Impact of New Homes VAT reduction and Increase in Income Loan Multiplier on Housing Affordability

Comments by Taoiseach Leo Varadkar at the McGill summer school[1]regarding the prospect of the Central Bank changing rules on mortgage lending has again brought into focus the impact of the lending rules on the affordability of housing and the viability of constructing housing at this price point. 
 
Given, as Mr Varadkar noted ,there are “a lot of people who are now paying more in rent than they would pay for their mortgage” with “many people stuck in a rent trap” – it would seem that some change in the Central Bank rules or level of VAT charged on new home sales might assist affordability of house purchase. In addition, with the upcoming expiration of the help-to-buy scheme (31/12/2019) questions are being asked whether it will continue given its positive impact on housing affordability.
 
Keogh Consulting have examined current affordability levels and calculated what value of loan a typical FTB can obtain and how much they can possibly save to accumulate a deposit. Given these estimates an affordability level for each household income level was calculated based on the household income distribution published by Ireland’s CSO – i.e. the price target that must be met by a housebuilder to enable a purchaser with a given income level buy a home.
 
We then examined the current makeup of the components of sales price of houses and apartments in Q3 2019 to discuss the feasibility of constructing homes for this market given the estimated affordability limits (updating previous work). The impact of increasing the CB loan income multipliers and reducing the level of VAT charged on the sale of new homes on overall affordability and viability of development was estimated for house and apartment developments. A comparison is then made of the cost of a 30-year mortgage v monthly rental payments to examine whether the monthly housing cost can be reduced below average rental levels for similar properties.
 
The analysis determined (full report downloadable here) the following:

• With a 4.5x income multiplier and a 3.0% VAT rate a loan costing €1,192 per month[2]could be obtained to  purchase a viable 3 bed house by the average Irish household (income €66,860). This would be below the average Irish rent of €1,366 per month & would improve monthly housing cost and give ownership at the end of a mortgage period.
• A price target of between €230K and €395K must be achieved to allow households earning between the 60th and the 80th percentile of the national household income distribution purchase a home.
• It is critical that developers understand income levels in their target catchment area to ensure sufficient demand exists for their developments at a given price point whether selling or renting.
• A mid-range 2-bed 75 sq m apartment is currently estimated to cost €460,000 to deliver. To achieve this price apartment site cost must not exceed €50,000 per unit. This delivery cost has increased by 9.1% since Q1 2018 on account of construction cost increases.
• At a this price level (€460K) the financial viability of apartment development is difficult and there is significant risk in starting projects for a developer – cost control is key in constructing for this segment of the housing market.
• A 3 bed semi-detached house is currently estimated to cost €364,000 to deliver. To achieve this price average site cost must not exceed €50,000 per unit. This delivery cost has increased by 5.7% since Q1 2018 on account of construction cost increases.
• Calculations indicate that at household income levels below €70,000 it may now take over 4 years to save to purchase a 1,100 sq ft house costing €364,000.
• Cost inflation is outpacing income growth and this is making affordability more difficult.
• At the bottom of the household income distribution curve it is difficult to deliver given the cost structure of delivery. There are c 1.1M households below the viability threshold – there is a market failure to serve this segment and other measures will have to be taken to provide housing for this segment.. 
• A reduction in VAT alone will not make housing affordable for households with income below €78K .
• An increase in the CB income multiplier will not make housing affordable for households with income below €69K
• At average Ireland household income levels  a reduction in VAT below 4.5% and an increase in the CB income multiplier of above 4.0x will make a viable 3 bed house affordable for the average Irish household. This combined measure could bring an estimated additional 218K households into the affordability net.
• At the 80thpercentile income level, €87,585, a VAT rate of 4.5% and a CB income multiplier of 3.9x will make a viable apartment affordable for a household. 

Thus, through a combination of a decrease in the VAT rate on new homes and an increase in the CB income multiplier an improvement in affordability could be achieved for differing accommodation types. These measures could partly offset some of the decreases in affordability being experienced on account of the increase in cost of delivery outpacing household income growth. 
 
The economic benefit of future ownership versus the cost of the VAT reduction to exchequer should be evaluated in support of this measure to improve current housing affordability.

[1]Irish Times, July 27th, 2019.
[2]Loan 30 years, 2.75% interest p.a. 1 year of saving.