With a building and materials cost inflation forecast of c. 4.0% through 2025 and expected labour cost increase in the range 2.5% - 3.5% in the same period I expect tender prices (for general building) to increase by up to 3.4% in 2025 based on these assumptions. This assumes that contractors hold gross margin targets of 7% given the expected level of activity in the market. With this forecast tender increase being lower than that experiences in 8 of the past 10 years it is a good time to progress projects to take advantage of current prices.

With the LDA seeking applications for over 600 cost rental apartment in January there has again been much discussion on the level at which the rent is set. The target for the rents was set at least 25% below market rates in the area. 
 
It is called cost rental because the rent is used to cover the cost of constructing the accommodation over the life of a long-term building. It has proven to be a very effective way of providing housing in many European countries and is a part of the LDA’s housing delivery mechanism. Through the Project Tosaigh initiative the LDA are currently trying to unlock stalled developments and kickstart construction through partnering with developers and make homes available as either cost rental or for purchase through a shared equity scheme.
 
While there has been recent discussion about cost rental these is less visibility on how rents are set, however, in a January Oireachtas housing committee meeting[1] there was some interaction among the witnesses and committee members on how the rent level was set and why the rent was at the level it was. The high level and unaffordability of the proposed cost rental rents  (>30% household disposable income) was highlighted by some of the attendees. 

[1]https://www.oireachtas.ie/en/debates/debate/joint_committee_on_housing_local_government_and_heritage/2024-01-23/3/accessed on 1/2/2024

There are difficulties in achieving rents below €1,000 per month given the costs associated with residential projects and the level of subsidy required to drive down the rent level under this delivery mechanism. Using the LDA Barnwell Point development in Hansfield Dublin 15 as an example this article and the attached financial model looks to illustrate how the rent is calculated based on assumptions made from publicly available sources. The subsidy or grant required to bring the monthly rent below €1,000 is also calculated. ​

​LDA Cost Hansfield Cost Rental Scheme
Having obtained planning in 2018 and being completed in late 2023 the Barnwell Point development (part of the wider Hansfield SDZ) by McGarrell Reilly involves 247 apartments over 6 blocks on a 1.5 Ha site with 272 carpark spaces. The works include the construction of 70 No. Studio & 1 bed apartments; 164 No. 2 bed apartments; 12 No. 2 bed duplex units; and 1 No. 3 apartments. With my estimate of total construction costs for the 21,447 sq m GIFA scheme at €66.8M the total development cost is €85.2M inclusive of VAT and land.

A net household income of up to €66,000 makes you eligible for the scheme. The rent is linked to the cost of the build, and will remain stable despite any market increase. Tenants will pay €1,400 per month to live in the 2-bedroom Cost Rental  homes delivered as part of this project[1]. The rent of €1,400 per month, based on the cost of delivering and maintaining the homes, is a significant reduction when compared to market rents for 2-bedroom apartments in this location (<25%) The projects have been delivered through the LDA’s Project Tosaigh initiative. The completed development will be manged by a named management agent (not the LDA).

​


Cost Drivers
The following are the costs that have to be covered when setting the cost rental rent level:

• Construction costs – The initial cost of developing the site and constructing the homes.
• Land Cost - although when provided by State usually zero.
• Maintenance costs – including planned, reactive and replacement costs for the estate and the buildings to cover wear and tear and refurbishment costs. This will rise usually in line with CPI inflation.
• Administration and General – the costs associated with running the rental units including insurance costs, salaries, taxes, marketing, accounting etc. This will rise usually in line with CPI inflation
• Cost of renewal - Periodic major replacement of elements such as roof coverings, windows, lifts, kitchens & white goods, electrical systems, boilers etc. which have reached the end of their useful life. This will rise usually in line with expected construction cost inflation.
• ​Finance Cost – cost associated with any loans used to fund construction of the homes. 

Residual Value at End of Analysis Period
The apartments are owned at the end of the assumed 40 year period and thus they have a residual value beyond the analysis period - this can be based on the market value at that time (using an appropriate terminal cap rate) or the rebuilding cost at that time (using an appropriate average construction inflation estimate). 

Discount Rate
The projects discount rate is the rate of return used to discount future cashflows back to their present value (PV). This rate is often an organisation’s weighted average cost of capital, required rate of return, or the hurdle rate expected relative to the risk of an investment. In Ireland the NDFA publishes recommended project specific discount rates. An approximation can be made by using a long term building loan.
 
The model (bit.ly/KeoghCostRental) calculates the present value of each individual cash flow (rental income or expense) as a growing annuity – a series of future periodic payments that grow at a proportionate rate. Final year values and costs are calculated by inflating incomes and costs using the assumed growth rates – these values and costs are then discounted to the present value using the discount rate. 

[1] The average rent across the development is calculated to be €1,347 p.c.m. with a total estimated gross income of €123,456 p.a.

One thing that is given minimal consideration is the fact that these analyses typically consider development on a standalone site - not the reality of development of multiple small, medium and large sites in parallel with differing risk profiles.

Decision makers need to have a range of tools and methodologies available to decide which projects to prioritise, particularly when making strategic investment decisions on multibillion-euro capital projects and programmes.
 
Recently in Ireland there has been much discussion on capital budgeting, cost benefit analysis, the risks inherent in long term projects and how best to put a plan in place to identify and manage these risks. When significant cost increases occur in projects with a knock-on impact of curtailing funding for other approved projects, or during an annual capital budgeting process with differing project classes competing for scarce capital, you need to be able to prioritise projects. This paper illustrates an approach to prioritisation.
 
With high stakes and sometimes political pressure, elaborate financial and economic models are prepared to justify potential projects. But when it comes down to the final decision, especially when hard choices need to be made among multiple opportunities, less rigorous assessment means are dusted down - arbitrarily discounting estimates of expected returns or economic benefit, for example, or applying overly broad risk premiums.
 
There are more transparent ways to bring assessments of risk into investment decisions. In particular, some analytical tools commonly employed in capital-intensive industries can be applied, such as those investing in projects with long lead times or those investing in shorter-term projects that depend on the economic cycle. The result can be a more informed, data-driven discussion on a range of possible outcomes. Of course, even these tools are subject to assumptions that can be speculative. But the insights they provide can still produce a more structured approach to making decisions and a better dialogue about trade-offs.
 
A simple residential real estate investment project is presented as a case study of using the approach which could be used for example by a development company when deciding how best to allocate investment over a portfolio of residential, commercial, retail and industrial project opportunities.
 
The real power of using these tools comes from using them systematically, however, leading to better decisions from a more informed starting point: a standard model for projects; a fact-based depiction of how much an organisation’s current performance is at risk; a consistent assessment of each project’s risks and returns; how those projects compare; and how current and potential projects can be best combined into a single portfolio.
 
Should you wish you find out more about this methodology or how Keogh Consulting can assist in assessment of your project portfolio please contact us at [email protected]

With news that proposals are going to Cabinet in the coming weeks to mandate builders to provide 10% of new developments to local authorities as social homes, and a further 10% as affordable housing the impact will be to increase price of homes for private purchasers (as required return on a project would then have to be achieved from selling a smaller number of units for sale to private purchasers). The scale of impact will vary but for a typical standard 2 bed apartment in an SHD type development this could add €9.5k (+2%) to the required sale price (with the average cost for a LA to purchase a 2-bed unit in such a development being €360.4k). For a 3-bed house the required price will increase from €338k to €346k (+2.5%).