Friday 30 September 2016

There's no bubble, but housing crisis will take time to fix

Published 31/01/2016 | 02:30

Housing and property are rarely out of the news. Over the past week, the latest figures on residential prices were published; the Royal Institute of the Architects of Ireland set out what it believes is the absurdity of the recent change to regulations on minimum apartment sizes; and the banking inquiry, which is so centred on property issues, was published (my column in the main section of this newspaper discusses that report).

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Let's start with the good news. The panic about another bubble in Dublin house prices is well and truly over. Last Wednesday's figures showed that the price of homes in the capital fell for the second consecutive month in December. At year's end they were a mere 2.6pc higher than at the end of 2014.

You may recall the hand-wringing in 2014 about another bubble inflating as residential prices in the capital soared by 40pc in just 16 months to October of that year. There was never any risk of a bubble - you can't have a bubble during a credit crunch - but such a high rate of inflation was bad.

Mercifully, as the first chart clearly shows, Dublin prices have levelled off. And there can be little doubt that the tighter rules on mortgages introduced by the Central Bank a year ago helped anchor prices.

The impact of the rules has, however, been hard to spot in prices outside the capital. As it happens, and as the chart also shows, there was a re-acceleration in non-Dublin home prices a year ago (after a brief lull) just as the new rules were coming into effect. This suggests that they are not the blunt instrument that some have claimed (prices remain 35pc off their bubble-era peak, suggesting that the rebound in prices outside the capital is more about correcting for the undershot that took place at the very bottom of the market).

The Central Bank's mortgage rules are called 'macroprudential policies', which essentially means financial regulation aimed at reducing risks to the economy as a whole. The loan-to-value and loan-to-income requirements introduced are not exclusive to Ireland. Similar systems are common elsewhere, and becoming more common.

As the second chart shows, fears that the rules would result in a large reduction in lending appear to have been overblown. Mortgage approval statistics from the Banking and Payments Federation Ireland (BPFI) indicates that there was no collapse of lending in 2015 compared with 2014 (of course, this is from a low base after the banking crisis, and the upturn in the past two years is a fraction of what it was during the boom).

It is still too early to see the full effect of the rules. The new Governor of the Central Bank, Philip Lane, has noted that the impact might only have kicked in last summer. Many mortgages in the first half of 2015 were likely to have been pre-approved. Furthermore, evidence from 2014 suggests that a majority of bank lending was already adhering to the rules that were subsequently introduced.

A review of the lending rules' direct and indirect impact will be carried out by the Central Bank later this year, and a study published in November.

The overall reaction to the rules has been mixed, at best. Opposition arose because some saw it as an over-reaction, and even more believed that the rules were too stringent. Others, no doubt, opposed it because they want to see house prices rise further.

It is not insignificant that all the main political parties came out in opposition - a future government could easily undermine the rules by bringing in tax breaks or subsidies for home buyers.

None of that is to say that the rules are perfect or that they might not have unintended consequences. A possible negative is that restrictions on lending could increase demand for rental accommodation, which is already very high.

While nobody disputes that there is a chronic under-supply of housing, there is much less agreement about its exact causes and solutions. Debate is complicated further given the plethora of vested interests and different ideologies.

Demand for housing is not going to slow any time soon. Ireland's population rose throughout the recession, and did so in spite of emigration. From 2010-15, TCD economist Ronan Lyons estimates that roughly 50,000 new households were formed in Dublin*. Yet only 10,000 new dwellings were built over the same period. It will likely take years to reach the yearly 25,000 housing units that are required to meet increased demand. As such, getting the construction industry back up and running must be the main priority.

For its part, the industry has been lobbying for tax breaks to stimulate the sector. Such calls are likely to become louder in the near future. But there is very good reason to be cautious about tax breaks: benefits could accrue to developers without increasing supply; and they can be very damaging, as their role in inflating the bubble showed.

The ESRI** has identified four reasons for the sluggish supply: the planning system, a lack of infrastructure, a lack of finance and high building costs.

The first two relate to the role of government. Planning permissions are at the lowest level in four decades and there is evidence that infrastructure is not in place in certain areas.

The third reason is finance. A housing development cannot be built without credit, and given the nature of our crash, it is unsurprising that banks may be unwilling or unable to lend to builders. Moreover, many developers have left the business or have poor credit ratings. There have therefore been calls for Nama and Irish pension funds to take the place once filled by banks.

A common complaint within the construction industry is that the cost of building exceeds the eventual return. The official House Building Cost Index, which counts the cost of labour and materials, has been more or less the same since the downturn, and the increase since 1997 of 70pc is similar to that of prices in general.

However, this metric does not take into account the costs of regulation. The aforementioned Ronan Lyons estimates that overall building costs have grown by 300pc since 1997 when changes in building standards, such as minimum size requirements and energy efficiency requirements, are included.

Lyons estimates that in 1997 a typical three-bedroom semi-detached property cost roughly €100,000 to build and sold at €120,000, giving a profit margin of 20pc. An equivalent home today would be worth €270,000, but, including regulations, would cost €400,000 to build. If these figures are correct, supply won't match demand for some time yet.

Such arguments were likely in the minds of the Department of Environment and Local Government when they reduced the minimum required size of apartments. As with the mortgage rules, a fierce debate over 'shoebox' apartments has ensued, culminating in the recent spat between the Department, architects and planners.

Expect plenty more such spats. It will take some time to fix a market that is, given its long lead times, as slow to change as that of housing.

* www.tara.tcd.ie/handle/2262/75036

** www.esri.ie/publications/tax-breaks-and-the-residential-property-market/

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