This article is from our October 2022 edition of MarketWatch.
30th November, 2022
With the cost-of-living crisis continuing to feature in headlines, and the resulting giveaway budget in Ireland, the key topics dominating conversation domestically continue to be energy, inflation, and the dreaded possibility of a recession. The outlook is even worse for any companies with UK exposure, with some earnings forecast to fall for Irish stocks with significant UK exposure going into 2023.
However, amid all this turmoil, one focus that has remained unchanged is the Irish love affair with property. Regardless of what happens in an uncertain world outside, the thinking goes, if you own your home at least you have some security. In this regard, one must have empathy with the younger generation of renters and would-be buyers in Ireland. Buying a house has never been an easy process, but it has now become so difficult that the average age for a first time buyer in Ireland is now 34 years old. It’s no wonder when average rents in Ireland stand at a whopping €1,460 a month, and an even more eye watering €2,260 a month for houses in Dublin. This makes the 10% deposit requirement to purchase a property a very difficult hurdle without the “bank of mum and dad” featuring heavily. Is there light at the end of the tunnel, or are we likely to see a reversion to the tried and tested solution in Ireland – mass emigration from frustrated generations?
From the viewpoint of a would-be first time buyer, one of the most frustrating aspects has to be that it’s actually cheaper to buy than rent – if you can scale the deposit hurdle and then be lucky enough to find a property that’s within budget (a separate debate). Current "macro-prudential" lending rules in Ireland are for banks to lend a peak 3.5x salary as a mortgage. Assuming that a first time buyer manages to find a home valued at €375,000, has €7,500 deposit saved and takes advantage of both the government’s "First Home Shared Equity" and "Help to Buy" scheme, that requires a salary of €75,000 per annum to be able to buy (or €96,500 if availing only the "Help to Buy" scheme alone)*. In repayment terms, that equates to a repayment rate of €1,044 per month on a thirty year mortgage if using both First Home and Help to Buy; or €1,438 if using only the Help to Buy Scheme based on a mortgage interest rate of 2.55%.* This is clearly much more attractive than the aforementioned current crippling rents. What could arguably help is if strict lending limits were to widen, and indeed macro-prudential lending rules are currently "under review", with results expected to be published in Q4. However, indications so far are that the 3.5x loan to income rule is likely to remain unchanged.
From a listed equity perspective, a number of topics have consistently raised their head with regards to the property market. We all know the statistics – Ireland has a supply-demand imbalance, and a widely accepted need for c. 45,000-50,000 houses to be built every year based upon demographic trends. However, despite the government recognising the clear need for housing in its Economic Budgets and its "Housing for All" scheme, the number of houses built continue to be well below the demand levels.
So what’s the hold up and is it going to improve? Well, there are a number of issues currently. Firstly, the planning permission system in Ireland appears to be dysfunctional, with many projects taking years in the planning process. Another issue is rising costs. Whilst the listed housebuilders in Ireland are talking about significant cost inflation rises of between 7-9% this year, the larger housebuilders actually benefit from economies of scale. In fact, the "real" cost rises for the smaller housebuilders are possibly much higher – up to 15% year-on-year in some cases. As a result, it would seem that some of the smaller developers appear to be struggling currently. Furthermore, with interest rates rising, the knock on effect is the price of bank lending also rises, which again hits the smaller developers hard. In particular, the cost required to fund apartments is challenging, from both a cost of financing perspective and also length of time in the planning process.
As with other industries, supply chains are also an issue in construction currently. This can lead to delays, with some products particularly impacted by gas supply, such as bricks, sanitary ware and aluminium products. At the time of writing, there have been some tentative signs of improvement in commodity prices, which will hopefully feed into a reduction in costs going forward. Nonetheless, material prices and availability are likely to remain issues impacting construction over the winter months. However, one bright spot in Ireland at least is the availability of labour. In this instance, the UK’s loss is our gain as UK labourers are re-locating to Ireland.
Overall, the tough situation surrounding the supply of housing seems set to remain difficult for the foreseeable future. This could improve if we were to see a resolution to the Ukraine war. We recently interviewed an industry expert to find out some more of the challenges and opportunities for the sector. This month, we spoke with Margaret Sweeney, the CEO of I-RES (Irish Residential Properties REIT Plc), which is Ireland’s leading provider of private residential rental accommodation, to ask her current views on the Irish property market.
Our highlights from the interview are below:
1. Margaret, for those readers that may not be familiar with a ‘REIT’ structure, can you tell us a little bit about them?
"REITs", or Real Estate Investment Trusts, have been around for over 20 years, and since 2014 in Ireland. The REIT structure is a very common model for real estate funding across Europe and is a feature of nearly every mature property market across the region. Typically, REITS are more liquid than direct property investments as shares can be bought and sold via a stock exchange. I-RES is focused on residential housing but REITs can also be focused on other types of property such as offices, hotels, warehousing, etc. REITs are also obliged to distribute 85% of profits as dividends to shareholders via a twice-yearly payment.
2. Interest rates and inflation worries continue to dominate the headlines in Ireland. How do these pressures impact I-RES?
Energy and other costs are certainly rising, with some cost increases in the construction of buildings particularly notable. However, I-RES has invested in new technology in its business which can help the company to navigate cost pressures. In addition, from a value perspective I-RES still represents good value for tenants, with average rents still 10-12% below market currently. Energy is a particular focus area for us at the moment. We are fortunate to have quite a young portfolio, almost all BER A-C rated. As part of our ESG commitment, we work closely with residents to reduce our usage and impact, and this is particularly important in the context of energy prices.
3. Can you tell us a bit about the Private Rented Sector (PRS) supply and demand fundamentals in Ireland currently?
Ireland is currently experiencing a huge lack of supply in the private rented market, and demographic trends would imply this structural imbalance will continue into the future. Population projections for Ireland suggest that by 2040, there will be an additional one million people in Ireland, all needing accommodation. Whilst estimates suggest that Ireland needs up to 50,000 new homes every year, only circa 16 20,000 homes are being built currently and this situation is unlikely to improve soon. Another demographic trend is people renting for longer and buying first homes later in life. The average age of a first time buyer in Ireland is now 34 years old, compared to older generations, where first properties were often bought as young as 25. An imbalance exists in the conversation around commercial landlords in Ireland - however the reality is that the current rental market is made-up of 93% private landlords and just 7% of commercial or corporate landlords, who fund and manage many homes that otherwise might not be in the current housing stock. However, there are a number of smaller landlords exiting the market due to current unfavourable conditions.
4. How is the legislation surrounding rent caps affecting the market?
Rent caps were introduced in Ireland in 2017/2018, with the initial cap being a maximum 4% annual increase in rents, with the figure subsequently being reviewed in July 2021 to be indexed in line with the harmonized index of consumer prices (HICP). Since then, the Government has capped the rent cap increase at a 2% maximum. Rent cap regulation is a blunt structure that has hindered supply and created numerous ‘stranded assets’ in Ireland. More broad-reaching rent regulation in other jurisdictions has been more successful in ensuring balance across a range of different objectives.
5. ESG, or Environment, Social and Governance investing, is presenting a number of opportunities and challenges for companies at the moment. Can you tell us about these in an I-RES context?
There are a lot of opportunities as a listed company from having a strong ESG rating. For example, bank debt rates are increasingly linked to ESG credentials, which can benefit relatively strong ESG performers. I-RES itself has particularly strong credentials in diversity and inclusion (considered a ‘G’ , or Governance factor), and also has high integration with local communities (an ‘S’ – or Social factor). We were recognised at European level last year with a ‘Best Practice Leader’ in the European Women on Boards Index. However, for the property sector generally, requirements pertaining to the Environmental piece can be more challenging. Lots of capital investment is needed to bring older buildings up to higher energy efficiency standards. However, it’s fair to say some governments could do more by recognising the additional expenses that this capital investment requires.
6. What do you expect Ireland’s PRS market to look like into 2023?
As touched on earlier, supply is a huge challenge in Ireland. For large scale apartment developments, this is particularly pronounced currently as with costs rising it is extremely difficult to price the likely cost of a future development. Lengthy and difficult planning permission processes (which can be up to 6 years) and detailed design specifications from the outset add significant complexity to scale developments. Furthermore, rising interest rates add to uncertainty over borrowing costs.
Warning: Forecasts are not a reliable indicator of future performance.
Warning: The opinions expressed in this interview are the views of the interviewee and do not reflect the views and opinions of Davy.