over the coming years) and domestic private finance increases to €900 million. Again this seems reasonably realistic. On this basis, they argue we would still need international capital to increase from about €4.3 billion to €7 billion. They also look at a scenario, in which private domestic finance increases more, to €1.5 billion. But even under this optimistic scenario, we would still need about €6.4 billion in private international finance to deliver the 30,000 units.
In order to achieve this massive increase in international investment in Ireland, they argue, the Government needs to “signal to the international capital markets that Ireland will remain a safe and stable investment environment”.
Okay, so what should we make of this report? First of all, it is important to point out that the data in the report is based on estimates. There are no exact figures for the level of development finance, and the report, as is often the case with industry reports, does not make the methodology clear and therefore is difficult to assess. Second of all, of course this is an industry body and so a degree of scepticism is warranted. Nevertheless, it does seem likely that the core problem they identify, the question of where the capital is going to come from to develop 30,000 units per annum, given the difficulties in the Irish banking sector, is a valid one.
I don’t think we know enough one way or another to have clear answers on these issues, but here are a few thoughts. The report focuses on one simple metric: how much development finance we need. The reality is that institutional investment is more complicated than this. Institutional investors buy land and assets, as well as providing development finance. They don’t just impact supply, they impact land and asset prices. If institutional capital grows by the volumes they estimate are required, it is very difficult to see how this will not have an extremely destabilising impact on the Irish system, e.g. inflating land and house prices, and leading to a housing system which is almost entirely focused on private rental apartments. The reality is, this is a scenario which no one wants, except of course the institutional investors themselves.
So while we need to be cognisant of the role played by institutional investors in the supply of housing, particularly Dublin apartments, there is also a strong case for trying to rebalance our housing system. This can be done in two ways. First, by attempting to promote homeownership, especially outside of core urban areas. This is what the government have been indicating they would like to do, but so far there is no real clear vision on how this can be achieved given the affordability issues. Second, by radically expanding non-market provision, specifically social housing and cost rental housing. For example, if we increased capital investment in social housing to €2 billion, and added to that €1.5 billion in funding for cost rental housing, and focused this on urban areas where demand and market prices are highest, we could substantially reduce reliance on international investors. This would also have the benefit of producing much better outcomes in terms of housing affordability and security of tenure, and would be much less likely to lead to rapid increases in land prices. Given how cheap it is for governments to borrow, and that we now have the Land Development Agency, we have a real opportunity to achieve this. In this case, Dublin would become much more like some other European cities like Copenhagen, Amsterdam or Vienna, in that new housing supply would be made up of a mix of affordable non-market apartments, on the one hand, and higher-end/luxury apartments in the private sector, on the other hand (note that even this scenario relies on a continuing role for institutional investors).
There are political problems here though. We are now reaching a point at which different visions of our housing system are clashing with one another in a much more dramatic fashion. The period between, let’s say, 2013 and 2018, was really focused solely on trying to bring some supply into the system – output of new housing was just so low at that point. In more recent years, as supply has started to return to more normal levels, although still of course relatively low, the politics have changed; the question of what type of supply is increasingly becoming the key question. Successive Governments since 2013 have taken the approach of just encouraging essentially all forms of supply - supporting international investment, expanding social housing especially through AHBs, fast tracking the planning system (e.g. Strategic Development Zones), subsidising first-time buyers (e.g. Help to Buy), and so on. What we’re seeing now, is these different types of supply competing with each other in a very literal sense.
The latest government decision is essentially a fudge. They say they want to support homeownership but not to the point of taking any real action to constrain institutional investors, nor I might add, by stopping Approved Housing Bodies from purchasing housing estates. But at some point a decision is going to be made about what type of housing system we are aiming towards - maybe the next election will decide this crucial question.
Events
The Conference of Irish Geographers has been on all this week, with some great papers on housing.
Given the amount of debate about Minister O'Brien's shared equity scheme, this discussion organised by the UK Chartered Institute for Housing on shared ownership might be of interest.
What I'm reading
What do international academics have to say about institutional investment? This paper by Megan Nethercote provides a very useful summary of the academic literature, while this paper by Gertjan Wijburg puts forward some thought-provoking ideas on 'de-financialization'.
On the subject of financialization, check out this new paper comparing housing in Ireland and Australia.