Author: Daniel1

Irish Housing Market Update

  1. The housing stock per head is still falling

Housing completions in 2021 amounted to 20,433 which is marginally down on the previous year and lower than the prepandemic figure of over 21,000 in 2019. This means that the housing stock is rising by around 1% a year and as such below the growth in population so the housing stock per head is falling, and has been declining since 2008.Planning permissions are running at around an annual pace of 40,000 and although not translating on a consistent basis into actual builds we expect completions to pick up strongly this year, to 25,000 and as such outpace the rise in population.

2.Employment growth is very strong

Housing demand is driven by household income growth , in turn strongly impacted by changes in employment. Ireland is again close to full employment with the vacancy rate at record levels .The Government’s fiscal support during the pandemic helped support the housing market by preventing a fall in household incomes, and employment in professional and other higher income occupations continued to rise.

3.House price growth is in line with fundamental models

There are various approaches to modelling house prices and we prefer a simple fundamental model comprising household income , the housing stock per head and real mortgage rates.The model tracks actual prices fairly well and does not point to a fundamental overvaluation (prices are actually modestly below fair value in the model ) and values should be rising given a combination of weak supply and rising employment and incomes. The predicted rise in 2021 was 6.7% (it is the annual average ) against the 8.3% outcome as per the CSO residential property price index . For 2022 the forecast is 10.0% which given that price inflation ended 2021 at 14.4% implies an end-2022 figure of around 6%, with the deceleration largely due to our expectation of a significant increase in housing supply.

4. Mortgages are still affordable relative to the long term trend.

The average new mortgage for house purchase in 2021 was just under €250,000 which assuming a 25-year term equates to €1150 a month given the average mortgage rate last year. That is actually well below the average monthly rent nationally and on our affordability model amounts to 26% of gross income. The long term average (going back to 1975) is 28.5% so on that basis affordability is by no means stretched, although the issue for many is accessing a mortgage and a property to buy. It is also noteworthy that the average loan to value appears to be falling, meaning higher deposits from buyers, no doubt reflecting the Help to Buy scheme and the scale of ‘forced’ savings during Lockdowns.

5. New Mortgage lending to rise to €13.6bn this year

Gross mortgage lending amounted to €10.5bn last year according to data from BPFI, which was over €2bn up on the previous year and the strongest annual figure since 2008.Switching has picked up but most lending is for house purchase, amounting to €8.6bn, with two-thirds of that going to First Time Buyers. In the coming year we expect the forecast rise in house completions to drive a significant increase in the number of mortgages for house purchase ( to 42,000 from 35,000 last year) which allied to higher house prices yields a figure of €11.4bn for house purchase. Total mortgage lending is projected at €13.6bn.

6. Net lending is positive again but weak

Perhaps the most striking aspect of the current house price boom is that it is not being driven by credit, as on past occasions.This in part reflects the impact on leverage from the Central Bank’s mortgage controls, with the average Loan to Income at 3.3 which is the lowest in the euro area. Institutional buying is also significant but households are repaying debt as mortgages from the previous boom mature. The result is that net mortgage lending last year rose by just €850m, or 1.2%, which is well below the euro average figure of 5.4%. The projected increase in gross lending should help to boost the net figure in 2022 and we expect an end-year increase of 3.5%.

7. Rent rises also unsurprising

Using data from the CSO on private rents actually paid, last year saw a marked change in the market; rents nationally were falling on an annual basis in the first few months of the year before picking up sharply to an 8.4% annual increase by December. Again this is in line with our fundamental model, driven by employment and the housing stock, although our projected rise in house completions does feed through into a slowdown in rental growth in 2022, to 4% by year-end. This may be an underestimate though, as it would appear that the supply of rental properties is being adversely impacted by rent controls

8. Mortgage rates may rise.

85% of new mortgages are on a fixed rate and that trend has been in place for some time now, so impacting the stock of outstanding mortgages and making the market less sensitive than it was to changes in ECB rates. Nonetheless , just over half the existing mortgage debt in Ireland is on a variable rate, with the majority of those loans on a Tracker rate, which moves with the ECB’s refinancing rate.The prospect of an increase in the latter has increased as the ECB now appears inclined to tighten monetary policy this year although any initial moves would be via the deposit rate, which would impact new variable rates and new fixed rates. Nothing is set in stone as yet but it is likely that borrowers will face higher rates for new loans by the autumn or earlier, with Tracker rates moving up in 2023.

ECB opens door to rate increases.

Today’s ECB press conference (3 Feb 2022) marked a very significant change in ECB rhetoric, and it now looks far more likely that interest rates are on the way up; the market is currently priced for short term rates to be 0.3% higher by year-end and to turn positive by the spring of 2023.

That may or may not materialise but it is clear that the recent upside surprises to EA inflation has shaken the ECB’s previous belief that inflation would fall steadily in the early months of 2022. That view had prompted President Lagarde to state that it was ‘highly unlikely’ that rates would rise at all this year, but when asked she refused to reiterate that line, arguing now that ‘the situation had changed’ and that the ECB was data dependent. Lagarde also noted a few times that the unemployment rate in the EA had fallen to a historic low of 7%, thus raising the risk of ‘second round’ effects i.e. higher wages feeding into higher costs and prices.

Inflation is now deemed subject to ‘upside risks’ and given that and the overall hawkish tone it was odd to see that the monetary policy statement still included the line ‘the Governing Council expects the key ECB interest rates to remain at their present or lower levels‘ (my italics), presumably an oversight.

The March meeting now assumes greater importance, as that will include updated Staff forecasts. The inflation projection for this year will almost certainly be revised much higher(it was 3.2% in the last forecast) but the crucial factor will be the figure for 2024, which was 1.8% and hence below target but could now move up to 2% or above.

The timing of any rate increase is complicated somewhat by the present ECB commitment to end QE before raising rates. The PEPP ends next month but as it stands there is no end-date fixed for net asset purchases, which from October are set at €20bn a month. So to raise rates this year the Governing council would first have to terminate net purchases.

What does this mean for Irish mortgage rates?. Any initial moves by the ECB would be through the deposit rate, which would affect market rates and hence new variable mortgage rates and new fixed rates. The refinancing rate, which affects Tracker mortgages would be unchanged initially but would probably rise as well as we move into 2023. This is not set in stone and weaker economic growth or a spike out in government borrowing costs might change things, but as its stands it appears the ECB is likely to tighten monetary policy sooner rather than later.

Modified Domestic Demand is not a measure of Irish Economic activity

The impact of multinationals on Irish GDP has in recent years prompted the CSO to publish other measures which are deemed to better capture ‘real’ economic activity and income in Ireland. Although not recognised internationally, these concepts are now often used by the Department of Finance, the Central Bank and some private sector forecasters in their projections.

One such measure is Modified Domestic Demand (MDD) but it is not a useful or indeed meaningful concept in terms of the output and income of the Irish economy.. Lets start with domestic demand itself, which is simply the total spending on goods and services by consumers and the government plus capital formation. The latter captures spending on construction, investment by firms on machinery and equipment, plus what is termed Intangibles, defined as spending on R&D and the creation of Intellectual property. This spending used to be seen as a cost but under revised National Accounts definitions is now included in the GDP figure as a source of capital creation.

To give some context, taking figures for 2020, personal consumption amounted to €100bn, government consumption was €40bn and capital formation €148bn giving a total of €288bn. The value of stocks produced but not sold is also added (€5bn), so MDD amounted to €293bn in that year. Note though that the stock component is small but is a production rather than a spending figure, unlike the other three.

Yet some of that domestic spending went on imports (i.e. goods and services produced elsewhere) which is precisely why total imports are deducted from the GDP figures to avoid inflating the amount of goods and services produced here. To say , therefore, that domestic demand will rise by 10% tells us nothing about where that demand is met from- will there be a huge boost to Irish firms or will that demand be satisfied by firms abroad. Similarly no account is taken of exports. It is one thing to argue that some multinational exports help to overstate Irish income and output but another to ignore all exports from whatever source, be it from indigenous firms or multinationals; €150bn of exports in goods alone were shipped out of this country in the first eleven months of last year.

Then comes the modified bit. The capital formation figures, as noted , include spending on Intangibles, which in Ireland are dominated by multinationals, extremely volatile even on an annual basis and exceptionally large. They boost capital investment but in effect have little impact on total GDP because most are service imports ( and hence take a negative sign in the GDP sum). While other imports are ignored the CSO modify the domestic demand figure by deducting R&D and Intellectual property imports, amounting to €100bn in 2020. One final deduction is made, which is the value of aircraft relating to leasing , although much smaller in impact, at €9bn in 2020. As a result modified capital formation drops to only €38bn (from €148bn) so MDD in total is reduced to €183bn from the original €293bn. GDP in that year was €373bn.

One argument put forward in defense of MDD is that it is highly correlated with employment, which is true, but the correlation between employment and GDP over the past decade is also very high, at 0.97. It is simply not a measure of output or income in Ireland, or even the output of the domestic economy. One final point: forecasting Irish GDP is difficult enough, but good luck in projecting spending on intangibles, which is the main modification in the MDD concept.