Sunday 23 October 2016

Lending rules won't freeze prices, but will freeze out buyers

Dr John McCartney

Published 23/12/2015 | 02:30

'By making it harder to buy, tighter lending limits will cause a further decline in the rate of home ownership'. Photo: Bloomberg
'By making it harder to buy, tighter lending limits will cause a further decline in the rate of home ownership'. Photo: Bloomberg

At a conference earlier this year I said that the Central Bank's new mortgage rules would ultimately not dampen house price growth. Tighter lending might initially freeze out some owner-occupiers - particularly in our cities where prices are highest. However, the idea that this would reduce housing demand is a fallacy. People have to live somewhere, and, if they are prevented from buying in town, only three principal options are available.

  • Go To

A minority might be able to bunk up in the family home. But most would have to choose between buying further out or staying in town and renting. The former would simply displace price inflation from the cities to the suburbs. The latter would cause rents to rise, driving up yields and attracting investors. This too would eventually cause price inflation, albeit via the scenic route.

This may be a contrarian view. But, so far, the only cogent argument I have heard against it runs as follows: By taking decisive action the Central Bank has sent out a signal that it will do whatever is necessary to prevent house prices from spiralling out of control. In so far as this dampens expectations of future capital appreciation, it should reduce speculative investment in housing. The result, it is argued, would be less demand and more sustainable price growth.

It is still too early to gauge which of these outcomes is emerging. House price growth has undoubtedly eased since lending rules were tightened in February, but only in Dublin. Outside the capital, price growth has actually accelerated from 8.2pc to 10.7pc, suggesting that inflation is simply being displaced.

There is also a question mark over the permanence of the slowdown in Dublin. Maybe by dampening expectations the Bank's intervention has ushered in a new era of slower house price growth. But I seriously doubt it. As expected, stricter lending criteria have diverted some owner- occupiers into the rented sector. This has caused rental growth to accelerate sharply since February, driving up yields. And here is the rub. With average one-bedroom apartments in Dublin now generating a gross yield of 7.6pc, even very modest expectations about future price growth - let's say 2pc per annum - imply a total return on residential property investment of almost 10pc per year. This compares with long-term deposit rates of just 1.7pc.

Even when we factor in the illiquidity, costs and risks associated with residential property investment, this differential is simply too attractive for investors to resist. Consequently, and contrary to some reports, we are seeing a significant flow of capital into residential property.

Almost 1,000 apartments have been block-purchased by experienced corporate investors this year. And, with €94bn of household money earning very little on deposit, private individuals are also getting involved. Indeed, buy-to-let investors have accounted for one-quarter of Savills' branch sales in the last six months.

Sure, uncertainty about rent control temporarily slowed this flow. But the recent confirmation of a two-year rent freeze has clarified things and will not deter new investors who can just frontload rents to compensate.

Ironically then, while stricter mortgage lending may curtail speculation and underpin financial stability, it is feeding into an alternative source of house price inflation - this time focused on income returns rather than capital appreciation.

Consequently, my view remains that the Bank's new macro-prudential rules will not contain Ireland's house price pressures. Nonetheless they may well have a profound impact on society.

By making it harder to buy, tighter lending limits will cause a further decline in the rate of home ownership.

This is a problem because, despite the rhetoric about equality of tenure, Irish families' financial habits are predicated on home ownership.

We traditionally accumulate wealth through long-term investment in our dwellings and so have never been a nation of savers. But if there is a pronounced tenure shift, can our savings ratio, which currently lies well below the eurozone average, adjust sufficiently to prevent households from becoming vulnerable to financial shocks?

Similarly, can our pensions system cope with larger numbers of people reaching retirement without owning their homes outright?

The current model allows people to live on modest pensions because they have no ongoing housing costs in retirement and because they have the safety net of housing equity for emergencies.

But, if retired people are going to have to fund rent or mortgage payments in the future, pension contributions need to rise today.

Over the next few months we will get a clearer view of how the new mortgage rules are affecting the housing market.

But, as ever when it comes to State intervention in the market, we also need to keep a careful eye on how unexpected side-effects of this policy are impacting on wider society.

Dr John McCartney is director of research at Savills Ireland

Irish Independent

Read More

Promoted articles

Don't Miss

Editor's Choice