As is probably little surprise to most, house prices fell significantly again in 2011, the fifth year in a row that prices were lower at the end of the year than at the start.
According to Central Statistics Office figures, prices will fall by about 15 per cent in 2011, compared to 10 per cent in 2010 and 20 per cent in 2009. The average house price was down 44 per cent from the peak by late 2011, while the average apartment price was down 57 per cent.
Prices in Dublin have fallen the most - detailed regional information from the property website Daft.ie shows that while asking prices in some rural counties are down by 40 per cent from the peak, those in Dublin are down by more than 50 per cent on average. If the typical buyer is securing a discount of about 10 per cent of asking price, this means that prices have fallen by 55 per cent in the capital.
At first glance, it might make sense that prices in Dublin are falling by more than they are elsewhere. After all, isn't that where prices went craziest during the boom years? But 2011 also saw the first of the fire-sales of residential properties, principally by British auctioneer Allsop.
These fire-sales give us valuable data-points about what the 'sell-it-tomorrow' price of property around the country is currently, and they are telling us that property values are down by about 65 per cent in Dublin, but by up to 75 per cent elsewhere in the country.
So, are prices in Dublin falling by more or less? The answer lies in what economists call liquidity, the ease with which a seller can find a buyer. In markets such as Dublin, there are still some transactions taking place, so a seller is getting some signals from the market.
With lending down over 90 per cent though, there are very few transactions happening in most parts of the country outside the main cities. This means that sellers in provincial markets find it very difficult to gauge conditions when they go out to sell and are thus, given the sums of money involved, cautious on cutting prices.
So Dubliners should not necessarily regard current trends that suggest prices for their homes have fallen by more as a negative sign, or that Dublin will be punished more for its boom-time sins. Instead, they should see it as a positive sign: if everywhere has to fall by, say, 60 per cent, then Dublin is closer to bottoming out.
But just how far do prices have to fall from the peak? There are the "gravity fundamentalists", those who believe that what goes up must come down, in house prices as in everything else. And, in large part, they are right.
House prices in Ireland in 1995, just as the Celtic tiger started, were no higher than in 1975, when records started, once general inflation is stripped out. So by their logic, the average house price will have to fall from €360,000 to about €100,000 before the market bottoms out, or a 70 per cent fall from the peak.
Stagnant house prices in Ireland over those two decades was nothing to do with a stagnant Irish economy. It's probably one of the strongest findings in relation to house prices internationally: once you take account of inflation, house prices don't go up.
For example, over the last 50 years, house prices in the US have increased ahead of inflation by less than half a per cent a year.
It even stretches to a centuries-long perspective: a study of one canal in Amsterdam found that house prices increased by less than 0.1 per cent above inflation between their construction in the 1600s and today. Housing may be very good at fighting inflation and storing value, but it's a terrible investment if you're looking for capital gains.
However, gravity is not the only force at work in property markets. If we want to understand where prices will settle, we need to take account of the huge changes in the Irish economy since 1995. In particular, the typical household has more earners and - believe it or not - each earner takes home a higher disposable income now.
Given that healthy housing markets are almost entirely based on mortgage finance, in turn reflecting a household's disposable income, this matters.
Assuming the underlying multiple of household income hasn't changed since the 1990s, this suggests that house prices need to fall about 60 per cent from their peak.
The income multiple is not the be-all-and-end-all, however. It doesn't reflect migration and the balance between supply and demand, for example. Nor does it reflect the fact that Ireland moved from its own currency to the euro.
To do that, we need to look at interest rates and at the ratio of rents to house prices.
Assuming the troubled euro survives (with Ireland still in it), this means that the average interest rate on a mortgage should be different to what we had under the punt.
The rate might not be the 4 per cent that fuelled the headiest days of the bubble, but it should be less than the 8 per cent average seen in the 1990s. If it's above 4 per cent, but below 8 per cent, you won't go too far wrong in assuming that Irish mortgage borrowers will enjoy an average interest of 6 per cent over the lifetime of their mortgages.
The other piece of the puzzle is rents. Rents reflect disposable income, but also incorporate everything from migration and oversupply to the value of local amenities. Ultimately, the value of a property is determined by its rental value.
This is why what happens in the rental market should be of interest not just for tenants and for landlords, but also for owner occupiers.
Since early 2010, rents have effectively stabilised, particularly in the cities, suggesting some underlying value for accommodation, assuming rent supplement is not distorting the market.
So if we know the level of rents and prevailing interest rates, where will house prices settle? The relationship between house prices and rents is not a straightforward one, but it's easiest to see it thus: annual rent relative to the house price is the equivalent of the interest rate on a savings account.
If someone offered you a 5 per cent annual return on savings, you'd take it in this environment. But if that 5 per cent was on property, which carries greater risk, would you take it? Currently, those buying at the fire-sales are holding out for a 10 per cent return.
This presents first-time buyers with an easy rule of thumb if they want to mimic those fire-sale purchasers: to come up with their offer, they need only find out the annual rental bill of the property and multiply it by ten. It would also, however, mean a 75 per cent fall in property prices from the peak.
Fire-sale prices are cash prices, and a sustained 10 per cent yield on property here would draw in international investors pretty quickly, pushing up prices: rental yields in most European countries are closer to 5 per cent.
Based on what happened in Ireland before the bubble, a market with normal channels of credit should see the yield settle about 6.75 per cent. If the rent-house price relationship does indeed go back to normal, and rents stabilise where they are now, this would suggest that the average house price should be about €150,000, or a fall of 60 per cent from the peak.
The key phrase is "normal channels of credit". As long as there is effectively no mortgage lending in Ireland - lending was down almost 95 per cent by mid-2011 - house prices will not stabilise where they "should" be. They will overshoot down towards the cash-only price we are seeing at the fire-sale auctions. And overshooting is very worrying for two reasons.
The first is the mortgage arrears problem. Contrary to the government's actions so far, variable interest rates of 4-5 per cent don't cause arrears: negative equity and unemployment cause arrears.
And government policy in this area, bullying the banks about interest rates, is not even neutral, it is actually making the problem of arrears worse. Diktats that prevent banks returning to sustainable lending at sustainable interest rates mean they lend less, which pushes prices even lower, making negative equity - and arrears - worse, not better.
The second problem with the lack of any functioning mortgage market is that overshooting on the way down dramatically increases the risk of a new bubble in future. It may seem contrarian to the point of comedy to be worrying about the next bubble already, but the danger is real.
House price expectations are adaptive: this means that people take what happened over the last five years, expect that to happen over the next five and base their decisions on that.
This behaviour is at the core of how buying frenzies and bubbles happen. So falling below a 'natural level' of house prices in Ireland of, say, €150,000 to a credit-constrained price of €130,000 and then rebounding back up is not the same at all as reaching that natural level and staying there.
Ultimately, we must remember that recovery in the property market is about transactions, not about prices. If credit returns at all in 2012, we may see activity return and prices level off in Dublin and the other cities. But credit won't return until banks are told as part of their stress-test check-ups that while they have to deleverage, new lending is a separate category.
If that doesn't happen, prices will continue to fall into 2012 and beyond. Even worse, they may overshoot, making the arrears problem worse and even risking another bubble.
Monday, November 28, 2011
Property & Construction News - Review of the Year: Capital punishment
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