The current state of Ireland’s housing system is well known: plagued by a chronic and growing shortage, especially in Dublin, both sale and rental prices increase quarter on quarter. Since the third quarter of 2012, sale prices in the capital have increased in all but three quarters. In the rental market, they have increased in every single quarter.
The fact that both sale and rental prices have now been rising longer than they were falling has led some to argue that we are in another housing bubble. Among the most prominent of those arguing another bubble is coming is David McWilliams.
On the face of it, one would have to be brave to bet against him. David argued a housing bubble was coming down the tracks as early as the late 1990s. Some write this off as “a stopped clock is right twice a day”. However, watching on YouTube his debate with Austin Hughes in October 2003, it is not the prediction of a crash that is arresting, rather how eerily accurate the mechanisms and fallout.
A couple of weeks ago, David argued that he believes there is another bubble building ‘very rapidly’ and that a crash will happen in ‘the coming years’. Outlining his case, he made two main points. The first is that you don’t need credit to have a housing bubble. The second concerns the price of a home relative to incomes. David, and others, believe that is simply not sustainable for three-bed semis in Dublin to cost €450,000 when an average wage is one tenth of this.
There are two minor quibbles with this latter point. The first is that almost nobody buys a property on their own anymore. The average new mortgage has gone from having 1.3 incomes in the 1990s to 1.7 incomes now. So the proper income in David’s example would be the average household income of roughly €75,000, not a single earner.
Also, while appealing, the average property price is not the correct one to use in this case. First-time buyers don’t buy the average property. They typically buy newly built homes at the edge of the city, in other words far cheaper than the overall average. So instead of €450,000 to €45,000, the real comparison is probably more likely €325,000 to €75,000.
Still, that means that the house price is 4.3 times income, well above the typical level regarded as affordable, which is three times income. But t is important to distinguish between what is healthy and what is sustainable. It is not healthy to have high housing prices in major cities, compared to people’s incomes. But cities around the world have been living with this for close to fifty years in some cases.
In Ireland, the ‘Dublin premium’ is just 30 years old. Up until that point, the average price of a home in the capital was the same as the rest of the country. It probably had a bedroom less and a much smaller garden but the price was effectively the same.
But this point works both ways. This is a phenomenon that has been building up for 30 years. It stems from restrictions on land use – the hidden costs of planning and zoning – that prevent housing supply from meeting housing demand. Other cities have had similar supply shortages for 50 years, so it is not obvious to me that expensive housing per se is enough to cause a collapse.
David’s other point is that you don’t need credit for a housing bubble. This is presumably to pre-empt someone like me arguing that the new Central Bank mortgage rules effectively rule out the type of lending that cause the 2000s bubble and subsequent crash.
The godfather of studying bubbles, Charles Kindleberger, argued that a rush of capital (i.e. money) was a necessary ingredient for any bubble. Capital comes in two forms: credit or equity, in other words borrowing to buy or using up savings to buy.
There are plenty of examples of bubbles where people have cashed in their savings to buy at unsustainable prices. It is argued that the dot-com bubble is the best recent example of this. What makes David’s argument trickier to carry over to housing is that real estate is typically very highly leverage in the first place; in other words, there’s lots of debt associated with property.
A savings-fuelled housing bubble is a much rarer phenomenon. Nonetheless, Australia, New Zealand and Canada have found themselves worrying about this problem as their housing markets bear the brunt of Chinese savers’ desire for external assets. But it’s not just about ownership. The key thing about a bubble is the ratio of sale to rental prices.
In markets like Auckland, Sydney and Vancouver, foreign purchasers of property left their dwellings empty, effectively taking them out of the market. But if something should trigger a departure for these buyers, a flood of new homes would come on to the market.
Earlier, I mentioned that both sale and rental prices have been increasing. Indeed, since 2012, rental prices have actually increased by more, in percentage terms, than sale prices. Rental prices are up three quarters in Dublin and by half outside Dublin from their lowest point. Sale prices are up by 60% in the capital and 47% elsewhere.
The single best barometer of a housing bubble remains the ratio of sale to rental prices in housing. It is generally thought of as safe to pay 20-25 times the annual rent to buy a home. This is the same a home giving you a return of 4% to 5% a year. Those buying four-bedroom homes in West Dublin currently are spending 23 times the rent on average, right in the safe zone.
In the Celtic Tiger bubble, people were prepared to pay 40-50 times and in some cases up to 100 times the annual rent. That key difference tells me that we should not be fighting the last war, when it comes to housing. We have a shortage of housing and that gets tackled one way only: more homes.
An edited version of this post was originally published in my column in the Sunday Independent.