ACCORDING to several reports, the rental sector in Ireland is gaining renewed momentum.

The latest figures from the Real Estate Alliance released last week suggest that rents have risen across the country by up to 15% over the last 12 months. The greatest increases have been seen in Trim and Navan, while parts of Cork city, Maynooth and Monaghan have seen increases of between 10% and 12%.

Average returns on investment in residential markets have risen to 3.5% in Q1 2007 . . . up on the 2.8%3.2% recorded at the end of 2006.

According to the survey of existing investors, the slowdown in the housing markets across the state has resulted in a more cautious and, potentially, a more fundamentals-driven approach to investing in the rental market. New purchases appear to be concentrating on excess demand areas, with an added emphasis on quality properties in wellestablished areas.

However, judging by the underlying market conditions, the new buoyancy most likely reflects short-term forces. First, increasing interest rates are squeezing more prospective first-time buyers into rental markets. Second, many agents argue that uncertainty about stamp duty is pushing would-be first-time buyers to delay their purchases. Third, there is robust demand for accommodation from foreign workers, who now make up some 60% of tenants nationwide.

Ironically, these reasons for the current strength of the rental markets conceal real economic vulnerabilities. Increasing interest rates have the effect of cooling the market for the first-time buyers if, and only if, there is no offsetting increase in home affordability.

In other words, if Ireland Inc continues to build properties that are predominantly unsuitable for younger families (either due to their location away from job centres or their small size), prices of firsttime buyer properties will not track overall changes in affordability caused by rising interest rates.

This is exactly what is happening in the markets.

For over a decade now, construction of new familytype properties in the Republic took place predominantly in the supersuburban areas . . . far away from jobs and cultural and social amenities that are definitive of the demand for housing amongst younger professionals.

Uncertainty about stamp duty reforms is hardly a factor at all in the decision making of the first-time buyers. Fewer than 10% of all first-time buyer transactions involve second-hand homes.

The only link between firsttime buyers and stamp duty is in the adverse effect the tax has on the supply of second-hand properties.

The third support for the rental market's robust returns is an example of short-term thinking that underpins our investors' obsession with property markets in general. With some 60% of all renters being foreign nationals, it should be patently clear that any investment in apartments blocks hinges on the buoyancy of the lowvalue-added services and construction sectors in Ireland. Our high employment in low-valueadded services is driven by consumer demand and will not survive through any appreciable productivityenhancing changes in the retail and wholesale sectors.

Should Ireland's domestic services sector match the US-level productivity in logistics, supply chain management and retail, employment in this sector will have to be 20%-25% lower than it is today.

Continued moderation in income growth over the next two to three years will ensure that such productivity reforms will be a matter of survival for the majority of Irish firms operating domestically.

A contraction in the domestic services sector will undoubtedly be matched by contraction in employment in construction. With a current slowdown in residential construction, adjusting for higher state capital expenditures, plus the pressure to increase our relatively low labour productivity, construction sector employment can fall by 18%-20% within the next three years.

Altogether, increases in productivity, coupled with the natural slowdown in the economy, will mean that 25% to 35% of our present-day foreign residents will not be here in two to three years.

Given current figures, something in the neighbourhood of 115,000 and 160,000 renters can be drained out of our rental property markets . . . hardly a promising prospect of a 'soft' landing for tens of thousands of our buy-to-rent investors.

INFLATION BOOMING

ACCORDING to the latest data from the CSO, annual Inflation remained at a whopping 5.1% in April. Equally predictably, statecontrolled or regulated sectors continue to lead inflation.

The most significant changes were increases in housing, water, electricity, gas & other fuels (+22.8%), alcoholic beverages & tobacco (+5.5%), education (+5.3%), restaurants & hotels (+5.1%) and health (+2.9%).

Mortgage interest costs rose some 46.5%, followed by a 20.5% increase in natural gas and a 12.6% hike in electricity. In comparison, bottled gas rose by just 5% while liquid fuels prices fell 7.2%.

This disparity reflects the fact that increases in natural gas and electricity costs have less to do with changes in the price of fossil fuels than with market failures in a state-dominated energy sector.

WRONG ON ENVIRONMENT

IN a recent article I speculated that today's environmental policy heads are being outflanked by businesses that are more accurate in predicting the future.

There are logical and factual arguments to support my claim.

Private profit opportunities arise because (a) the market structure for existent goods changes, as in the case of higher oil prices driving new generation technologies, or (b) governments decide to subsidise speci"c business activities, as in the case of the taxpayers being asked to put billions into half-thought-through environmental schemes. Over time, businesses focusing on the "rst approach thrive, and businesses pursuing state-created opportunities fail.

Consider the example of bioethanol promotion policies. The demand for bio-ethanol is driven primarily by government subsidies. At a time when the price of agricultural inputs into bioethanol production (maize, grains, sugar cane) is heavily subsidised, the high price of substitutes . . . oil . . .creates an opportunity to earn profits.

However, as ethanol production accelerates, the price of agricultural commodities rises, yielding a corresponding increase in the prices of agricultural products and a simultaneous decrease in profit margins in bioethanol. Even holding the price of oil at current historical highs, another 10% increase in the demand for bio-ethanol will be likely to wipe out all profit opportunities in the sector.

Smart private money recognises that bio-ethanol producers must use technologies that do not drive up prices of agricultural commodities. These investors are looking into longterm technological innovation to convert currently unusable fibres into ethanol. These companies are not reacting to the gloom-and-doom UN IPCC reports. They are watching what is happening in oil and animal feed and grains markets.