Courtesy of Mark Thoma, here is a nice graph with house price-rent ratios for five countries, including Ireland.

13 replies on “Bubbles”

It’s interesting to see how well the bubble inversely tracked interest rates right up until things went badly pear shaped last year. Clearly the Irish bubble was showing signs of being deflated gradually in 2000\2001 but the adoption of the euro and the subsequent ECB low interest rate policies in response to recessionary fears in Germany and France clearly exacerbated the problem for Ireland, as was widely pointed out at the time.
I’m rather intrigued by the Q1 09 upward spike for Ireland though – the fall in rents is clearly substantially worse than the fall in house prices which is not (yet at least) being seen elsewhere. Is there any explanation for this?


Ireland’s housing boom expanded housing supply dramatically whereas in other housing bubbles, most severely in the UK, spiralling house prices did not coincide with proportionate increases in supply. This dynamic aspect of Ireland’s housebuilding boom has, since the bubble collapsed and the banking crisis, resulted in huge numbers of over-priced housing with fewer buyers and tighter finance. Consequentially, developers have been forced to offer a proportion of these over-priced homes for rental.

Ireland’s combination of poor institutional mechanisms for repossession and bankruptcy and the unwillingness of Irish banks and government policy to permit downward price adjustment of housing is artificially moderating the decline in house price sales. On the other hand, unsold homes are being offered for rent which has led to a collapse in residential rents. This is why Irish housing is becoming more unaffordable not less.

The upward trend in P/E ratio of housing is not sustainable and it is envisaged therefore that there is a need for more public discussion and informed analysis of how the level of house prices will affect the broader economy.

Very interesting stuff. Does the 2009 Q1 spike indicate that sellers are reluctant to adjust to lower prices as rents fall? (Assuming prices are in some way a function of rent)

I assume we will see a downward trend again once repo’s kick in? Since buyers are dispersed and don’t necessarily have good info or advice, is it likely that they fail to take these things into account?

As i’ve said before, what i’d really like to see if a graph showing average monthly mortgage bills (assuming amortisation) vs average after tax household disposable income (including mortgage interest relief). Or even average rents vs after tax household income (including rent reliefs). This affordability gauge of cost (mortgage/rent bills) vs income (disposable household earnings) would take into account changing tax environments, falling interest rates, longer mortgage terms, more dual income households etc etc etc and i think would give a far better barometer of how ‘big’ the current bubble grew relative to the long term average.

A pity he did not include Australia. Property prices here are astronomical, compared to income. Rents are stable and values appear to be declining as the government is giving a $21,000 grant to first time buyers of new houses. Hence the market is in smaller homes depressing the median. For the moment, there is no bubble and no deflation, except in mining towns where it lasted three years and in Sydney, where it seemed to start in 2002. Oh and super expensive houses in the $2,000,000 dollar bracket. Odd, as the market here does not allow interest as a tax deduction except for rentals. But sales have plummeted.

My read of the Thoma graph is that there are too many houses in Ireland for the current population. Emigration is increasing and immigration from E U is reversing. Rents appear to be a more current marker of the value of property, as sellers will not sell unless they must to avoid loss of equity, which may have been illusory but human nature is slow to adapt. Foreclosures will have little effect as Ireland does not have the same culture as in the UK or USA: eviction is rare for historical reasons.

Can it be concluded that house prices would have almost corrected themselves at this stage if it was not for the collapse in rents?

Is net outward migration (reducing demand for rent) now responsible for preventing this ratio from reaching equilibrium, causing house prices to fall further?

The price-rent ratio doesn’t take into account things like increasing the term of the mortgage, increasing the percentage of the house price that can be borrowed or the increase in interest only mortgages. All of these affect the affordability of mortgages and must affect the equilibrium price of housing.

I tried to graph the cost of an interest only mortgage minus rent. It could be argued that both are “dead money” and consumers of housing will choose whether to buy or rent based on the desire to minimize the amount of “dead money” they spend.

The relationship was volatile because of frequent changes in interest rates. However, when interest rates were stable over a period of time, the relationship appeared to reach an equilibrium. If ECB rates soon stabilise at close to zero, this relationship should become important.

In the current market, where it is reasonable to suggest that real house prices won’t be any higher in 5 yrs time than they are right now, it would make sense for anyone on an interest only loan to switch to renting. I say this from both the point of view of flexibility both socially and financially, but also from the point of view of an incredibly uncertain economic outlook for both jobs and asset prices where clearly there are more downside than upside risks right now.

The problem with this is that the transactions costs of selling and then re-buying at a later date are more or less the guts of 10% between stamp, legal, and estate agent fees on both transactions. On an average house price of €250k, most people aren’t willing to leave 25k on the table.

There seems to be two alternative outcomes in housing.

1. Capital costs of housing remain persistently high

2. House prices adjust downwards

I’d be interested to read what the likely impact of each scenario will have for the wider economy..

Just to observe that where Irish residential property prices bottom out, and how quickly the bottom is reached, will be affected by decisions as to how property is taxed in future.

@Eoin has rightly noted that high levels of stamp duty, in combination with other transaction costs, are a disincentive to trading property. If, as seems likely, stamp duty is reduced, a logical outcome would be that property would be more efficiently allocated than it is at present. A more efficient allocation might mean that less property was needed, with people whose families have grown more likely to trade down. Presumably, this would drive down demand for new residences (although it might increase spending on renovations). While it might not affect the long term equilibrium price of property, a short to medium term increase in the excess of supply over demand might depress prices over the medium term.

Any new periodic property tax related to the value of the property would also tend to drive efficient allocation of property, again reducing the volume of property required. Presumably, a second effect would be to drive property prices down by the net present value of expected taxes.

All these things being linked, perhaps the Government should look at two additional costs before plumping for a property tax:
1) The incremental cost of maintaining bank solvency if the tax drives down residential property values; and
2) The net costs associated with a possible net loss of construction jobs arising from a more efficient allocation of existing residential property.

One policy conclusion that probably can be drawn from the graph is that institutional factors matter. The German rental housing market is one of the most tightly regulated housing markets in the world. Rent increases per year are capped way below of what we have seen here even on a quarterly basis. In a market in which the supply side reacts only sluggish to demand shocks, such as the housing market, overshooting prices only create a wrong incentive for Dublin taxi drivers to act as speculative buyers on the one hand side and property developers on the other.

“Very interesting stuff. Does the 2009 Q1 spike indicate that sellers are reluctant to adjust to lower prices as rents fall? (Assuming prices are in some way a function of rent)”

I think the dominant factor at work here is supply of properties of both types (sales and lettings). The last spike in rents (throughout 2007) was driven by demand and supply sides of the market moving at different paces. Potential buyers stayed in rented accommodation a bit longer, while prospective sellers (including of new builds) still piled on to the sales market.

The unwinding of the lettings market – down 17% so far and likely to see falls of the same size again – is because some of the very large excess in the supply side has switched over to lettings. There are three to four times as many properties available to rent now compared to two years ago.

Rents and house prices are falling at a similar pace at the moment (by daft.ie metrics at any rate) so I would expect the ratio to not alter too much over the rest of the year.

By coincidence, a couple of days ago, I looked at the buy-rent decision from the point of view of a first-time buyer since 2006 – http://short.ie/buy-or-rent – we’re back to cheaper to buy territory, but presumably buyer confidence is nowhere near back in place. Presumably, they’re going to hold off more or less until they see the graph above return back to normal… which is going to be tricky if rents are falling steadily.

A note of caution on interpreting these graphs. Owner-occupied houses provide a service yield not a cash yield so the comparison of rental income / house price ratios to cash flow/ price ratios of financial assets needs to be done with caution (as Kevin O’Rourke hinted in his comments). Rental costs and the service yield of owner-occupied housing can move quite differently over the medium term. One alternative approach is to multiply the mortgage rate by a house price index to get imputed service yield. This is a useful estimate but it is just circular when related to the house price index. Very difficult to estimate the service yield of owner-occupied housing independently.

Comments are closed.