Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

Irish house prices: calling the bottom and worrying about the next bubble

The latest House Price report was released yesterday. The commentary is provided by Sheila O’Flanagan, one of Ireland’s best known exports as an author of fiction but also in a previous life a sovereign bond trader. Her commentary is well worth a read and focuses on the role of fear in the market.

The latest news

The quarter-on-quarter fall in house prices in the third quarter of the year was 3.5%. This is once again in the 3-5% range, i.e. house price falls were of a similar scale to the previous 12 quarters. For the third quarter in a row, the fall in Dublin was greater than the fall outside Ireland’s five main cities. Indeed, there are only two quarters (the final two of 2010) where the average asking price in Dublin fell by less. As a result, asking prices are now 51% below the peak on average in Dublin, compared to 45% elsewhere in the country.

Asking prices actually rose in Galway (city and county) and in a more substantial way in Monaghan and Carlow in the third quarter of the year. It’s unclear what’s driving this. One could argue it could be just an artefact of the quieter summer months. However, this didn’t happen in 2008, 2009 or 2010, so I think what’ s more likely to have happened is that sellers (and/or their estate agents) are trying to factor in bidders’ discounts below the advertised price. Given the subsequent experience of other counties where asking prices have been stable for three or even six months, I would expect prices to fall in those areas in the next quarter.

The key supply-side metric, stock sitting on the market, remains stubbornly high. This is particularly the case in Munster and Connacht-Ulster, where time to sell is typically 9-15 months. In per capita terms, stock sitting on the market is relatively low in Dublin, where the typical time to sell is just four months, and is still high but steadily falling (slowly) in Leinster.

Calling the bottom

Three month ago, when the last House Price Report was released, I put its figures into a longer-term context. In particular, I compared current asking prices with long-term series for two standard metrics for calculating the value of housing – income multiples and rent ratios. Both of those metrics suggested that the average house price in Ireland “should” be about €150,000. As of three months ago, it was €201,000 and it is now €194,000.

How does that compare with the fire-sale prices we are seeing? Last week, I took a look at the latest fire-sale prices in Ireland. The finding was that the typical fall in price from the peak is of the order of 70%. A 70% fall in the typical value of a home would equate with an average house price of €115,000.

I think the fire-sale prices differ from equilibrium prices in two key respects: firstly, they are almost exclusively cash-only prices (i.e. no mortgage credit). And secondly, they are overwhelmingly investors, not owner-occupiers. As longer-standing readers of the blog may remember, part of my academic research is investigating just how investors and owner-occupiers differ in their real estate decisions. But theory would suggest that owner occupiers will pay more, like for like, than an investor will. So 70% marks the watermark for the Irish economy as it currently stands, an economy without credit.

But what if Ireland does actually return to being an economy with credit? When might the market bottom out in such a circumstance? It’s worth noting just how steady the average quarter-on-quarter fall in asking prices has been since 2008, at basically 4% with only minor variations either side. What would happen if this trend continued? If asking prices continue to fall 4% every quarter, by the first quarter of 2013, the average asking price nationwide will be €150,000, or 60% below the peak, in line with the expectations from using income or yield metrics of what house prices should be.

Average house price (and how long to reach it), by different measures

The graph above shows the average level of house prices at various different points in time/scenarios and also (on the right-hand axis) how long it would take in quarters of 4% falls to get from current asking prices to that level.

Worrying about the next bubble

If, however, credit hasn’t returned by the start of 2013, if the Government hasn’t changed tack and the banks are still trying to “deleverage” (i.e. ignore new lending and run down old lending), then prices will continue to fall. They may continue to fall for probably another two years. On-going 4% falls each quarter would mean prices were 70% below the peak, or €115,000 on average, by end-2014.

The risk, of course, is that credit doesn’t return until that point is reached. Were that to happen, instead of the bottom of the market looking like it should, i.e. prices stabilise and then increase in line with inflation, prices instead would be 33% undervalued (according to the two metrics I’ve used above). This overshooting on the way down is a real danger because it risks creating a bubble on the way back up. After all, we all know what happened the last time house prices increased at double-digit rates!

Another bubble is probably farthest from the minds of most, including the Government, at the moment. However, it’s precisely when that’s the case that we must put in place the protections we need, such as site value taxation, maximum loan-to-value and even a ban on variable rate mortgages. I’ve heard that a number of US retail banks have had their interest in setting up in Ireland stymied by the Financial Regulator, probably out of fear of deposit flight.

But if the Government is effectively shutting Ireland off to new banks, then it is even more imperative that our existing banks serve the function for which they were saved using our money. The next round of stress tests for Irish banks, in early 2012, offer the perfect opportunity to set aside capital specifically for new lending. Banks are petrified that new lending equals new write-offs down the line – as long as they base it on conservatives multiples of rental income, there is little risk that will be the case.

House prices bottoming out sooner and without the melodrama of overshooting and another bubble, or prolonging the bust for another two years and risking a new bubble? The choice is with the Government.

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      • Jagdip Singh ,

        Hi Ronan,

        Superb presentation, Oxford’s learned environs are obviously paying off!

        There is one observation I would make, and that has been made to me in a property valuation context previously by one of the industry’s old hands. And that is that property prices are like someone travelling in an elevator. And under normal circumstances, the elevator will comfortably bring you from one floor to another.

        However in the case of a crash, it’s as if the cable is cut and you call towards earth. And trying to fix a theoretical bottom based on fundamentals is about as feasible as waiting until the elevator just crashes to the ground and then jumping. It doesn’t work.

        It’s the same on the way up in a bubble; the fundamentals of earnings ratios, rent yield (sometimes), supply:demand, cost of construction excluding land all tell you that the market is over-valued but perception is all, people will sacrifice income and stretch themselves if they see a tax-free capital gain of just €10k a year, never mind the €30-60k that was not uncommon during the boom.

        So congratulations on an attempt to call the bottom based on fundamentals – and I for one have not seen this clever format before – but the overshoot based on perceptions is probably a very difficult one to call. I recall Min Noonan saying there was evidence that after the bottom was reached there was a 20% bounce soon afterwards. I wasn’t able to locate the research which was apparently based on experiences in Seattle, Washington but I did analyse the Halifax series for the UK and found no evidence of such a general bounce.

        • David johnston ,

          Yes, Ronan, things are still getting worse (sadly).
          With a big shadow inventory of homes upon which mortgages are effectively in default not yet addressed there may be further room to the downside. Asking prices really mean very little at present. It would be completed purchase prices that would suggest where true market values lie. an economy without excessive credit is a new idea. Anyone remember the 1970’s? The events of the Celtic tiger credit rush were more a historical aberration than a norm. They won’t happen again before 2090. (Kondratieff)

          • Niall ,

            It’s a terrible pity that competition in the market is being actively discouraged.

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