Irish rents boosted by mortgage controls and investor demand.

According to the 2016 census around 1 in 5 of Irish households were in private rented accommodatiom, against under 10% a decade earlier, with the actual numbers more than doubling to over 300,000. Over that period the average monthly rent paid fell by over 20% between 2008 and 2011  before recovering strongly and then pushing to new highs; the 2017 average was €1050 and this year will probably be around €1120 ( the rent actually paid, used here, differs from the asking rent on new lets).

What determines the level of rent? It is generally argued that rents, unlike house prices,  are not prone to speculative bubbles, largely because leverage is not involved, and the market is competitive, with a large number of individual renters. So real factors are likely to dominate  and in  our own rental model two are key. Employment appears to be a big driver of the demand for rental property while the main factor acting to dampen rental growth is the change in  the housing stock relative to the population. Consequently, the persistent upward move in rents over recent years is readily explainable, given a backdrop of surging employment and weak house completions, the latter  proving too low to prevent the housing stock per head from falling.

As can be seen in the chart, our model tracks actual rents very well, although over the last three years the model is underpredicting, by up to 10% in 2018, which implies something else is at play supporting rental values, particularly as there are now controls on existing rents in the major cities.. In our view there are two factors which together are pushing rents above where they might be given employment levels and housing supply. The first is the Central Bank’s mortgage controls, which were first  introduced in 2015 and modified since. The most recent change came into effect this year and reduced the number of mortgages for first time buyers that can exceed the 3.5 LTI limit to 20% from the 25% that had been drawn down in 2017.  Income is the key constraint for this segment of the market and the number of mortgage approvals for FTBs fell in the first half of 2018 relative to the final six months of last year. In other words, would be buyers that might have secured a mortgage on the previous criterion are still renting.

In addition, the combination of high rental yields and low returns on traditional lower risk assets ( influenced by QE) have spurred huge investor interest in the Irish rental market, from Reits, pension funds, foreign investment funds and individuals- a third of transactions  this year are to non-household buyers or an individual not occupying the property and that share has been above 30% since late 2013.

The rental market will eventually cool as the supply of housing increases ( or if there is an employment shock) but rents appear to be higher than the fundamentals dictate  as would- be house buyers have to compete with investors seeking relatively high yields and are also  constrained by controls on leverage.

 

1 in 5 new mortgage loans now not for house purchase

House price inflation in Dublin is slowing according to the recent CSO data; values rose by just 0.9% in the three months to May and actually fell in South Dublin, by 1.0%. An increase in supply is widely expected to dampen price pressures but new house sales year to date  in the Capital are marginally down on the same period last year, as are total transactions, so demand factors may be playing a part. London and Dublin prices have been highly correlated in recent years and the price falls seen in the former may be having an impact on investor interest in the Dublin market. For buyers with Irish mortgages the latest data  from the BPFI, on approvals and drawdowns, indicates that the recent tightening of mortgage controls is impacting and that affordability is becoming more important as a constraining factor.

Mortgage approvals for house purchase fell by an annual 4.6% in June and  rose marginally in the second quarter as a whole ( by 0.8%) . FTB approvals fell in q2, however, by 0.8%, and have been weak since the the first few months of the year; 10,882 mortgages were approved for first time buyers in the first half of 2018, against over 11,000 in the same period last year. A quarter of mortgage loans to FTB’s exceeded the 3.5 LTI limit last year and the permitted excess was reduced to 20% in 2018, so one might expect that to dampen lending for house purchase, particularly as affordability ( the annual payment on a new mortgage relative to income) has deteriorated given the rise in house prices and associated increase in the value of an average new mortgage. Indeed, it is noteworthy that the average new mortgage for house purchase in q2 of €225,500 was broadly unchanged on q1 and 5% higher than a year earlier, as against a 9% increase in 2017.

The number of mortgages for house purchase  actually drawn down in q2 amounted to 7,381 or 9.2% above the same period in 2017, a slower pace of  growth than the 9.6% increase in q1 and the 14.7% recorded in q4 last year. The value figure was €1.7bn, up an annual 14.7%, against an 18.5% annual rise in q1. The growth in total mortgage lending ( i.e including top-ups and re-mortgaging/ switching) was unchanged at 22%, however, amounting to €2bn in q2 , driven by  a doubling of re-mortgaging/ switching over the year. Indeed, the latter amounts to 14% of total loans in q2 and one in five mortgage loans are now not for house purchase, the highest share since 2011.

In sum, the growth in mortgage lending for house purchase is slowing, and the average new mortgage is also growing at a more modest pace , with FTBs squeezed by affordability and tighter mortgage controls. The steady stream of lower mortgage rate announcements indicates banks are responding, and that competition is more intense in re-mortgaging and switching.

New supply data implies housebuilding consensus may be too optimistic.

Annual house price inflation accelerated  to 13% in April, the strongest pace for three years, bringing the increase from the cycle low to 76%, albeit still leaving prices nationally some 20% below the previous peak. Credit does not appear to have played a significant role in this recovery, at least to date ( net mortgage lending has only recently stopped falling and new lending appears to account for only half of transactions) and analysts have emphasisied more fundamental factors on the demand and supply side of the housing market.

In that model  housing demand has exceeded supply for some time now with the implication that prices will continue to rise ( absent a shock to employment or a steep rise in interest rates) until housing supply has picked up to a level which brings balance to the market. Supply, as in new housing completions, is picking up from historically low levels and in time is generally expected to approach and then meet estimates of annual housing demand. For example, the ESRI expect completions to exceed 23,000 this year and to reach 37,000 by 2020.

That expectation was based on completions data from ESB connections which put the annual figure at over 19,000 last year, although some thought that overstated the actual flow of new properties. Fortunately, the CSO has now started to publish completion figures on a quarterly basis, based on a range of sources , and they imply that completions may be much lower than generally expected over the next few years. The new figures, dating back to the first quarter of 2011, show completions of  57,000 over the past seven years, against an ESB total of over 90,000, a difference of 33,000. Last year’s total is now put at under 14,500, or 5,000 less than the ESB figure, and for this year the CSO figure  for q1 is 3,500. The latter may have been adversely affected by the weather but a full year figure of 17,000 or so seems much more likely than  anything approaching 25,000.

The implication is that the housing stock has been growing at a slower pace than previously thought  and that the stock  per head of population , a key variable in many demand/supply models, is still falling ( it started to decline in 2011) and will continue to decline for the next few years. Indeed, new population projections by the CSO highlight that demographic pressures will remain a feature of the Irish market; the population is projected to grow by over 300,000 by 2021 on a high net migration scenario or by 1.3% per annum, against a housing stock still growing by  well under 1%.

 

 

Irish housing transactions fall in q1 with cash buyers still dominating

The CSO’s Residential Property Price index for March showed prices still accelerating nationally, with the annual change at  12.7% from a downwardly revised 12.5% in February and 12.1% at the end of 2017. Property price inflation in the capital slowed, to 12.1% from 12.6% the previous month, but picked up strongly over the rest of the country, to 13.4% from 12.3% . Prices  were particularly strong in the mid-West (Clare, Limerick and Tipperary), rising by an annual 16.4% but fell for the second consecutive month in the Border counties, reducing the annual gain to 8.8%. Within Dublin, house prices in the city rose by an annual 14.2%, with South Dublin lagging, showing  a rise of 9.6%.

The housing market is generally perceived as characterised by chronic excess demand although the exact amount of new supply (house completions) is subject to some doubt. The number of housing transactions is available though, through the CSO, and the figure for the first quarter is actually down on the previous year, at 13,967 versus 14,500. The decline in turnover was particularly acute in Dublin, with transactions down 10% to 4,500.

The number of mortgages drawn down for house purchase in q1 , at 6,400 , was up by some 10% on the previous year, but that still implies that over half the transactions in the quarter (54%) were financed by non-mortgage buyers, a persistent feature of the market. First time buyers account for more than half of loans but are clearly competing against investors, both corporate and individuals, as well as each other, for the limited supply available.

Moreover, the approvals data, a leading indicator of drawdowns, indicates that lending is actually slowing, and quite sharply; approvals in q1 were  down on the previous year, by 4%, and by 13.7% in March alone. We have noted before that the Central Bank’s latest modifications to their mortgage controls, which took effect this year, was an effective tightening, as only 20% of FTB loans can exceed the 3.5 LTI limit , as opposed to an actual 25% last year. Indeed, new  mortgage lending was offset by redemptions and repayments in the three months to March. In other words net lending was negative and with new lending slowing and accounting for less than half the transactions in the market it is hard to argue that prices are being fuelled by credit. Rental yields in excess of 5% is obviously attracting buyers in a QE driven environment of zero short rates and  10 year bond yields of under 1%.

Irish net mortgage lending falls again in Q1 and approvals also decline.

In the autumn of last year the flow of new mortgage lending  in Ireland started to offset repayments and redemptions for the first time since early 2010 and the annual rate of change turned (marginally) positive in January. Net bank lending to the non-financial corporate sector also began to pick up, although again the annual rate of growth was barely above zero, albeit adding to the view that the credit cycle was turning. The latest figures, to end-March, cast  doubt on that however, as net mortgage lending rose in the month but contracted by €28m in the first quarter. This still left the annual growth rate in positive territory , albeit at an unchanged 0.2%, but the annual change in corporate lending turned down again, at -0.3%, following a €365m decline over the first three months. Consumer credit, boosted by car purchases, had been growing strongly but has also softened, declining for four straight months in cash terms  reducing the annual  rate of growth to 2.4% in March.

New mortgage lending is still growing, of course, amounting to €1.7bn in Q1, with €1.4bn  of that used for house purchase, but the pace of growth in the latter is slowing. particularly in terms of the number of mortgages drawn down. That figure was 6,400 in the first quarter, which represents a 9.6% increase on the previous year , compard to a 14.7% rise in the previous quarter and 26% growth a year earlier. The latter pace is clearly unsustainable and some easing was to be expected but the approvals data paints a more disconcerting picture; approvals for house purchase in March fell by an annual 13.6% bringing the annual decline in q1 to 4%.

The shortage of houses for sale is no doubt impacting ( transactions fell marginally in the first two months of 2018 compared to a year earlier) while the Central Bank limits on lending may also be a factor, particularly the Loan to Income restriction which is particularly relevant for First Time Buyers.  The average mortgage for house purchase rose by 22% in the three years to end-2017, against just a 4.4% rise in average pay, with house prices rising by 31% over the same period.

There is clearly an affordability issue developing, exacerbated by the spending power of non-mortgage buyers,  who see housing as an attractive asset class in a QE world of expensive equities and historically low government bond yields. The weak credit environment is also an ongoing issue for the Irish headquartered banks; total loans continue to fall, declining to under €176bn in March,  a fresh cycle low, and exceeding deposits by some €8bn. The Central Bank has expressed some concern about the pace of new lending in recent months but the issue facing the economy and the banking sytem in terms of net credit is very different.

Irish new mortgage lending rises by 29% in 2017 but affordability is deteriorating

Irish mortgage providers lent €6.4bn for house purchase in 2017, the strongest figure since 2008, with top-ups and re-mortgaging bringing the total to €7.3bn, a 29% increase on the previous year The final quarter was particularly strong, when adjusted for the usual seasonal effects , and we expect further growth in 2018, although affordability is deteriorating and the Central Bank’s modifications to its mortgage controls will no doubt have some impact on First Time Buyers , as Loan to Income is the main constraint for that segment of the market. Indeed, there was a notable slowdown in approvals in the last few months of the year, perhaps indicating that lenders are already adjusting to the rule changes.

Drawdowns were very strong in the final quarter, nonetheless, with over 8,700 mortgages for house purchase including over 5,000 to FTB’s, some 60% of the total. For 2017 as a whole 29,400 mortgages for house purchase were drawn down, still a far cry from the boom figures in excess of 100,000 but significanttly above the low recorded in 2011 (11,000) and 18% above the total in 2016. The value of lending for house purchase implies an average mortgage of over €217,000, against €200,000 in 2016, and a cycle low of €174,000 five years ago.

Interest rates on new loan have not materially changed over that period and household incomes have risen but the increase in mortgage size is such that affordability, the ability to service a mortgage, has deteriorated. Our own model compares  the annual cost of a new , 25-year repayment mortgage to our estimate of gross  borrower income, and shows that the ratio rose to 30% in 2017, the highest since 2009 and above the long run average (back to 1975)  of  29.5. The ratio is still well below the heights recorded at the peak of the boom ( over 40%) but our forecast is for a further deterioration in 2018, to 31.2 , and this assumes no change in interst rates, so any rise in the latter  would indicate a greater deterioration.

At the moment a rate rise looks unlikely until 2019, at least, and the affordability change expected does not look material enough to have a significant impact on lending, given the prospect of further gains in employment, an acceleration in wage inflation and stronger house completions. Against that, the Central Bank’s changes to mortgage controls are undoubtedly a policy tightening, in our view, although not  sufficient to prevent further growth in new lending, and we anticipate a figure around €9bn in 2018. Net lending has also started to grow in recent months, so the coming year will probably see the first rise in Irish mortgage debt in a decade.

 

 

State’s strange move into higher risk, high leverage mortgage lending

First Time buyers accounted for 11,896 transactions in the Irish housing market in the first eleven months of 2017, which is 1700 up on the same period in 2016 but still only around 20% of total turnover. The Government has sought to support that segment of demand via a tax rebate to help those seeking to buy or build a new home (the Help to Buy scheme) and has just announced a fresh initiative, this time in the form of State mortgage lending ( Rebuilding Ireland Home Loan) , although the scheme has a number of odd features and appears a strange step to take.

To qualify, would-be borrowers have to have been rejected by at least two lenders, which immediately implies that the State would be taking on if not sub-prime then certainly higher risk loans. The lending decision will be taken by local authorities, so someone in those authorities will be making credit risk decisions, raising the issue of the criteria that will be used to decide which applicant is successful.

Third, the State is driving a coach and horses through the Central Bank’s mortgage controls and one wonders what the Bank makes of it and whether it was consulted. Lending institutions are required to limit mortgage loans to  a maximum of 3.5 times  the borrowers income , with 20% of lending to FTB’s  per annum allowed above that. The  specific limit  for FTB’s has just been introduced and represents a de facto tightening of standards, as 24% of lending to that segment exceeded the limit in the first half of 2017. Yet the State scheme allows a LTI range from 3.8 to 5.0, which is much higher leverage than deemed acceptable  to private lenders, and therefore higher risk.

The scheme does have a loan to value limit ( 90%) and a maximum property price, so putting a cap  on a given loan, although it does differentiate by location; properties in the major cities and in the counties surrounding Dublin carry a  maximum loan of €288,000 as against €225,000 elsewhere. Over 60% of transactions are in the former areas so the €200m allocated implies that less than 800 loans could be granted in 2018. Total mortgage lending for house purchase this year is likely to be around €8.5bn so the scheme is not material in terms of the overall market.

Finally, we have the issue of funding costs. Successful borrowers will have three options, two fixed rates and one floating, all well below current market rates. For example, a 25-year mortgage would cost 2% fixed, and a fixed rate for that term is not available from Irish banks- in general, banks can’t borrow at that maturity, so 3-5 year fixed  is the most common (although some 10-year is now available). The State can and has borrowed for 25 years and longer, with a bond maturing in 2045 trading at around 1.8%, implying a very small margin if that was tapped to fund this initiative.

Successful borrowers will be getting a cheap loan with the State taking on a level of risk that the private sector is unwilling to bear, at least at that cost, and indeed  what the Central Bank is also unwilling for borrowers or lenders to countenance.

Strong new mortgage lending but cash still king in housing market.

The number of new loans for Irish  house purchase topped 8,000 in the the third quarter , according to new data from the BPFI, the highest quarterly total in nine years, with the value figure of €1.8bn also the strongest since late 2008.The average new loan is now €221,000, which is substantially above the €170,000 cycle low recorded in 2013, albeit still well shy of the pre crash peak in excess of €280,000. In fact new lending is  also finally offsetting debt repayment and net mortgage lending  turned positive in the quarter for the first time since early 2010 according to figures from the Central Bank.

So the current housing cycle has been unusual in that it has occurred against a backdrop of  an overall contraction in  credit. Moreover, new lending for house purchase still appears to be accounting for only  50% of housing transactions; the CSO data base shows around 15,500 transactions (filings) in q3, which is almost double the number of mortgage drawdowns. The year to date figures reveal a similar picture, with 20,716 new loans for house purchase set againt over 43,000 in turnover, implying that over 52% of transactions are either cash buyers or have access to a credit source other than Irish mortgage lenders.

The approvals data also suggests that mortgage buyers are being squeezed in the market; approvals  for house purchase exceeded 20,000 in the six months to end- Sept but less than 15,000 were actually drawn down, an unusually low ratio. So potential buyers may be being outbid by investors amid general excess demand. The CSO’s monthly residential price index would certainly indicate that upward pressures are still very much in evidence; annual  house price inflation nationally accelerated to 12.8% in September and 13.2% excluding Dublin. Price inflation in the capital is re-accelerating again after a softer period last winter and the 12.2% annual increase in September brought the total rise from the cycle low to 87%.

Prices nationally are up some 70% since the low in early 2013 and the average new mortgage  has risen 30% in that period, again implying that credit has not been a significant factor in driving the market. Indeed, it would appear that the Central Bank’s mortgage controls have certainly not had a material impact on house prices overall, given the influence of non-credit factors, although they may well have impacted expectations around the announcement period.As we have argued elsewhere  (http://danmclaughlin.ie/blog/qe-is-fuelling-irish-house-prices/) the broader financial backdrop, notably the ECB’s asset purchase programme , has impacted the market by pushing down the rate of return on alternative assets and boosting investor interest in property markets.

QE is fuelling Irish House Prices

Irish residential property prices have risen 60% since the lows of early 2013 but  this cycle is investor rather than credit driven. Gross mortgage lending for house purchase has picked but the average new loan has risen by just 28% over the past four years, implying a fall the average loan to value ratio, while data on transactions (recently revised up by the CSO) indicates that mortgage loans  still appear to be accounting for less than half of turnover in the market. New lending is also now constrained by the Central Bank’s mortgage controls.Moreover, net mortgage lending ( i.e new lending minus repayments) has been falling now for over seven years, although there are recent signs that it may finally be bottoming out.

Nothing here then to indicate that credit is playing a strong role in driving prices and it is curious that little attention has been paid to the impact of the ECB’s monetary policy  on the housing market, and, more specifically, its  non-standard measures including the asset purchase programme. The latter, QE, is designed to boost bond prices and hence lower yields so that ‘ investors may choose to take the funds they receive in exchange for assets sold to the ECB and invest them in other assets. By increasing demand for assets more broadly, this mechanism … pushes prices up and yields down, even for assets that are not directly targeted by the APP’.

QE is generally perceived as having a significant impact on equity markets and it would be odd if it did not therefore impact other  asset markets, including property, and we  can readily  see this at play in the Irish data on transactions. In 2011, investors (here defined as Buy to Let individuals  plus non-household buyers) accounted for 16% of residential transactions rising to 24% by 2012 and averaging a third of the market or more since 2014.

The yield on ‘risk-free’ assets , such as Government bonds, plays a big role in investment decisions and so the plunge in Irish Bond yields has been  a very significant backdrop for the Irish residential and indeed commercial property market : 10-year Irish yields peaked at double digit rates in mid 2011 but really started to fall sharply following Draghi’s ‘whatever it takes’ speech in 2012, and fell below 1% , where they still reside, following the commencement of QE in early 2015.

In contrast, the gross yield on residential property ( average rent/ house price) has not declined significantly in our rental model, and is still at 4.8%, having peaked at 5.4% in 2013. The rental yield fell to  a low of 2.75% during the last cycle, and is still well above the post EMU average (4.25%) and of course extraordinarily high relative to the ‘risk free’ rate available on Irish bonds, let alone Bunds.

The scale of investor interest in Irish property is therefore not surprising given the yield on offer and  is unlikely to disappear any time soon. Higher bond yields would make a difference, no doubt, and in that context the future of QE plays a part; the ECB will soon decide whether to scale back its asset purchases or indeed cease any additional buying. Yet it is likely to reinvest the proceeds of maturing bonds for a while at least, therefore maintaining the stock of QE, so absent an inflation shock bond yields may well stay low by historical standards. If so investor interest in Irish property will continue to be a big driver of the market.

Irish Mortgage Lending crimped by supply and competition from non-debt buyers.

The latest data from the BPFI on  Irish new mortgage lending shows that 6,781 loans  for house purchase were drawn down in the second quarter, with the annual increase at 17.6%, providing further evidence that the year as a whole is likely to see a substantial increase on the 2016 total of some 25,000. Yet the annual pace is slowing, following a 26% increase in q1, and on our seasonally adjusted model  lending actually fell on the quarter. What is more striking though is the unusually large divergence between mortgage approvals and actual drawdowns ; approvals for house purchase in the second quarter amounted to 10,250. Looking at the picture over the first six months, approvals stood at 18,576 against a drawdown total of 12,634 , which is a wide gap even allowing for the usual lags between approval and purchase.

Buyers with approval may delay purchase if they are nervous about the market but survey’s suggest that price expectations have risen of late so that would normally bring forward the timing of transactions. The alternative explanation is that buyers with approval are being squeezed by the limited supply of property for sale and the prevalence of would-be purchasers not reliant on debt finance. The ECB’s QE is compressing yields on financial assets, making residential property a more attractive alternative. Judging by the CSO figures on transactions (executions) in the first quarter, mortgage loans are still  only accounting for around 50% of the total ( the q2  transaction data have  yet to be published).

The BPFI data also reveals that the average mortgage for house purchase is now just under €214,000. 8.1% above the previous year and at levels last seen in early 2010. In cash terms mortgage lending for house purchase  in the quarter amounted to €1.45bn and overall lending rose to €1.65bn when top-ups and re-mortgaging is included, bringing the total for the half-year to some €3bn. Our forecast for the full year is currently €7.2bn but we are likely to revise that down, given the  slowing momentum in the numbers drawdown.

Nonetheless, new mortgage lending is growing and it now appears is finally close to offsetting repayments, with the latest Central Bank data on net lending showing  that the  monthly decline in that series is now extremely small. Irish household deleveraging started  in mid-2008 and one doubts if few or any thought it would last this long.