The pitfalls of wooing the first-time buyer

Earlier this week, the Housing Minister announced that this year’s Budget will see some form of tax rebate or other fiscal incentive introduced for first-time buyers buying newly built homes. This seems like something of a political no-brainer: as a group, first-time buyers enjoy an esteem not far off ‘war widows’, so what could go wrong helping such a needy bunch?

The main problem with wooing the first-time buyer vote is that, as the Minister noted himself, they form the single biggest chunk of the market. First-time buyers compete with other first-time buyers when buying property. Therefore, if you have a certain number of homes in the country, giving first-time buyers more capital to bid against each other will have only one outcome: it will drive the price of housing up.

First-time buyers will, in the short term, suffer no ill-effects: as a group, their bargaining power has improved relative to the rest of the market.

The rest of the market — consider the hardpressed second-time buyer who has just escaped a decade of negative equity — will be squeezed out at the margin by these turbo-charged first-time buyers. And the whole market will suffer from higher prices relative to incomes.

This is the standard — and most important — interpretation to give to any “help to first-time buyer” scheme that is proposed anywhere in the world. In housing, or indeed in any market, the solution to a lack of supply is not to further stimulate demand.

In fairness to the Minister, what is proposed will be tied to the construction of new homes and will not apply to existing property. Does this fundamentally change the analysis?

To see the impact of a hand-out for newly built property only, let’s take a simple, stylised example of the housing market. To start, suppose that it costs €285,000 in labour and materials and that this cost doesn’t vary around the country. And, to keep things simple, assume there are only three markets in the country — urban, commuter and rural — and that the cost of a site in each market is €50,000, €25,000 and €10,000.

In the urban market, a family home sells for €400,000 — put another way, this is the maximum the average first-time buyer can afford. In this market, building is already viable, as the site and build costs total €335,000 (adding the cost of labour, materials and site). In the two other markets, building is not. In the commuter market, a family home sells for €300,000 but costs €310,000 to make, once the site is included. In the rural market, where a family home sells for €200,000, this is also well short of the €295,000 site and construction costs the developer faces.

So far, so good. Now, suppose the Government introduces a tax rebate for first-time buyers purchasing a newly built home. Suppose this new rebate is for €10,000 and is designed in such a way that it comes from gross income, not net income. With a marginal rate of income tax for most couples of basically 50pc, this boosts the average first-time buyer’s budget by €20,000.

Let’s start with the easy case. In the rural market, this tax rebate has absolutely no effect. Yes, it boosts the buyer’s income from €200,000 to €220,000 but this is still significantly below the €295,000 all-in cost.

The commuter market is where things start to get interesting. Here, the average first-time buyer has seen their budget increase from €300,000 to €320,000. Given the house costs €310,000 all-in, building is now viable. A policymaker might be tempted to conclude that the rebate has worked.

But this is the benefit of the rebate. What about its cost? The first aspect of the cost is that the house will not be sold for €310,000. It will be sold for €320,000. So while the rebate has boosted construction, it has also pushed up property prices. Prices will be determined by the buyer’s budget and not the seller’s cost, for the simple reason that there is so much demand relative to supply. However, a policy-maker might look at this and still conclude that, compared to a world with no building in the commuter market, this is an improvement.

Arguably, the more substantive element of the cost of this rebate is seen in the urban market. Here, first-time buyers have also had their budget boosted, from €400,000 to €420,000. Unsurprisingly, given that demand far outstrips supply, the extra budget goes straight to the developer.

In short, where building is viable anyway — and where it is viable only because of the rebate — the consequence of the rebate will be to fuel house price inflation. In markets where building is viable neither with nor without the rebate, it will have no effect at all.

There is one other element to be borne in mind. The third aspect of the cost is the tax revenue foregone by the taxpayer. Whatever income tax would have been taken in has been spent instead pushing up housing prices. This revenue could have funded social housing or other State investment, or indeed day-to-day expenditure.

Those arguing in favour of the proposed firsttime buyer new-build tax rebate need to be able to produce evidence that the gain, in terms of new supply — and at higher, rather than lower, cost — outweighs the upswing in housing prices and the revenue foregone by the taxpayer. More specifically, we as taxpayers deserve to know which markets will be made viable by this measure and which are the equivalent of the urban and rural markets above.

If policy-makers want to boost supply, there is a more direct way of doing so and one that comes with none of the side-effects described above. If building homes is too expensive relative to the real economy, then those costs need to be lowered. A tax rebate takes the pressure off the development community to find ways of building the same quality for less money. The burden of proof is on those in favour.