Bit early to blame Central Bank for house price fall

The CSO’s  residential property index   for February showed a fall in Dublin prices for the second month in a row, the 0.7% decline bringing the fall over three months to 2.4%. This still left the annual rise at over 21% but the market in the capital has clearly lost some momentum over recent months and some have claimed that the Central Bank’s new macro-prudential controls on mortgage lending are responsible. Prices excluding Dublin were flat in February but also fell on a three month basis, albeit by only 0.3%, so adding to the perception that there is a common factor at work across the country.

The evidence is not persuasive, however, at least not yet. The rules only came into operation in late January , for a start, and there does not appear to have been a significant shift in the recent pattern of mortgage approvals ahead of the decision. Mortgage approvals in the three months to January rose by an annual 55,5%, and as such not materially different from the 56.5% in the three months to December. Housing transactions in January were actually very strong, according to the Property Price Register(PPR), rising by an annual 68% . The available February data does show a marked deceleration in the pace of annual growth in transactions, to 35%, but that figure may be quite different when all the filings are included, which does take time.

The Central Bank’s own research (1) also suggests that the mortgage limits on Loan to Value and Loan to Income will have little impact on prices but a more significant  effect on mortgage lending and on the supply of housing, which they suggest will be some 2-3% lower per annum for a number of years ,resulting in a loss of some  2000  units  after 4 years relative  to an unchanged policy forecast. That  reduction in supply will put upward pressure on prices , so dampening any downward effect from tighter credit standards.

Any such simulation depends on the housing model used of course, and the ESRI (2) has just come out with some findings of its own. These also point to a significant effect from the new mortgage rules on house completions, with a supply fall of some 4%-5%, although they predict a larger effect than the Central Bank on prices, albeit  still a modest 4%-5%.

Another problem inherent in linking recent price trends in residential property to the Central Bank regulations is that not all housing is behaving the same way. Apartment prices nationally rose by 1.9% in February and by 2.5% on a three-month basis. Apartments in the capital also rose strongly on the month, by 2%, and by 1.8% over three months. The price series on apartments is extremely volatile but apartment prices in Dublin have now risen faster than houses over the past year (by 24.5% versus 21.1%).

Perhaps a better explanation for the most recent slowdown in house prices is simply that a market which appears to be primarily  driven by cash buyers is likely to lose momentum. That’s not to suggest that prices are likely to fall sharply but that annual house price growth in excess of 20% is unlikely to be repeated for long in the absence of excessive credit growth. New mortgage lending is picking up , and showing very strong percentage growth given the low base, but it is still accounting for less than 50% of housing transactions. Indeed, the latest PPR figures show transactions of over 15,600 in the final quarter of 2014, with the number of new mortgages drawn down for house purchase amounting to less than 7,000 , or 44% of the total.

(1) ‘Assessing the Impact of macro-prudential measures’ Central Bank of Ireland, Economic Letters , Vol. 2015, No.3

(2) ‘Quarterly Economic Commentary’, Spring 2015, ESRI

Dublin House Prices: Bubble or not?

The CSO recently released the latest Irish house price data, for October, revealing that residential property prices excluding Dublin  are picking up at an accelerating pace; prices rose by 4.8% over the past three months, bringing the annual increase in October to 8.7%, an inflation rate last seen in early 2007. Yet prices are still only 12% up from the lows recorded eighteen months ago and  so few would consider that the market over the bulk of the country is overheating, particularly as national prices still look far from overvalued relative to affordability, incomes or rent.

The price trend in Dublin is very different. Prices there have risen by 46% from the lows recorded in the summer of 2012 and are now 38% below the levels seen in early 2007, a peak now generally considered the height of a Bubble. That term is now reappearing in the context of commentary on the residential property market in the capital and it does arguably satisfy some of the usual criteria employed to categorise a Bubble. One is rapid price appreciation and that is certainly the case ;  the annual increase in October was 24.2%, a pace rarely seen and then only back in 1997 and 1998, in the run-up to euro membership. Moreover, the pace of price inflation has accelerated this year and  the past three months has seen a 9.3% rise, or over 42% at an annualized rate. Expectations of further price gains is also a common feature of asset Bubbles and that also appears to be present; a recent Daft.ie survey showed respondents expect Dublin prices to rise by an average 12% over the next year, up from 6% twelve  months ago, even though  only 15% believe housing in the Capital is still good value (the  value figure for housing ex Dublin is 50%).

Price expectation is an important determinant of  the actual house price trend , notably in terms of the user cost of housing ( the total cost of buying a home with a mortgage, including the mortgage rate, maintenance, depreciation and any tax breaks). That user cost is now negative, particularly so in Dublin, because the expected capital appreciation from buying a home exceeds the other costs, including the mortgage rate.

Bubbles are also often associated with leverage and Dublin fails the Bubble test on that measure as credit is clearly not a driver, or at least credit from the main Irish mortgage lenders. Data from the Banking and Payments Federation Ireland (formally the IBF) showed that the number of new mortgages for house purchase  in Ireland amounted to 5763 in the third quarter, against total property transactions of 11,257 as reported in the Property Price register, so 51% of transactions were funded by Irish mortgages, a proportion that has risen through the year ( from 46% in q1) but is still well below the 80%-85% one associates with more normal market conditions.

A final Bubble test is whether  asset prices make sense relative to fundamentals and here there is often room for debate (witness the range of views on US equity markets and Euro bond yields). In terms of housing one metric is to compare prices with  private rents , as the latter represents the amount consumers are willing to pay for the utility housing provides . Rents nationally, as reported by the CSO, have been rising now for four years, by a cumulative 21%, and have picked up momentum again in recent months after a sluggish period earlier in the year, increasing by 2.5% in the  three months to October. The CSO does not provide a regional breakdown but Daft.ie does , and their figures broadly track the official data. The website shows  strong double digit growth in Dublin rents (around an annual 15% of late, with growth elsewhere at less than half that pace)  and provides detailed rental figures across housing size and type. For example , a 3-bedroom house  in Dublin currently rents at an average €1,518 per month, or €18,216 a year. In theory, the price of any house, discounted at an appropriate rate, should give a present value equal to the rent. If we use the average new mortgage rate as our discount rate ( 3.25%, as quoted by the Central bank) that  Dublin rent implies a house price of €560,000. The Central bank data has been criticized and is going to be revised so an alternative would be to use the standard variable mortgage rate of around 4.25%. On that basis the house price would be  €430,000.

How much is the average price of a house in Dublin? Our own estimates, based on updating the Irish Permanent index (no longer published) with the CSO index gives an actual  figure around €300,000, which is broadly consistent with the average asking price of €325,000 quoted by Daft.ie. The median price of Dublin property transacted  in q3 on the Property Price register was under €280,000 so the implication is that prices in the capital are still not excessive relative to rents, despite the recent pace of price appreciation.The latter reflects ,in part, a recovery from over- sold territory but nonetheless ticks a few Bubble boxes, but not all.