An important indicator that the market is stabilising is that private rents in the first seven months are up less than 5 per cent on last year, writes Eunan King

Following a deceleration in house price inflation last year, the early part of this year witnessed a resurgence following the lifting of budgetary measures affecting investors.

The "buy-to-let" market appears to be growing strongly and there seems to have been a rise in developments sold "off the plans" that will not come onstream until late this year or early next. The market, like housing markets in the US and Britain, is also being supported by the unattractive state of equity markets.

However, caution is warranted. While we were very upbeat about house prices in the last number of years, that view was based on a shortage of supply relative to our estimates of demand. In a 1999 assessment of the strength of the housing market, we estimated that demand could be as high as 56,000 per annum until 2006. This was at the very top end of our range of estimates of likely demand. At that time, completions were just rising through 40,000. Prices therefore continued to firm.

However, in 2000 and 2001 completions were 49,812 and 52,602 respectively. Completions in the first quarter of 2002 were more than 8 per cent above the same period in 2001. Home Bond data, compiled under the Home Bond insurance scheme, show an even more buoyant picture - up by 54 per cent in the first half of 2002 on the same period in 2001.

Home Bond data and house completions diverged sharply last year but we attributed this to a huge upswing in Home Bond applications in the first half of 2000, followed by the tax penalties imposed on investors in June of that year. The stock of Home Bond applications obtained in the first half of 2000 appears to have been sufficient to allow completions to rise in 2001, in contrast to a decline in applications. The number of applications in the first half of 2000 was 20,251. In the first half of 2002, however, applications totalled 24,143.

The preliminary results of the 2002 census released recently allow us to make some further analysis of the change in demand for housing over the period 1996- 2002. In the six-year period, the population rose by 48,000 per annum. Over the same period, house completions also rose by an estimated 48,000 per annum, if we pencil in 56,000 completions for this year.

Since some of the completions were replacement dwellings, the net addition to the housing stock is less than 48,000 per annum. On the basis that replacement is about 1 per cent of housing stock we estimated net additions over this period were about 35,000 per annum.

If we relate the population change to this estimated addition to the housing stock, we find that, on average, the population rose by 1.4 persons per new household. We had earlier estimated that the rise in the population from now to 2006 would be about 44,000 per annum but our assumptions on net immigration may now appear too conservative.

Net immigration averaged 25,000 per annum in the 1996- 2002 period, according to the census, whereas we had assumed net immigration would peak at about 18,000. If we push our assumption for average net immigration up to 22,000 per annum, this would result in the population rising at an average of 48,000 per annum, the same as in the intercensal period just past.

This would suggest that the required supply of new housing will need to be at a pace similar to that of the past six years - about 48,000 a year.

The current pace of new housebuilding is, however, about 56,000 per annum. This rate of housebuilding is unlikely to be sustained over the next four years.

With house construction running at rates that are at least in line with underlying demand, then prices should not rise much, if at all from here on.

There are several factors that could influence this view. Delays in the planning process, a current complaint among builders, may curtail supply. Immigration may be higher or lower than the assumption of 22,000 per annum. Demand for holiday homes may be greater or less than in the 1996-2002 period.

We estimated the number of holiday homes built in the 1996-2002 period at more than 4,000 per annum. This was done by assuming that in counties where the rise in the population was less than the rise in the number of houses, the reason was holiday home construction.

We estimated how many houses would have been built in such counties if the ratio of the population increase to new houses were the same as in the rest of the State. This is probably a conservative estimate since counties where the population change to new house ratio was not much above one are also likely to have seen holiday home construction.

Our guess is that holiday home demand in the period ahead may be greater than 4,000 per annum, because the tax on investor measures impeded holiday home investment in the period just past. The population now in work is much greater than at the beginning of the intercensal period from 1996 and, therefore, the aggregate income available for holiday home purchase in coming years is correspondingly greater.

The evidence from house prices to support this analysis - that demand and supply may be close to balance - is encouraging, if not yet compelling. However, it does not support the view that there is a large excess of demand over supply.

House prices, on the Permanent TSB measure, rose on average by 0.8 per cent per month in the seven months to July. However, the most recent three months have seen the pace drop to less than 0.5 per cent per month. In the past four years, the monthly rate was around 1.5 per cent per month, except in 1998, when it was 2.2 per cent.

Prices are up only 4 per cent in the first seven months of this year compared to the same period in 2001, despite the surge in demand following the lifting of the investor tax measures in the Budget.

The price of existing houses has risen by a similar percentage. From this it would appear that balance is certainly closer than in any of the past four years.

An important indicator that the market is stabilising is that private rents, as measured by the CPI, in the first seven months of this year are up less than 5 per cent on the same period last year. Since November, rents have been stable and indeed fell by 1 per cent in May and were unchanged in June and July.

The three months to July show rents only 2 per cent above a year ago. The rental market is the key indicator of the balance between demand and supply.

Rents rose sharply in the past two years following activity cutbacks by investors on foot of Government measures of June 2000, at a time when the level of house prices had shut an increased number out of the possibility of home ownership, pushing them towards renting.

Eunan King is a senior economist with NCB Stockbrokers