Cost Rental - The Workings Behind Setting A Cost Rental Price. Part 1

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:

1. Construction costs – The initial cost of developing the site and constructing the homes.
2. Land Cost - although when provided by State usually zero.
3. 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.
4. 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
5. 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.
6. Finance Cost – cost associated with any loans used to fund construction of the homes. 

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. 

Estimate of Additional Subsidy Required For Affordable Rent on Enniskerry Pilot

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.