Irish residential property price inflation has slowed appreciably this year. According to the CSO the annual change in the average residential property in September was just 1.1%, against 8.5% a year earlier. Prices in Dublin are now falling, by an annual 1.3%, and although still rising elsewhere in the country the pace of appreciation has slowed to 3.6% from double digit gains a year earlier. Indeed in parts of the capital the falls are steep, with house prices in Dun Laoghaire /Rathdown 6.8% lower than a year ago, indicating that it is the more expensive areas that are seeing the largest falls.
What is driving the change? There are various approaches to modelling house prices and some straightforward metrics one can use to gauge whether residential property looks ‘cheap’ or ‘dear’, although there are data issues, including measuring the average price of a house- the CSO data is only available from 2010, for example, although the Department of the Environment has quarterly estimates going back much further, albeit solely based on mortgage lending.
One common metric is the house price to rent ratio, and on our model, using data back to 1990, the ratio is around the long run average and is actually falling currently, as rental growth in 2019 of 5.5% is outpacing house price inflation. House prices do look more expensive relative to incomes, although interest rates are historically low with the result that the cost of an average new mortgage relative to income is below the long run average i.e. affordability is supportive rather than excessive.
An alternative approach is to model house prices relative to ‘fundamentals’ , with the most common being mortgage rates, disposable income, the housing stock and demographic changes. The Central Bank uses one such model (among a suite) and as pointed out in the Bank’s latest Financial Stability Review it is currently pointing to prices well below where fundamentals suggest they should be. Moreover, the model is predicting 12% price growth this year, so the recent slowdown is not readily explainable.
Our own fundamental model leads to a similar conclusion. Mortgage rates have edged lower over the past five years but the major positive demand driver for house prices in the model is the very strong growth seen in household disposable income , with both employment and wages rising at a strong pace, a trend still apparent. An increase in the supply of houses should act as a brake and that is indeed often cited as a factor behind the slowdown but we find this not to be the case. The housing stock per head of population has the most significant impact and although completions are rising ,and may exceed 20,000 this year, that adds only 1% to the housing stock against annual population growth of 1.3%. Indeed the housing stock per head has been falling since 2010, and so is acting to push prices up rather than dampen price growth.
So if such fundamental models imply prices should be higher there must be something else at work which is not captured in the regressions. Credit growth is one obvious factor, and we have seen a change there as the Central Bank has put limits on new mortgage lending since 2015. The Bank believes that new PDH lending would be much higher in the absence of such controls, as would house prices, although Irish banks are now required to hold much more capital so one might argue that lending would not have risen as quickly as in the past given the additional cost to the banks of every new loan. The Central Bank actually voiced concern about the profitability of Irish banks in the Stability Review, which sits uneasily with the narrative commonly observed in many parts of the media.
Another factor not captured in models is the type of buyer, and in Ireland’s case there has been a significant increase in ‘sale for rent’, with builders agreeing a block price for a development with an institutional buyer attracted by the high yields on offer. The average price per unit sold is below what would have been achieved if each had been sold separately, acting to depress prices.
Sentiment and expectations also play a role and not readily captured in a model. Brexit and its potential negative impact on the Irish economy is an obvious factor here and consumer confidence surveys have certainly shown a significant fall this year. That uncertainty may be relieved to some extent if the UK actually announces its withdrawal in January but then the issue switches to the type of trade relationship post- Brexit, so potentially prolonging the negative impact on sentiment.
If that were the case house prices could continue to ‘underperform’ the fundamentals regardless of how the economy perfoms. Risks also abound in terms of employment and income while the current consensus view on housing supply may well be too optimistic, as softer house prices will dampen completions and hence continue to depress the housing stock per capita.