Why have foreign funds targeted the Irish property market?

The Irish property market and the law of unintended consequences: there’s enough material for a book. The rapid acceleration in PRS (private rental sector) investment – the latest dynamic to percolate through the system – and the narrative that goes with it, namely that so-called “cuckoo funds” are pushing first-time buyers out of the market, has prompted a national outcry.

It has also panicked the Government into making policy on the hoof. Earlier this month, it introduced a higher, 10 per cent rate of stamp duty on the bulk-buying of homes, seemingly in response to a single transaction, the purchase of a housing estate in north Dublin by UK property investor Round Hill Capital.

The influx of these funds – Sherry FitzGerald estimates that PRS funds have invested close to €7 billion into the Irish property market since 2011 – including €3.7 billion since 2018 – is undoubtedly part of a wider global trend. The world is awash with cheap money, and housing offers standout returns for investors. Dublin is a prime example because of the high rents it produces.

But two big domestic policy measures have also inadvertently fashioned this dynamic. The first one relates to the de-risking of the banking sector. The National Asset Management Agency (Nama) was set up after the crash to cleanse bank balance sheets of toxic assets. The agency took over €74 billion of bad property loans – albeit at a massive discount – and commenced a gigantic auction to recoup its outlay on behalf of the taxpayer.

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Nama sales were facilitated by government policy, which included a capital gains tax (CGT) amnesty for investors and the introduction of new legislation setting up property Reits (real estate investment trusts), which bought assets, and of course extremely favourable tax laws. Oaktree, Kennedy Wilson, Hines and Ires Reit (the latter is now the largest landlord in the country) were among dozens of funds to partake.

De-risking

So institutional investors – and remember, we didn’t have them before 2008 – were systemically embedded in the country’s recovery from the crash via Nama and the de-risking of bank balance sheets.

The then Fine Gael-Labour government’s fear was that without them there would have been no buyers, property prices would fall further and banks would have to take larger write-downs on non-performing loans (NPLs), potentially requiring the State to pump in more money.

The next big policy initiative came in the form of changes to planning standards, ostensibly designed to encourage more high-density development. This allowed for a greater cluster of apartments on a given site, effectively by changing aspect ratios, reducing the requirement for car parking spaces and allowing for greater elevation.

In the middle of a housing crisis, we're getting high-end, luxury housing – a lot of which remains vacant because of the high rent – alongside a dearth of affordable units

The unintended consequence of this was to reconfigure how an urban apartment development is financed. Previously, a developer secured finance to build out his or her scheme on a phased basis. While this still pertains, the new higher-density, build-to-rent standards require more of the financing upfront. With banks still convalescing from the crash and loath to lend to developers, foreign investment funds filled the void.

Most of the big schemes in Dublin are now being built on the basis of a pre-sale or a pre-let agreement, whereby the developer is financed by the end buyer, or financed because there is a guaranteed end buyer or tenant. And because the end buyer is a PRS investor, the units bypass the sales market in favour of the rental sector, hence the perception that first-time buyers are being squeezed out of the market. This mode of procurement now appears to be the only game in town.

The Construction Industry Federation (CIF) estimates that investment funds bought 95 per cent of the apartments completed in 2019. More recently, they've begun to buy housing schemes including starter home developments in Dublin's commuter belt.

Price metrics

And even if the funds were minded – for whatever reason – to sell the units to owner-occupiers, the price metrics don’t work. The Society of Chartered Surveyors Ireland (SCSI) puts the cost of delivering apartments in urban Dublin at between €493,000 for a two-bedroom unit in a medium-rise development and €619,000 for a two-bedroom unit in a high-rise development. And so, in the middle of a housing crisis, we’re getting high-end, luxury housing – a lot of which remains vacant because of the high rent – alongside a dearth of affordable units. The same thing has happened in London.

Successive Irish governments, perhaps with an eye on inflating property values – seen as a requirement for Nama to recoup its investment and for the banks to stay healthy – have created the current fund dynamic. They’ve enticed funds here and, in part, engineered a situation that leaves developers increasingly reliant on foreign investment. The upshot is more people renting and fewer people buying. Home ownership has collapsed among adults of prime working age – 25-39 year olds – from 22 per cent in 2011 to 16 per cent in 2016, according to the official figures, and to an estimated 12 per cent now.

The glut of global investment in housing is, of course, fuelled by accommodative fiscal and monetary policy, including the massive quantitative easing programmes deployed by central banks to cushion economies from the impact of coronavirus. But what happens when this turns, as surely it must? Will higher interest rates choke off the investment and who then will fund the development?