A well-functioning housing market is crucial for Irish society and the economy. The boom to bust story of the Irish housing market is well documented and is a clear historical reminder of what can go wrong when poor public policies are pursued.
A future policy position must be built on prudential and sustainable principles. The progress made by the Irish banking sector in the past 17 years is testament to those principles.
Based on new population projections as well as estimated pent-up demand, it is now agreed that we will need to build at least 50,000 homes annually over the next five years. There are various factors affecting housing output such as the inefficiencies in the planning system, availability of zoned and serviced land, labour capacity and productivity of the sector, as well as availability of capital investment.
Recognising the potential challenges around all other factors affecting the output of the residential construction sector in Ireland, the domestic banking sector believes that more can be done in the provision of additional development finance, which can help to spur on new housing starts across the country.
It is well documented that outside of the top tier of developers, the strength of many developers’ balance sheets is constrained. This directly impacts their ability to secure development finance.
Where banks may advance up to 65 per cent on a loan-to-cost basis, the developer needs to bridge the gap with their own funds or with mezzanine finance, which can be expensive.
There is a compelling rationale for some form of a financial instrument, such as a credit guarantee scheme, for small builders to be put in place, partially underwritten by the State, to advance finance to these developers with viable projects but insufficient equity.
This would enable the banks to advance finance to additional developments, without compromising credit underwriting standards. Expanding the capacity of a sector by way of risk sharing with the State is not uncommon in the European Union context either.
The funding challenge to deliver the increased levels of housing output required is significant. The State’s investment in housing is at historically high levels, increasing from an estimated €1 billion to €6.5 billion over the past decade.
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In terms of spending on housing as a percentage of national income, Ireland’s figure is much higher than that of any other EU member state. However, this level of investment may become unsustainable if the currently strong public finances position deteriorates, and additional funding is required from private sources.
The Department of Finance estimates show that an increased level of output will require around €20 billion of funding, of which nearly €17 billion needs to come from private capital sources. It should be noted that this level of funding is not required each year as housing projects go through different stages of development and funding is recycled within the system.
The banks are already providing significant finance to the housing market, both in terms of mortgage and development finance. However, it is vital that the lending capacity of the banking sector is fully utilised. On average, lending in the Irish banking sector continues to require significantly more capital for unexpected losses than the average for the European banking sector.
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For example, Irish banks on average still hold nearly 50 per cent more capital for lending to small and medium sized enterprises (SMEs) compared to their European counterparts, and nearly twice as much capital for mortgage lending.
A partial credit guarantee scheme, focused on smaller builders, provides a critical risk sharing model between banks, builders and the State. Typically, smaller builders in today’s new funding and lending environment tend to work on one site at a time, constraining housing output but also constraining the ability to scale in size as a house-building business. The presence of large-scale plc businesses (stock market listed companies) in the housing construction sector, is helping to improve economies of scale production but we need more builders of scale.
The banking industry and the Government produced during the pandemic a well-designed credit guarantee scheme to help the investment channels continue to flow for business. While the rules on euro zone bank lending are today vastly different from the rules that applied 20 years ago, we face a challenge from a capital perspective to make lending viable for SME house building.
The viability of apartment building, an increasing percentage of all new homes being delivered in urban areas, is recognised as extremely challenging to finance. It’s just possible that a building credit guarantee scheme, well designed and focused on housing output, is a better way to incentivise the use of capital for house building than broadly based tax breaks.
Brian Hayes is chief executive of Banking & Payments Federation Ireland
