Economics Dan McLaughlinThe Irish housing market continues to confound those expecting a correction let alone a crash, with all the available indicators pointing to another strong start to the year.
Annual mortgage-lending growth is accelerating, reaching a new record of 26.1 per cent in February, and house prices nationally are still rising, increasing by 1.3 per cent in the first two months of the year, taking the value of the average home over 13 per cent above its level in February 2003.
This price performance is surprising against a backdrop of record housing supply and reports of falling rents, raising concerns in some quarters that a "bubble" has developed, i.e. prices are being driven by expectations of future gains and are no longer explainable in terms of fundamental economic analysis.
Interestingly, new research by the Irish Central Bank, which has itself voiced concerns about residential property values, rejects this bubble view, concluding that "there is no apparent evidence of recent overvaluation in the housing sector" and that prices "are in line with their long-run equilibrium value".
The research paper, by Mr Kieran McQuinn, is entitled A Model of the Irish Housing Sector and is available on the Central Bank's website. In the model, the supply of housing depends on price, building costs and the cost of building land - a rise in house prices boosts supply and hence augments the housing stock, but completions are negatively affected by an increase in land prices or a rise in building costs.
On the demand side, the key driver is income per head (which picks up wage and employment growth), with migration and the flow of mortgage loans also having a positive impact.
Interest rates affect demand too, with a rise in real rates having a negative impact. The price of housing is then determined by the interaction of these demand and supply factors and when the model was fitted to quarterly data over the 1980-2002 period, it explained some 80 per cent of actual price changes, picking up the main turning points in the housing cycle.
A few examples will serve to illustrate the dynamics of the housing model. A fall in real interest rates, such as followed Irish membership of the euro, boosts housing demand for any given level of income, and hence raises prices.
This in turn will eventually give rise to additional completions and the resulting rise in the housing stock will serve to restore equilibrium.
Similarly, a rise in employment or wages or an increase in migration will boost demand, setting off a similar market reaction, with price gains giving rise to more completions. Supply is very responsive to price in the model and it is worth noting that this works both with rising and falling prices. A generalised price fall, should it occur, would result in lower completions, which would act as a factor putting a floor under prices - the more responsive the supply, the smaller the downward price adjustment.
Of course, supply has risen dramatically in recent years but this has yet to fully offset the strength of demand, despite the rise in mortgage debt, leaving the paper to note: "While house prices are undoubtedly high by historical levels, the combination of higher disposable incomes and lower interest rates means that the affordability of relatively higher mortgage payments for Irish property owners is quite sustainable in the medium term."
If one accepts the model as a useful approximation of reality, the route to stable prices is clearly signposted from a policy perspective. On the demand side, a rise in interest rates would dampen borrowing and hence housing demand, and no doubt would have been forthcoming before now if the Irish Central Bank still had monetary sovereignty. That now lies with the ECB of course and, as such, is out of Irish control, perhaps even perversely delivering lower interest rates in the near term, although the chances of that have probably receded. Measures to reduce income via tax increases would also dampen demand but one doubts these would be contemplated. We are left with supply as the only mechanism available to restore equilibrium to the market but the authorities can do little to influence this in a positive way, other than ensure the existence of a planning process which is efficient and transparent in delivering housing in keeping with the infrastructure available in a given area.
The model outlined above does include a variant which has a rental component and one could argue that rents should play a role in demand given the presence of investors in the property market.
My own rental model shows that the average rental yield nationally is currently around 4 per cent and that rents are fairly low relative to mortgage payments, and both should act to dampen investor demand. That allied to the scale of supply argues for a steady deceleration in house-price inflation this year as the market mechanism works to restore the market to a better balance.
