In last week’s Sunday Independent, we learned that a substantial fraction of the population – almost two in five – are worried about another housing crash. The public have every right to be concerned about what’s happening in the housing sector. As each year passes with only a small fraction of the 50,000 or so new homes needed being built, we run into more and more bottlenecks.
However, what happened the Irish housing market – and indeed the wider economy – in the period 2001 to 2012 was a bubble, one of epic proportions that will be used in textbooks around the world for decades to come.
It has all the defining hallmarks of a bubble. The first part of a bubble is an initially benign economic boom. In Ireland’s case, this was the start of the Celtic Tiger in the mid-1990s, which brought about rising prices, especially for housing.
It is important to remember that, with two exceptions, house prices had been largely unchanged for twenty years from the 1970s. However, year after year of rapidly increasing prices created a new normal and this convinced both borrowers and lenders that things had changed.
A major driver of Ireland’s economic growth was a very benign global economic environment, following the end of the Cold War. Tied to this was the Single European Market and a period of financialization across the developed world.
Financialization meant in practice the rise of universal banks and, with them, the death of Building Societies. These specialist institutions were not ‘too big to fail’ and so had to lend prudently to survive. Ironically, Building Societies were among the loudest in calling for the deregulation that would see them gobbled up by the new larger banks.
Ireland’s banks, which had existed as banks for the commercial sector since the early 19th century, now had a new business arm – mortgages – and access to almost unlimited capital from overseas. It was partly this lack of experience that led them to scrap the requirement for a substantial down-payment from those taking out a mortgage.
As late as 2000, the typical first-time buyer deposit was over 30%, according to Central Bank figures. But by the mid-2000s, this had fallen to less than 10%. Indeed more than one quarter of first-time buyers in 2006 had no deposit at all.
And this is what was at the heart of the Irish bubble – and indeed all bubbles: a glut of capital. One of the main chapters in my doctorate looks at what drove the Irish bubble and crash and it found that easy lending was at the heart of pushing up house prices between 2001 and 2007. This is in contrast to the period from 1995 to 2001, where a mix of fundamentals drove up house prices.
The fall in house prices after 2007 reflected a combination of expectations realigning and prices finally reflecting all the new supply built in the bubble, particularly outside the main cities.
Probably the single best statistic to spot a bubble is not trends in house prices per se, but rather trends in sale prices relative to rental prices. Investors call this the yield and it can be thought of as the equivalent of an interest rate: what percentage of the value of the property is the annual rent? Or, flipped around, how many years rent do you need to buy a home?
This one measure is hopefully enough to show just how different the housing market is now to 12 or 15 years ago. In 2002, the average Dublin property sold for 20 years rent. This is in line with international norms, where a range of 15-25 years is typically given as normal.
However, by late 2006, the average Dublin property was now selling for 33 years rent. All the extra new homes that were built should have lowered housing prices – and they did have an impact on rents. But the glut of mortgage credit meant that, even when rents fell, price rose.
Since the peak of the market in 2007, though, yields on property in Dublin – and all across Ireland – have normalised. This happened because prices fell by far more (roughly 55%) than rents (roughly 30%). This was a much-needed correction and a much more sensible multiple of annual rents has prevailed in the market over the last five years.
With capital not running riot in the Irish housing market, and with yields at healthy levels, there is little risk of a crash similar to the one we have just seen. But does this mean that there is nothing to worry about when it comes to Irish housing?
Absolutely not! If anything, the problems in the housing sector now are the opposite of those from a decade ago. Instead of a glut of housing, there is a scarcity – an extreme scarcity in the cities.
If the country were at risk of a housing bubble bursting, there would be clear implications for policymakers. In particular, the Central Bank would need to take action. Instead, what we have is an acute lack of homes. I estimate that in Dublin, over the last six years, just one new dwelling has been built for every five new households formed.
Instead of the Central Bank, it is the Department of Housing that must lead the charge in tackling our current housing woes. Moves to control rents or help first-time buyers are really about demand. But the problem is in supply. That should be the focus until the country is building more than 40,000 new homes a year.
An edited version of this post was originally published in my column in the Sunday Independent.