Published on May 10th, 2016 | by Martin Clancy
We need to escape 10% rental inflation being the new normal
Guest post by Ronan Lyons.
The figures in this latest Daft.ie rental report show an increase in the average rent nationwide of 9.3% in the year to March 2016. This represents a remarkably persistent rate of rental inflation, with the average annual increase rents since the second quarter of 2014 being 9.6%. Granted, there has been a shift in the composition of rental inflation, away from Dublin and towards the other cities in the rest of Leinster in particular.
Nonetheless, there is the danger that this very high rate of inflation becomes something of a new normal. There is nothing normal – or indeed sustainable – about inflation in rents of 10%. This is particularly the case, given that the rate of inflation in the wider economy is close to 0%. In other words, if this situation persisted into the future, the average household would have to devote an ever greater share of its income, just to pay its rent.
There rule of thumb about a household’s accommodation costs is that their accommodation costs, in the form of rents or mortgage payments, should not be greater than roughly one third of the household’s disposable income. If we take a household whose gross income is €45,000, this leaves them with roughly €3,000 a month in their after-tax disposable income. This means a household earning €45,000 should not be spending more than €1,000 a month on its rent. It is worth noting that an income of €45,000 is in the upper half of the income distribution, in other words this household is on an above-average income.
However, if we look at the rental market, we can see a growing disconnect between household incomes and prevailing rents. West Dublin, for example, is typically viewed as one of the most affordable parts of the rental market in the capital. The average rent for a three-bedroom house in West Dublin, though, has increased from less than €900 in 2012 to more than €1,300 in early 2016. In other words, it is becoming increasingly difficult, even for those with above-average incomes, to house themselves in or near the capital.
We know that investors involved in renting out accommodation require a net yield, or annual financial return, of at least 5%. The maths of finance means that once we know this, we can scale up from the monthly rent to construction costs. A monthly rent of €1300 converts into upfront construction cost of €260,000. And this brings up a second and more worrying point about the supply of homes in Ireland.
Even if the developer required land for free, it is not possible to build either a two-bedroom apartment or a three bed semi-detached house in Ireland currently for €260,000. So even before Ireland’s dysfunctional land market has its impact on affordability – and therefore on the volume of new construction – there is a fundamental problem in construction costs in Ireland being too high relative to our own incomes.
The formation, at last, of the new government hopefully marks the start of a new chapter in terms of housing policy in Ireland. It is widely acknowledged that, along with healthcare and possibly water charges, housing is the most pressing issue facing the new government. However, housing policy currently is dispersed across a number of departments and government organisations, including the Property Services Regulatory Authority, the Central Bank, the Housing Agency, the Department of Social Protection, the Department of Finance, the Department of the Environment, and local authorities, as well as others.
This means that no one government minister turns up at Cabinet meetings with housing consistently number one on their agenda, as happens routinely with health and education. Therefore, a new Housing Minister, or someone with similar responsibilities, could bring much-needed focus to housing policy in Ireland. And as the first item on their agenda needs to be a government sponsored audit of construction costs for the most common types of homes built in Ireland.
I would suggest this involves establishing in a transparent way the details of the costs involved in building a two-bedroom apartment, a three-bedroom semi-detached home, and four bed bungalow. This should be done not only for Ireland but also for other countries, including Northern Ireland, England, Denmark, and other economic peers. Comparisons should also be made to Ireland 10, 20 and 30 years ago, to see the impact on costs of changes in regulations and specifications.
By doing this, and by doing it in a transparent way that can be improved by industry experts or others if better evidence emerges, this will firstly create a consensus on what has been a contentious issue of the past two years, namely the level of construction costs. Perhaps more importantly, this will also identify the three, four or five policy measures that would have the greatest impact in bringing construction costs back in line with real incomes. Until this measure is taken, there will be no clarity in housing policy around supply and more importantly there will to be an increasing mismatch between the new demand for homes of all forms, including rental, and their supply.