Why placing priority on building smaller homes is misguided
Published 27/04/2016 | 02:30
Political stability will require the incoming government to seek cross-party understanding on key issues, including housing. This creates the opportunity for a coordinated approach to policy, but there are also risks, as attempting to please everyone could result in a mishmash. Moreover, hasty decisions could make things worse.
Ireland's housing supply is fixed in the short term. We have too few developers, and finance is scarce. This won't change overnight, so housing output will continue to undershoot in the medium term.
In these circumstances, subsidising buyers or renters can only cause inflation - giving people more money to compete for the same number of properties inevitably drives up prices.
Also, attempts to assist particular household types would almost certainly disadvantage others. For example, a help-to-buy scheme would enable first-time buyers to pay more. But, with fixed supply, this would crowd-out investors, driving up rents. Conversely, tenant-focused measures like tax relief on rental payments would benefit investors, at the expense of owner-occupiers.
With demand-side interventions likely to be counterproductive, policy must focus on supply. Private developers require a 10pc to 15pc profit to make housebuilding attractive, relative to alternative uses of their time and money. In many locations, this margin currently does not exist after costs like land, materials, labour, finance and VAT have been subtracted from achievable sales prices.
This can only be resolved in two ways - higher prices or lower costs. The latest CSO figures confirm that house prices are continuing to increase at around 7.4pc per annum. With demand outstripping supply, prices will rise if we do nothing. Development will follow, but only at prices that are problematic for society. Therefore, we must cut costs.
A popular suggestion is to do this by building smaller units. This is deeply misguided. The number of twentysomethings - singles and couples who might want smaller units - has collapsed by 33pc since 2008. In contrast, the numbers of children and 30-49-year-olds have risen by 9pc and 7pc respectively. These cohorts need bigger dwellings because they cohabit in families. The focus should therefore be on delivering larger family homes.
Another suggestion is to cut VAT on new homes. This would directly reduce costs, making marginal schemes viable. However, there are three common arguments against this. Firstly, the emotional argument that VAT reductions just feed developers' profits. This is true, but if tight margins are preventing development, increased profits are surely part of the solution.
Secondly, the ideological argument that cutting VAT transfers public money to private developers. Perhaps, but with dormant construction, VAT receipts from housebuilding are currently negligible. The exchequer would gain from greater activity.
Finally, there is the argument that VAT reductions would inflate land values. When acquiring sites, developers pay what remains after all other costs, including the required profit margin, have been deducted from expected revenues from sales. If a scheme was already viable, cutting VAT would create 'supernormal' profits.
Under competitive conditions, developers would flood in and bidding for sites would drive up land values. Costs would not fall - lower VAT would be offset by dearer sites.
But it wouldn't play out like this in today's context. Firstly, VAT cuts will only stimulate competition for sites once margins exceed the 10pc-15pc target. Many schemes are currently generating less than this and, until that level is reached, VAT reductions would flow into restoring margins.
Secondly, the development industry is currently not that competitive. Until more players are able to chase sites, VAT cuts will benefit developers rather than landowners.
Over the next two years many projects will become viable and new developers will emerge to make the industry more competitive. At that stage VAT reductions would only enrich landowners. Until then, however, temporary VAT cuts would help to kick-start housing supply.
Dr John McCartney is Director of Research at Savills