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.

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.

Ghost Estate Report

From the Department of the Environment “Mr Michael Finneran, T.D., Minister for Housing and Local Services, and Mr. Ciarán Cuffe, T.D., Minister of State, with Special Responsibility for Planning, Sustainable Transport & Horticulture’, today (21 October, 2010) published a National Housing Development Survey.”

In other words, the Ghost Estate report has been published. For reasons best known to themselves, the DoE has only released a summary (link to a Word document here) so far. Is it so difficult to generate a PDF and stick it on the website?

No Really, We Did Have A Huge House Price Boom

There are lots of aspects of the performance of the Irish economy that people disagree about. However, I had been under the impression until this week that everyone agreed that Ireland experienced an exceptional increase in real housing prices in the during the period before the recession.

It turns out, however, that I was wrong. Not everyone agrees with this. Earlier this week, there was a discussion on this website of a paper by Carmen and Vince Reinhart, which reported some figures for real house price appreciation between 1997 and 2007.

Among the figures reported by the Reinharts on Table 4 of their paper were the following:

U. Kingdom +150.1pc
Spain +118.5pc
Sweden +114.9pc
Ireland +114.8pc
France +111.6

These figures have been debated elsewhere on this site but not in a way that would clarify the key fact. That Ireland really did have a larger increase in real house prices than these other countries is not that hard to check.

Here are the facts. The Department of the Environment reports that the average second hand house in the Republic of Ireland cost €102,711 in 1997 and cost €377,850 in 2007, an increase of 268%. The average value of the CPI increased by 42.4 percent between 1997 and 2007. So, from the DoE figures, we can calculate the real house price increase from 368 / 1.424 = 258. In other words, real Irish house prices rose by 158% from 1997 to 2007.  And, for what it’s worth, the real increase from 1995 to 2007 was 246%.

So, yes we really did have a huge house price boom. Certainly a boom that was bigger than occurred in Spain, Sweden or France. Morgan Kelly didn’t just make it up.

Cue comments from house price boom deniers, flat earthers and folks who believe Elvis is alive and living with Michael Jackson

Daft House Price Report: 2010:Q2

The latest Daft house price report is now available here. Ronan Lyons discusses the report here and also discusses the need for a property tax.

The report shows asking prices down 36% from peak. Since asking prices during the boom tended to be less than purchase prices while the opposite seems to be the case now, I reckon it’s fair to view this figure as consistent with an actual decline in prices of over 40% since peak.

Are we near bottom? Nothing ever stops real estate vested interests from assuring everyone that things are stabilising and it’s a great time to buy. However, I reckon we still have further to go. The recent Honohan report informed us on page 83 that the (quite sensible) McQuinn-O’Reilly model indicated that house prices were 33% over-valued in 2007:Q2 relative to what could be justified by disposable income and mortgage rates.

This would justify a decline of one-third in house prices even if incomes hadn’t changed. However, nominal GNP has dropped by about 17% since house prices peaked while income tax rates have been increased. Headline mortgage rates are lower now for those on tracker mortgages but the more relevant measure is probably the cost of financing for the marginal new buyer and these are a good bit higher. One also has to factor in that people will need to make allowance for rate hikes to come.

Taken together, I think a peak-to-trough decline of about 60% wouldn’t be too surprising.

Update: John the Optimist reminds me that an overvaluation of 33% corresponds to 25% decline (100/133) which is fair enough. However, to be honest, I was being deliberately understated in the original post. Add in 17% for the decline in GDP, 10% for the effect of increased tax rates, and who knows what for tight mortgage credit and rate hikes to come and one can easily justify greater than 60%.

Daft Report for 2010:Q1

The latest Daft report is out, including a commentary from Brian Lucey. The analysis of asking prices is, as always, interesting and useful. However, given the evidence on how long it is taking units to sell, it seems clear that asking prices are still above what would be required to produce a normally functioning market.

The recent receiver-driven apartment sales in Mullingar that attracted considerable buying interest (Independent story here) perhaps provide an insight into the gap between asking prices elsewhere and what would be needed to attract demand. The two-bed units in Mullingar were priced to start at €82,000 and I seem to recall that the median two-bed in this scheme was selling for €90,000. For what it’s worth, a non-scientific comparison shows that the average asking price for two bed units in Westmeath in the Daft report is €162,000.

Lenihan Says NAMA Will Stop Houses Prices Falling

In an interesting prediction, the Minister for Finance, Brian Lenihan, has said that Irish house prices will now hit bottom thanks to the NAMA transfers. The Sunday Independent reports:

Yesterday, Mr Lenihan told the Sunday Independent: “One of the good things about the steep discount, averaging 47 per cent, is that the residential property market will now be stabilised at a realistic level.”

He added: “You can now buy in confidence that the price is realistic.”

Perhaps I’m being stupid here, but I’m having troubles linking (a) The setting of prices that the government is willing to pay to banks for non-performing property loans (largely backed by commercial or development property) with (b) Prices that people are willing to pay for residential properties.

The Minister reckons the NAMA transfers will act to boost the residential property market. Just playing devil’s advocate, one could point a large surplus of properties for sale, high unemployment, pay cuts, future tax increases, higher mortgage interest margins, and future increases in ECB interest rates as factors that could act against whatever positive effect the NAMA transfers are supposed to have.