Social housing as an investment

When you get past the ideological mobs that crowd commentary on the housing crisis, there is a pressing need to bring 50,000 products to market readiness over three years. Even when Ireland experienced external shocks, as we did during the Global Financial Crisis (GFC), housing demand didn’t go away and fresh future shocks, while elevating risks and reducing rents, are unlikely to be of a scale that extinguishes the housing crisis or removes the pressing need for affordable homes.

Visualise the Aviva Stadium full to the rafters, now picture each seat as a house or an apartment. That is the scale of the task, one in five of these units is to be sourced from the private market which means that, in many cases, the standard of the house or apartment has to be raised, to comply with the specifications required by local councils and housing agencies to meet the benchmark for social housing. This ought to create a thriving secondary market for a limited stock of 10,000 social housing units which is the government target, where investors seek income protected from inflation for the unexpired portion of the long-term leases, buying from early investors who want to sell.

Picture this… the Aviva Stadium full of Social Housing Units

What we are seeing appears to be a radical reframing of Irish home living, closer to continental models and away from the notion that everyone owns their own home. Arguments about affordable homeownership run aground on hard economics: Who will foot the bill to make all private housing affordable? By how much would property prices have to collapse to do so? At what collateral costs and which new rules would the Central Bank have to impose on lenders to stop prices escalating?

Is the answer to nationalise all housing, passing construction, maintenance and controls to the state? Last year, I put this question to a socialist gathering at which no one was paying tax at the top rate. Last year, I asked by how much would Irish property prices have to collapse to get to nirvana where starter homes (for example in Kinsale, Dalkey, Castleconnell and Salthill) would be selling for under five times average wages? The response was a mantra about rights to housing, just like water and education but provided someone else pays for them.

The Swedish example

In Stockholm, where there are rigid rent controls for years, there is still a housing crisis. It takes between nine and 20 years to get an apartment and there is a black market in subletting to get around the elevated rent control costs. It isn’t the only example of clumsy attempts to reboot failed property markets in the din of ideological clashes and demonisation of opposing views, so whether you are labelled a value investor or a vulture is part of that theatre and quite removed from the reality of behavioural economics on the ground. It’s a fairy tale to think that the state can rigidly control the housing market which brings us to hard reality, Ireland needs to ramp up supply fast, right across the market mix, the base of which is social housing.

Make no mistake, there is a new and reformed social housing market about to take off which its own characteristics and its own risks. This will be evident when all local councils catch up with the pioneers, those local councils already more advanced, better organised and responding at speed to early investors.

Now available are 25-year, government-supported leases, many of which produce net yields after all costs averaging 5.0% p.a. and linked to Irish inflation (HICP), decoupled from the private rental market.

This not to be confused with gross rental yields before vacancy costs, turnover costs, advertising and maintenance costs bite and where rents are exposed to rent deflationary risks.

The scramble to get into the social housing market will be joined by funds, private investors, self-administered pension schemes and other specialist players. You can shortly expect your local real estate agent or financial broker to call to tell you how once the pariah is now the blushing bride, so how might this play out and what are the pitfalls?

Elusive lower risk high yields, linked to Irish (HICP) inflation

Worldwide, high long-term yields are a species facing extinction in this climate, ever since the glut in capital creation from a decade of extreme monetary policies, hunted down cheap assets and crushed yields nearly everywhere. Property markets in many parts of the world, Australia, Canada, Sweden are already looking very overheated and many parts of the Irish market, a laggard until a few years ago, are at pre-crisis peaks. The underlying issue is a structural problem in the global financial system, too much debt and not enough economic growth to sustain it without creating ever larger bubbles.

The tiny yields on deposits, Government bonds, dividends from PLCs and coupons from corporate bonds means that digging out good yields cannot be done without greatly increased risk, for example, by straying into the dark waters of the junk bond market or into shadow banking. But still the demand for yield remains sky high, the problem is how to get high yield at lowest risk?

25-year leases, without the headaches

In 2019, there are 25-year leases available that start at net yields of around 5.0% p.a. in Dublin, but with annual rent linked to Irish inflation (Harmonised Index of Consumer Prices – HICP). Units are bought at market prices directly from their owners and refurbished where required to get them to the required specifications. They can be sold back into the market with the unexpired lease to the next buyer at any stage, so there’s no lock-in. The break-even to recover all entry costs looks to be around two or three years, because property is a long-term business.

The new model

The resident is the client of the local government or housing agency, who in turn are the client of the investor. This is the key difference. The local council or housing agency deal with residents, turnover, advertising and all problems, leaving just building insurance, apartment management fees and local property tax to the investor.  These are typically fully repairing leases where the counterparty is a State body or local council.  Most importantly there is no vacancy risk (saving a default by the State itself) so income is guaranteed for 25 years and moves with European inflation.

There is likely to be two routes to market, collective funds for the small retail investor and the direct ownership model which means that there is no intermediary between you and your houses and apartments, with cash flowing directly from the local council or housing agency to your bank account and the title deeds held by your solicitor.

For personal investment, rents will attract income tax with offsets for allowable costs and gains will be subject to Capital Gains Tax. These taxes are delayed where the investment is by Self-Administered Retirement Trusts (SARTS) and Personal Retirement Bonds, but ultimately on retirement as the units move to Approved Retirement Funds they will come under normal taxation.

Gearing at 50% may also be available from specialist lenders, but these will likely be on a capital and interest basis and strictly underwritten in line with Central Bank rules

What could go wrong?

Be quite clear, lots can go wrong. There is no such thing as a risk-free investment, including bank deposits, in this climate of fragility and excess debt, so it’s important to look past the Government backed yields at the asset class itself and at the Irish economy in assessing risks.

Not to put too fine a point on it, social housing, at least in the past, has not been done well in Ireland, creating disadvantaged areas. Although this is now addressed by modern mixed area planning, the capacity for blighted pockets remains. So, the capital value of a social housing portfolio in the years to come will be affected by its quality, its location, how it is maintained and the impact of the biggest player, the State.

This could mean that there is no real gain in capital values and maybe even losses when today’s prices are measured against those of future years. It is why higher yield stock may be attractive to offset weakness on the capital gain side. Managing this risk is down to judgement on where and what to buy today coupled with knowledge about long-term area development plans.

The Government could overbuild and oversupply social housing in pockets and although this does seem farfetched from today’s standpoint, it is a real risk as capital floods into chase returns, reversing the demand/supply imbalance. An oversupply would depress prices when selling units.

The rent is linked to Irish inflation so in the event of an Irish deflationary period – in other words, declining GDP and falling prices generally – rents will move accordingly.

The agencies of the State could default on their lease commitments collapsing the market locally where there is a local council bankruptcy or if the State itself were to become insolvent and locked out of affordable credit in sovereign bond markets. This risk is explored in detail in The Pivot. This could happen if we experience another severe global crisis, which results in municipal defaults, a national default on sovereign bonds and an internal default to creditors across the economy during a harsh austerity programme. The point is that nothing is absolutely guaranteed national and local governments can and do default under extreme circumstances.

The State itself can behave differently than today especially if socialist type policies are implemented, the risk of which cannot be understated when one looks at Corbyn’s Labour manifesto for Britain, renationalising parts of industry and forcing wealth redistribution through high taxation. Corbyn’s Labour is very different to Blair’s Labour party and has come as a shock to moderates. The lesson is that, here in Ireland, it would be unwise to diminish the risk to a property market dominated by one central player, prone to cyclical leadership changes driven by local political pressures despite current ‘new politics’ arithmetic.

There is the risk of buying a pig in a poke, selecting overpriced, poor quality stock. This risk can be controlled, firstly, by the fact that premises are the subject of inspection by local councils and housing agencies before leases are confirmed secondly, by checking on the work undertaken by those refurbishing property and thirdly by measuring prices against relative prices from equivalent local sales.

Finally, like all property investment, this is not and has never been low risk. Property is an illiquid asset, it is also medium to high-risk investment notwithstanding the Government backing for 25-year leases. Add bank credit and risks rise further as do rewards if it all works out and the return compensates for the risks being taken. To be quite clear, social housing has a place in a mix of uncorrelated assets but it is no silver bullet.

The demand

You probably don’t need reminding that current demand is high, Ireland has a very challenging social housing deficit that will remain so for a long time to come, given the impossible entry costs into the private ownership market, the dearth of supply and the demographics of a strongly growing population. Here are some quick facts:

• By 2018, the Social Housing Waiting List had grown to 85,800.
• It is estimated that 10% of the Irish population already live in homes, with more people than rooms.
• In 2018, there were 9,104 people officially homeless.
• The Irish Government target of delivering 50,000 units by 2021 involved a commitment of €5.85bn to the project
• It is estimated that 33,500 units will be built, 6,500 acquired from the market and 10,000 leased by local government and housing agencies.
• The Irish population continues to expand, net population growth last year was 52,900 according to the CSO and the long-term trend is very strong.

Early starters

Until recently, had you emailed a local government enquiring about a social housing registration you’d have waited a few months before getting a reply. Dialling in to find officials responsible for dealing with investors was like looking for life on the Moon. That’s all changed, but not at every local government. Specialist early starters report fast moving local councils now across Dublin, Waterford, Louth and Donegal. Many other areas are gearing up but there are some laggards who shun contact and are still locked into past practices. This is a new market and such behaviour can’t last too long, not if targets are to be reached and other local governments blaze a trail.

Unless you are versed in direct property and well connected to local council movers you may be better working through specialist firms established specifically for this purpose and well advanced among State agencies who see these as a source of bulk supply. This will require them to produce a turnkey service, starting with getting the fit right for you and finishing with securing leases by complying with social housing specifications and that includes fixture and fittings, BER rating, etc.

If you can’t afford a social housing unit, you are unlikely to be locked out of the market. Smaller investment is likely to be met in the very near future by social housing funds, launched to the public and filling up with a set amount of capital ready to do deals, but will need careful examination when the time comes to study up on liquidity, costs and terms and conditions. These are likely to be distributed through financial brokers and other players in due course.

As a general rule, the first in any new market ought to pick the best fruits and expect this to be little different. Units currently average €250k all in with starting net yields at around 5.0% p.a. in Dublin.

If you’d like more information, register your interest here!

NB: Direct investment in property, like land, precious metals, art, etc., is an investment in physical assets. It is not a financial instrument, it is not regulated by the Central Bank of Ireland nor covered by the Financial Services Ombudsman or Investor Compensation Scheme. Independent legal and taxation advice is a must.