Mortgage Controls, the ECB and the Irish Housing market

Ireland’s monetary policy is set by the ECB and has had a very significant impact on household income and wealth in Ireland over recent years, as well as a profound effect on the housing market, particularly in relation to house prices and the ownership of the housing stock. Yet little attention is paid to it, in contrast to say Germany where it is heavily criticised and indeed the subject of legal challenge.  Similarly, the Central Bank introduced mortgage controls five years ago ,which again has had a material impact not only on housing but on credit growth, the distribution of wealth in Ireland and indeed on the political landscape, begetting policies designed to mitigate the consequences of these  monetary and macro prudential decisions.

Let’s start  with the controls. The average new mortgage for house purchase peaked in 2008 at €270,000 and then plunged alongside house prices before  bottoming in 2012 at €174,000. Since then it has risen steadily, reaching €233,000 last year, which when related to  rising incomes and the much lower cost of a mortgage indicates that affordability is much improved and in fact is still better than the long run average.

Mortgage controls are designed to limit  household leverage, imposing a LTI limit of 3.5 ( with some exceptions) and the Central Bank acknowledged in 2015 that  one might expect this to dampen house price inflation, credit growth and also negatively impact housing supply. We do not know how the market would have developed in the absence of such controls but the Central Bank  made a stab at answering  in their recent Financial Stability Review , estimating that prices in the period to the first quarter of 2019 would have been around 20% higher, or 4% per annum, with PDH lending substantially higher, by some 40%.The Bank does not show an estimate for housing supply but if prices had been higher completions would presumaly have been stronger, although what is also clear  is that the longer term relationship between house prices and supply has shifted since the crash, in that house building  has been much weaker in response to the actual price changes observed than experienced in the past.

If housing demand exceeds supply prices and/ or rents will increase, with that split being affected by, inter alia, the growth in income for  would be buyers, the cost and availability of credit and the type of buyer in the market. So if mortgage lending would have been higher in the absence of controls  then  some would-be buyers are forced to rent or live at home if that is an option. This has thrown up the odd situation  where the average rent nationally in 2019 was around €1200 per month, while the average monthly payment on a new  FTB 25-year mortgage  was  €1076 i.e. the rental payment could sustain a mortgage of  €254,000 instead of the actual FTB average last year of  €227,000. Landlords are therefore taking on higher credit risk than banks, and the average LTI for  FTBs  is actually only 3.1, which may be too low in an economy where the cost of housebuilding is high and where the  average rental payment  would service a mortgage with an LTI of 3.5 . It also  looks very conservative compared to the UK, where the LTI  cap is  4.5, with a 15% exception on a rolling twelve month basis rather than a calendar year.Rental growth in the UK has also been much weaker than in Ireland.

The type of buyer has also changed. The introduction of mortgage controls  coincided (?) with the ECB’s decision to buy bonds under QE, which alongside negative rates has pushed  Government bond yields into negative territory, including Irish debt out to 10 years. That renders Irish residential rentals yields ( which appear to be above 5%) unusually attractive and so we have had an influx of institutional buyers into the market, which was not a feature of previous cycles. Since the end of 2014  institutional buyers have purchased a quarter of new housing according to the CSO data, rising to 33% last year alone, which is then rented, with housebuilders also now more inclined to pre-sell developments to institutional buyers rather than risk waiting to sell to individuals.

QE is designed to boost investment in assets other than bonds and so will push up house prices, but  at the same time the Central Bank controls have constrained   access to mortgages for households. That not only has implications for owner occupation but also wealth: gross Irish household wealth rose to €947bn in the third quarter of 2019, of which €545bn was in the form of housing, or €412bn net of debt.Wealth in Ireland is therefore disproportionately held in property and so the combination of controls and QE has and will have  broader implications for wealth in Ireland  and its distribution over time.

As to the future, QE is open-ended at present and the market is not priced for a return to positive ECB  rates for years so the yield on bonds is unlikely to rise sharply, thereby maintaining the demand for rental yield. Similarly the Central Bank appears happy with the mortgage controls as they are, albeit showing some concern about the profitability of Irish banks (too low, that is), and if change occurs it may be to move towards a debt service metric- the impact of a fixed  LTI limit on mortgage payments  when rates are 3% would be be very different if rates were 5%.

A demand shock could change everything ( rents fell by over 20% from 2008 to 2010) as indeed could a supply shock. That might be positive (an upside surprise in terms of house completions) but also negative – an extension of rental controls or a rent freeze would reduce the value of the housing stock and it would be a very unusual economic development if that encouraged more completions.

Irish Mortgage Regulations impacting housing market

In late January the Irish Central Bank announced a set of macro-prudential controls on mortgage lending, Similar regulations have been introduced elsewhere, in line with the new orthodoxy in central banking, which  seeks measures to influence credit growth outside the traditional interest rate channel, particularly as rates are currently at historically low levels. The Irish version imposed a loan to value limit of 3.5 on Personal Dwelling Home (PDH) mortgages, but in the current Irish context the  second limit, on Loan to Value (LTV) was seen as a more binding constraint. A  maximum LTV of 80% is now in operation on PDH  mortgage loans, with first time buyers allowed 90% on properties up to €220k. Banks are allowed some discretion , but it is limited in that only 15% of loans can exceed these LTV ceilings.

Contrary to some commentary (and expectation), the controls were not seen as having a material impact on prices, and the Central Bank’s research showed that the  main effects would be on mortgage lending and the supply of new housing. Of course the controls would be pointless absent some effect on credit creation and in the Bank’s base case lending falls by 9% on the introduction of the new regulations and subsequently recovers some ground, although remaining below the benchmark case ( i.e. absent any controls) for over seven years.  In simple terms the new rules will require prospective buyers to save for longer, which also implies greater pressure on the rental market for any given level of housing demand.

Six months in, there is some evidence that the measures are having an impact across the housing market. Mortgage credit standards tightened appreciably in the first quarter and the latest Central Bank data shows that mortgage demand eased considerably in q2, from very buoyant levels over the past year.  That change is also evident in terms of mortgage approvals, with the annual increase slowing sharply in the three months to May, to 17%, from 41% in q1 and 56% in the final quarter of 2014 ( the latter  was probably affected by expectations ). Indeed, the annual rise in approvals in May alone was less than 8% and our own  mortgage models points to drawdowns for house purchase of 5.2k in q2, unchanged from the previous quarter.  New mortgage lending is still growing strongly on an annual basis but at a much slower pace.

Turnover in the housing market , which picked up very sharply in 2014, also appears to be slowing, based on data from the Property Price Register. Transactions amounted to 10.5k in the first quarter of 2015 and  also exceeded  10k in q2, but the annual rate of growth slowed to 13% from over 55%. The June figure was actually 7% down on the previous year and although late additions to the  Register are common the broad picture is unlikely to be seriously altered.

What about prices?  An unusual feature of the current upturn in residential values is the relatively high share of transactions (over 50%) driven by cash and so it would be surprising if the mortgage controls did have a very significant impact in that area. Dublin prices did fall in the first three months of the year, by 1.6%, but rose by 2% in q2, with a similar pattern evident in the rest of the country (a 2% rise following a 0.3% fall). The market has certainly cooled relative to the first half of 2014, but smaller price gains rather than outright falls appears to be the order of the day.

What about private sector rents?  Here, data from the CSO does point to an acceleration in what was already a buoyant market; rents rose by 1.7% in the three months to December but then picked up by 3% in the first quarter of 2015, followed by a 2.4% advance in q2. That means rents nationally are only 2% below the all-time highs recorded in 2008 and are therefore likely to surpass that figure by the final quarter of 2015.  As for housing supply it is too early to tell. although with only 2,600 completions in q1 the base figure is already very low by historical standards.

The central bank model predictions are therefore panning out in broad terms; mortgage demand has slowed, approvals have eased and transactions have  been affected , although  the impact on prices has not been dramatic.  In addition, the  upward trend in rents shows no signs of abating and that  perhaps  best illustrates  the real issue in the market- the shortage  of housing supply in the areas people want to live.