Expectations, credit and house prices

Happy new year to the irisheconomy.ie community. Of course new year means new quarter and new quarter means house price reports…

The latest Daft.ie House Price report is out this morning. The PDF is available here. For me, the key takeaway is as follows: house prices fell in the final quarter of 2014 and it seems very unlikely to have been statistical noise or a seasonal effect. 35 areas are analysed in each report. For each of the first three quarters of the year, an average of 32 showed quarterly gains in asking prices. For the final quarter, this flipped, with 30 of 35 regions showing a fall. For Dublin, this was the first quarterly fall since mid-2012. (Given the size of increases earlier in the year, a one-quarter fall still leaves the year-on-year change large and positive: 20% in Dublin and 8% elsewhere.) Broadly speaking, a mix-adjusted analysis of Price Register transactions shows the same. While it is only one quarter, it seems more than just a statistical blip.

For me, the check-list of what matters for house prices contains five items: [1] household incomes, [2] demographics and [3] housing supply (“the fundamentals”); and [4] credit and [5] expectations, these last two being the “asset factors” that can create and destroy housing bubbles. None of the fundamentals changed dramatically in the final three months of the year (the only thing you could argue was a slightly higher volume of listings in Dublin), so the change after September must be due to asset factors.

The Central Bank proposed in October to cap residential mortgages as early as January 2015, although this could not affect prices directly in 2014. So the last remaining candidate is expectations.* The quarterly Daft.ie report includes findings from a survey of housing market sentiment. This survey indicates that, yes, those active in the housing market did revise downward their expectations about future house price growth, particularly in Dublin. Whereas those surveyed in September expected a 12% increase in Dublin house prices over the next 12 months, this had fallen to less than 5% by December. I expect that the Central Bank would be happy if it were the case that their proposals strengthened the link in people’s heads between fundamentals (in particular people’s incomes) and house prices.

As for my opinions on the Central Bank guidelines themselves, I submitted a response to the Central Bank’s Consultation Paper, which is available online here. The TL;DR version is “max LTV good, max LTI bad”. I made similar points at an Oireachtas hearing on this and related topics in late November.

* Some have argued that the end of Capital Gains Tax relief was what drove trends in the final months of 2014. The theoretical reasoning behind this is unclear – it is not obvious that this would affect supply more than demand – while practically speaking, it is also not clear how this would have managed to infiltrate the vast bulk of the market which is not of interest to investors. When asked what they thought was driving house prices, those active in the housing market rarely mentioned tax factors, instead picking credit and supply as the main factors.

Allsop Auction Price Declines

Congratulations to regular commenter Dreaded Estate for producing this spreadsheet comparing sales prices at last week’s Allsop auction with the earliest available asking prices. Across the 46 properties for which previous asking prices could be found, the weighted average discount relative to the earliest asking price was 69 percent.

One can complain about this small sample (though Namawinelake points us to this map, showing a nice geographical mix) and also about extrapolating from the prices recorded at these kinds of “fire sale” auction. However, my inclination is that this is useful information about where the property market is likely to bottom out.  (Of course, even with seventy percent discounts, most people will still need to find a bank willing to give them a mortgage to buy a house.)

Mortgage Activity “Remains Subdued”

For good or ill, the future financial prospects of the Irish sovereign depend in various ways on the future of the Irish property market, both via its purchases of NAMA property and its investment in banks with considerable mortgage books.

The Irish Bankers Federation report on the mortgage market (data here and press release here) paints a picture of a market that has almost completely collapsed. NAMAWineLake provides his customary high quality analysis here. I’d note that the series seem to have a seasonal pattern so comparisons of 2011:Q1 with peak may be a little misleading but even year-over-year comparisons paint a picture of a market in freefall. These figures also tie in pretty well with the figures from the new house price index from the CSO which showed a faster pace of price decline in the three months to March 2011 than had been seen since mid-2009.

CSO House Price Index

The CSO have released a new house price index (press release here and data here). Analysis by Namawinelake here.

Frank Daly on Residential House Prices

The complications caused by the absence of a properly representative national house price index have been illustrated again via a speech given by NAMA’s Chairman Frank Daly (see NAMAWinelake here). Frank discusses NAMA’s assessment of the residential sector as follows:

On the residential sector the Central Bank is forecasting falls of 60% from peak (end 2006) to end 2012 under its adverse scenario or 55% under its baseline scenario – based we understand on the PTSB\ESRI index. At NAMA we are not surprised by this and it is not as alarming as one would first think. We do not believe that the PTSB\ESRI index currently showing close to 40% fall from peak is realistic and reflective of where the market is. NAMA’s base valuation date was November 2009 and at this date we were already taking account of on average 50% falls in residential property values from the peak.

So while the residential market may have some little more to fall and no one can be certain that an average fall of 60% from peak may not occur in residential house prices, we would believe that the bulk of this has happened already.

Based on my own anecdotal sample, I’m inclined to agree with Daly that residential prices have fallen more than shown by the PTSB\ESRI index. However, the implications for the Central Bank stress testing exercise strike me as a little more serious than Daly suggests. Daly indicates that most of the peak-to-trough decline envisaged in the Central Bank stress scenarios has already happened.

But this raises the question as to whether the stress scenarios should be based on a peak-to-trough calculations or should they be based on an assumption about a current level of prices and an additional assumption about further declines. It’s not clear why the scenarios should be based on a peak-to-trough assumption. And if, for example, the valuation of residential mortgage portfolios is based on an inaccurate assessment of current levels of house prices, then this may undermine the credibility of the calculations. I would hope that the report accompanying the stress test results would discuss this issue.