Cost rental is effectively affordable, high-quality rental accommodation, provided by the State or local authorities. 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 loan. This enables government and local authorities to plan affordable housing in the long term, and to continue to build new housing even during a downturn. It has proven to be a very effective way of providing housing in many European countries and has been name checked by the new Minister for Housing as being a proposed delivery mechanism. While there has been much discussion about cost rental in the past 18 months these is less visibility on how rents are set. The high level and unaffordability of the proposed cost rental rents (>30% household disposable income) has been noted by a range of commentators. There are difficulties in achieving rents below €1,000 per month given the costs associated with the projects. This article and the attached financial model (link here) 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. Enniskerry Pilot Cost Rental Scheme Due for completion in 2021 the State’s first cost rental scheme will provide rental accommodation at Enniskerry Road at below market costs. The works include the construction of 155 dwellings, consisting of 30 No. 1 bed apartments; 77 No. 2 bed apartments; 18 No. 2 bed duplex units; 4 No. 2 bed houses; and 26 No. 3 bed houses. Total costs for the scheme are noted to be between €53 – 54M after a construction tender was agreed for €45M inclusive of VAT. Part of a mixed tenure scheme 105 of these apartments will be used to provide social housing, and 50 will be rented to low- and middle income workers at prices up to 30% below market rents for the area. Workers earning up to €50,000 and €75,000, as a couple would be 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 €1,200 per month to live in the 2-bedroom Cost Rental homes delivered as part of this project. The rent of €1,200 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. Funding was provided with an EIB loan via the Housing Finance Agency over a 40 years loan term. Grant funding of €4M was provided via the services site fund towards costs associated with site infrastructure development - this subsidy to the project was required in order to bring the targeted rent level to close to €1,200 per month. The completed development will be manged by Respond & Tuath Housing Associations. Cost Drivers The following are the costs that have to be covered when setting a cost rental rent level:
Residual Value at End of Analysis Period The unit has 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 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. Additional Subsidy or Grant Estimation The model allows a user to determine the additional subsidy or grant required to hit a target rental level. Due to the cost structure of apartment construction significant additional subsidy is required to lower the monthly rental cost to below €1,000. Final Note
All models are wrong, but some are useful - I hope that this is a useful model for users. a) No doubt some will question the assumptions made - I have looked to base them on sensible ranges and publicly available information regarding cost rental schemes. b) The modelling mechanisms - I have looked to have the financial modelling reflect (in a simplified manner) what happens in a property development project. The breakeven cost rental rent is very sensitive to the assumptions made - it would be a good outcome for me to be totally corrected so that I can change either assumptions or modelling mechanism to that which closer reflects reality - please drop an email if so.
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Ireland is currently in the middle of the COVID-19 crisis with significant economic and health impact throughout the island. The Irish Government have looked to shield the economy and have put in place stay at home measures. Construction had been stopped in Ireland up to 18th May with sites starting to reopen last week. An economic contraction is forecast with the IMF[1] forecasting a contraction of -7.5% in real GDP in the Euro Area (v -4.5% in global financial crisis 2009) for 2020. The ESRI[2] have forecast a contraction of -7.1% in GDP with a 12 week shutdown. Hopefully this contraction may reverse when the stay at home policy is reversed on a phased basis, however, it is possible that it may take until early 2022 until GDP in Ireland recovers to current levels.
This crisis will a) shift the demand curve for housing (given reduced household incomes), b) reduce the supply of housing (given reduced housing output) and c) increase cost of delivery (given increase in programme related costs, reduced productivity and delay in sales and completions). This paper (download full paper here) looks at the impact of these changes. With the current housing supply deficit demand for housing will remain after the COVID-19 crisis with a mix of tenure types required in the market – however, the affordable price point for purchase will change, at least in the medium term, with viability of development issues given that pool of able purchasers may have shrunk. Housing demand - In 2020 & 2021 our forecasts indicate that there may be a change in overall demand due to migration changes on account of COVID-19. With no emigration or immigration due to global travel restrictions, we estimate a net migration decrease on account of these restrictions from 34k to c17k. This forecast indicates that overall demand for housing may fall to below 25,000 in 2020 & 2021 before rising again in 2022 to above 30,000 as hopefully migration flows resume. This demand will be made up of a range of tenure types. Housing supply – Covid-19 has halted construction activity in Ireland since the beginning of March. A phased restart of construction activities on sites has commenced since 18th May. Reduced completions will create further supply difficulties in the housing market and increase the housing supply deficit. We estimate the reduced construction output could increase housing supply deficit by 21k units in period to 2022. Construction Industry Economic Output - With the reduced number of completions a reduction in residential construction output of €4.6bn in 2020 & €3.8bn in 2021 is forecast – this will have significant impact on employment, GNP & exchequer returns. The exact impact on construction costs is unclear at present – the cost of site safety measures and programme extensions will have to be recovered of profitability will be impacted. Housing Prices – On account of the COVID-19 lockdown there have been little or no transactions in the market since early March[3]. The impact on home prices is unclear but will depend on a number of factors including speed of recovery, unemployment, average incomes and global economic trends including FDI landscape moving forward. This will make affordability more difficult with a lowering of the number of potential purchasers for new homes (with consequent increase in demand for other tenure types). Gross Household Incomes – Given current economic conditions it is likely that income levels will at best stay flat and in all lilklihood decrease through 2020. Banks probable unwillingness to advance loans to potential purchasers on reduced incomes on account of temporary COVID-19 measures will stop transactions, make affordability for potential purchasers (particularly those workers in high-contact sectors) more difficult and reduce demand for housing at current price levels. Impact on FTB Numbers – Our calculations indicate that at the economically viable house delivery price of €325k there may be potentially 12.5% less households able to purchase over pre Covid period (approximately 225k households may have fallen out of the affordability net[4]). Affordability – Based on uplifted CSO13 household income data adjusted for Covid-19 impact:
Could offsetting VAT payments for a purchaser help – Some commentators have suggested that payment of VAT over an extended period could help affordability. We have analysed such a scheme – implementation of such a scheme would lower the upfront cost of purchasing a home by transferring some of the risk from a funder to the State and allow a household with lower gross income purchase a home. However, it would increase the monthly housing cost for a household – the same impact could be achieved with an increase in LTI multiplier of 4.0x and result in a €180 per month saving over the cost of illustrated VAT offset scheme. Shared equity scheme – A specific and targeted state shared equity scheme could help lower barriers to home ownership for households and mitigate affordability challenges facilitating prospective buyers with average household incomes to get a foothold on the property ladder. Careful consideration would have to be given to the design of the scheme to ensure fairness, transparency, effectiveness and affordability while making sure that it takes account of Central Bank macro prudential rules. A household with a €60k income would save €3,080 per annum over annual average rental cost for a 2 bed townhouse with a combination of 30.4% shared equity loan and a standard mortgage for the remainder. Filling the Housing Supply Gap – With exchequer receipts generated on account of construction of an apartment estimated to amount to €134k per unit (house €99k per unit) – assuming a 130% shadow cost of government funding would imply that a stimulus programme costing up to €103k per apartment (house €76k per unit) would have a cost benefit ratio of 1. With full employment and a deficit of construction capacity such a measure may have had negligible stimulus impact up to now and perhaps resulted in price increases. However, given that the current crisis has reduced manning levels of construction sites and consequently employment, there may be spare construction capacity that could be put to use on opening sites that up to now were not viable but with a stimulus could become economically viable – getting homes that otherwise would not be built, built! Conclusion Housing developers need to have an understanding of prospective purchasers affordability levels and how the current crisis may have impacted their ability to purchase a new home. Now is a time to reappraise and stress test projects under differing scenarios regarding input costs and achievable price targets to determine their vulnerability. Priority should be given to those with highest risk adjusted returns and where possible these projects should be progressed through preliminary design, planning, procurement to get to a shovel ready state. This understanding of delivery costs, affordability levels of potential purchasers and number at each price point is key in prioritising projects and may allow more sites to open and excess construction capacity to be used to progress construction projects – this paper looks to examine these questions. Assuming demand for housing holds, albeit at a different price point, there will be an ongoing need for residential developers to contract with main contractors and a range of sub contractors in their supply chains in the future. Thus, while activity on sites is ramping up or paused, it is imperative to retain two way relationships between developers and their supply chain given current exposure to significant risks on all sides. Given new site measures that must be in place a focus should be made on improved workflow and coordination of activites on sites to minimise productivity reductions and indeed capture productivity opportunities. Collaboration is key and working together the future can be planned to minimise impact on profitability throughout the housing supply chain through formulating the most appropriate mitigation strategy for effective delivery,. Finally, given market failure to provide the number and mix of housing types required on account of economic viability issues, the State needs to consider the best way to provide stimulus to encourage construction of houses and ensure that the impact on housing supply during the current crisis can be minimised. Direct stimulus (e.g. through VAT reduction) or measures such as shared equity schemes may be part of the solution. [1] https://blogs.imf.org/2020/04/14/the-great-lockdown-worst-economic-downturn-since-the-great-depression/ [2] Source: ESRI April 2020 [3] Source: Irish Times. 3rd April, 2020. “Housing market grinds to a halt as Covid-19 crisis takes hold”. [4] This is the Total Addressable Market – the number of potential purchasers will be lower of course. Covid-19 has halted construction activity. A phased restart of construction activities on sites will commence at the end of May. There are a number of issues:
Our report (download here) draws the following conclusions:
Affordability issues in the housing market are resulting in increasing numbers renting. This situation is exerting upward pressure on rents and now creating rental affordability issues. This raises the questions is it more affordable to buy than rent and what is an affordable rent for households?
Given the continued increase in rental costs, a current slowdown in the rate of housing price increase[1] raises the attractiveness of ownership over rental. Determining is it really cheaper to buy than rent is important for the State when looking to create solutions to address current housing provision issues, and, for developers when determining the target market and price level for their housing product? Our study (download here) calculates estimated median household income levels in each county in Ireland[2] and determines the proportion of household income available for housing costs. The proportion of household income available towards housing costs is then compared to average rents in each county to determine the affordability of renting in that county. This analysis highlights that:
From the CSO property price register (and in particular first-time buyer house price data) the cost of a 30-year mortgage to buy a median FTB home is calculated for each county. This cost is then compared with average rental cost in that County. This element of our analysis highlights that:
Given (for the seventh month in a row) the number of homeless people in Ireland exceeds 10,000, a sustainable level of housing supply needs to be provided with significant acceleration in construction required to rapidly increase housing numbers, more readily meet demand, reduce rental costs and bring down homeless numbers. The issues around housing provision and housing affordability are complex and affect every family but none more so that the vulnerable people in our society – a functioning rental market needs to be in place with a range of options provided by state and private sector available for families. Options that need to be considered include a structured cost rental model using low cost loans, increased rent supplements and housing assistance payment rates in line with market rent. At the same time a balance needs to be made between the Central Bank’s safeguarding of financial stability and the ability of households to get loans costing less than current rental cost to purchase affordable homes. [1] Source: https://www.daft.ie/report/2019-Q3-houseprice-daftreport.pdf [2] Source: Keogh Consulting calculations from 2017 SILC data |
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