THE Irish economy is not out of the woods. There are quite a number of things that could yet go seriously wrong, including in the banks and with the public finances. Even the recovery itself could falter.
If you want to worry, fret about these matters. There is much less to fear from property prices.
Developments in Dublin over the past 18 months in particular have led to talk of a bubble. While property prices could fall again if there was another recession or a big external shock, they are not going to fall because of the bursting of another bubble — for the simple reason that there is no bubble.
Many people react strongly to anyone who says that the recent uptick in house prices in the capital is not a bubble. This is understandable. The effects of the property and construction crash have so traumatised the nation that we have gone from being blase about the risks of property price increases in the pre-2007 period, to being paranoid about them now.
Assessing the extent to which property prices reflect the underlying fundamentals is not an exact science, but there are a whole series of metrics which should be watched and, when taken together, give a very good indication of the sustainability of price rises. When these metrics begin to get out of line with historical or international norms, it is time to start worrying. Currently, none of the warning lights are flashing.
After a price overshoot, there is usually an undershoot The very definition of an asset price bubble is that prices overshoot the level that all supply and demand factors suggest they should be at. When a bubble bursts, the process goes into reverse. Then, prices tend to undershoot for a variety of reasons, including the drying up of credit and the postponing of purchases by buyers in order to avoid immediate capital loss.
Dublin prices rose faster than prices outside the capital during the bubble. Since the crash they have fallen further. With prices in the capital in March of this year (the latest figures available) still exactly half what they were at the peak in February 2007, despite the rises since 2012, there is no sign of a bubble. The uptick over the past 18 months is much more about a correction of the post-crash undershoot.
Bubbles can’t inflate without excessive credit
The growth in mortgage lending was extraordinary from 2002 until 2008. This was the central factor in inflating the bubble, as excessive credit expansion is in blowing up bubbles of most kinds.
But since the crash, that has all gone into reverse, and bank loans has been very hard to come by. The aggregate amount of mortgage lending by banks in the Irish market has been falling since 2008. And this credit crunch shows little sign of easing, according to any available data. Just last week the latest Central Bank figures on the banks’ combined mortgage lending showed that the downward trend continued up to March. This is entirely inconsistent with a bubble.
Prices to average incomes are now below the long run average
Up to 2007, property prices rose much more rapidly than incomes. This is usually a sign that something is awry. It was certainly the case in Ireland when, according to data in The Economist*, Ireland’s average property price-to-income ratio in 2008 was further out of line with its historical norm than any other country in-|cluded in |its database.
Since the crash, things have gone sharply into reverse. The huge decline in prices has far out-stripped falls in income. The price-to-income ratio is now below its long run average and among the lowest of the countries covered in The Economist’s database.
High property price inflation is not necessarily proof of a bubble
In the years 2000 to 2008, property prices in Ireland rose very sharply. But the increase was not exceptional, as the second chart shows. Many countries saw large increases.
Ireland is unusual in the scale of its crash, with real property prices now back at 1999 levels. Of the developed economies, only Japan has experienced a bigger decline over the same period.
Big increases in property prices do not automatically end in a crash. Britain, France and Sweden actually experienced sharper real-term increases than Ireland from 2000 and none has experienced a crash.
Why was Ireland different? Along with the unusually large increase in mortgage debt over the time, Ireland was an extreme outlier in the extent to which the supply of new housing increased. The annual output of new homes reached four times the long run average by 2006. This should have contained price increases (but it didn’t because there was so much excessive credit). When the crunch came, the underlying supply and demand factors moved closer into alignment and the market crashed.
This huge oversupply is still at play in many rural areas, and prices are very unlikely to rise by much, even over the long term. In urban areas, however, things are different. Less new supply came on stream up to 2007 (owing to space constraints) and, with so little new building over the past half decade and many people holding off on selling in the hope of getting a higher price in the future, the Dublin market is seriously undersupplied.
Figures contained in the latest report from property website Daft.ie show how tight supply is in the capital. In Dublin 10,000 homes are coming on the market annually, which represents just one in 50 properties. This is well below the norm in a well-functioning market.
All these facts and figures do not convince everyone that the recent increases in Dublin prices will not end up being reversed in another crash. In many conversations I have had on the matter people rightly point out that many supposed experts said there was no bubble even as late as 2008. Almost invariably, they ask if I was one of those bubble deniers. This is entirely fair, because anyone who dismissed the risks then has no credibility to speak on the subject now.
I didn’t live in Ireland for any of the boom and bubble years and didn’t comment much on property matters. While I will very candidly admit that I never thought the downturn would be as deep as it turned out to be, I hope readers might forgive me the vulgarity of citing what I did say on property.
Just over eight years ago — on April 12, 2006 — on an RTE Prime Time show about the property market, I said this. “Debt levels have reached levels where the warning lights are flashing urgently… taking on further debt at a time when there are big risks is something people need to be very careful about.”
On the risks of buying a property at that time, I said, “Make sure your income is recession-proof and that you are happy to stay in the home for five or 10 years.”