Thursday 22 February 2018

Cost of building homes needs to come down

‘There is nothing odd about no one building if the price they’d
get is less than their costs’. Photo: Jason Alden/Bloomberg
‘There is nothing odd about no one building if the price they’d get is less than their costs’. Photo: Jason Alden/Bloomberg

Ronan Lyons

As we inch closer to a new government taking office, there is broad agreement that housing will be close to top of the agenda for the new cabinet and that the main issue is a lack of supply. But there is no clear consensus yet on what steps the new cabinet, and any new senior minister for housing, might take. I believe that there are four main areas for housing policy.

Last week's column looked at one area, policy in relation to mortgages. Capping mortgages is all about putting sustainable limits on what people can borrow and thus about ensuring that demand is, in plain language, reasonable. We know to our cost as a society what happens when people are given access to too much credit.

This week, I'd like to focus on the cost of construction as currently the single biggest barrier to housing supply and thus to resolving the current shortage of housing. An ESRI report out this week suggested, somewhat bizarrely, that the lack of new building at a time of rising prices and rents flies in the face of economic theory. This would be true if construction was free, but once you take account of costs, there is nothing at all odd about no one building if the price they would get is less than the costs they would incur.

Once you cap mortgages, you have effectively capped house prices. Therefore, for new supply to be built, the cost must be less than whatever level of house prices is deemed sustainable. In other words, if the Central Bank is capping house prices, we need someone to at least be monitoring and ideally capping construction costs too.

The problem currently is that those most likely to make the point that costs are too high are those least likely to be believed by the wider public - for example, developers, builders and estate agents. The public has learned the hard way that insider analysis and expert advice are not the same thing.

The best figures I can find suggest that the cost of building a two-bedroom apartment in Ireland currently is roughly €280,000. This figure excludes any land costs but includes VAT, local authority levies and a 12.5pc profit margin. This up-front cost, though, means little until we convert it into monthly figures and therefore bring it into the real economy.

Assuming that the ultimate landlord would like a rental income of 5pc a year, this up-front cost of €280,000 converts into a monthly rent of €1,400. Bearing in mind that this excludes land, a realistic actual monthly rent for a newly built two-bedroom apartment is probably closer to €1,800.

The average rent for a two-bedroom apartment in Dublin currently is €1,300 and in only two parts of the city - Dublin 2 and Dublin 4 - is it above €1,600. Unsurprisingly, any apartment building that is taking place currently is concentrated in these areas.

And these costs do not vary significantly around the country, so the problem is much worse when you look at Ireland's other major cities. Rents for two-bedroom apartments in Cork currently average €825, while in Waterford, they are just €550.

You could ban profit, scrap VAT and decree that all land is free - but economic theory and common sense suggest that you should not expect to see any new apartments being built in the vast majority of the country.

But, you may ask, where did I get my figures from? They result from my interaction with investors, developers, quantity surveyors, architects and estate agents - but ultimately we should not be working in a vacuum where we have to rely on indicative figures like mine.

We need official figures that all parties largely agree on, rather than squabbles between industry practitioners and vested interest. If we want the Government to take meaningful action on increasing housing supply, we need it to take meaningful action to reduce the cost of building, so that it comes back in line with our own incomes and that requires figures on what costs how much.

Fortunately, the National Competitiveness Council - an agency focused on the externally trading sector and with a track record of solid statistical analysis - has committed to benchmarking construction costs in Ireland to costs in our economic peers. If their study opens up the innards of build costs, this will effectively form an action plan: where does Ireland stick out, relative to other countries, and why?

One argument you often hear against lowering costs is that these may just result in more profits, not lower rents. There is no empirical evidence to back this up; all the evidence from Ireland and elsewhere is that if you build more homes, prices and rents fall. But perhaps the obvious drawback to this argument is simpler: nothing is being built currently, so there is nothing to profit from.

More importantly, this argument completely misunderstands how modern developers - such as the REITs, Hines and Kennedy Wilson - operate. They look at construction costs and then add in a percentage profit margin on top and see how that compares to prevailing rents.

With profits in percentage terms, lower costs actually mean lower euro profits per home, the compensation for developers being that they build a greater number.

With mortgages and house prices capped, we need construction costs to be capped also, so that there are no barriers to building all the new homes that Ireland needs each year. That will suffice for many - but not for all. In next week's column, I will explain how I think we can ensure a social housing system that guarantees a right to housing for all.

Ronan Lyons is Assistant Professor of Economics at Trinity College Dublin and author of the Daft.ie reports.

Sunday Independent

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