Wednesday 22 November 2017

After all the highs and lows, we still put it all on the house

Photo: Aidan Crawley
Photo: Aidan Crawley
Donnacha Fox

Donnacha Fox

After all we've been through, we're still obsessed with property!

The visceral reaction to the new mortgage lending caps introduced by the Central Bank, shows even though our speculative property splurge ended in tears, the cult of property is still coursing through our veins.

While we might not like the new residential mortgage lending limits and may disagree on the size of the deposit required or the timing of the measures, the principle of a lending cap is a good one.

When the proposed new mortgage rules were first floated last October by Central Bank Governor Patrick Honohan, I recall very few commentators in favour of the proposals. In brief, the Central Bank proposed that all new house loans be capped at an 80pc loan-to-value limit (LTV) and subject to 3.5 times income. Buy-to-let LTVs would be limited to 70pc.

During the consultation period, the Central Bank received 157 submissions from a range of groups, including the Government, the Department of Finance, the banks, the property and construction sectors and members of the public. Nearly all the submissions received were "unanimous" in their opposition to the measures on the grounds the new limits were "too restrictive", the Central Bank said.

The new rules came into effect on January 28. The only climbdown by the bank was that first-time buyers could borrow up to an LTV of 90pc to a maximum of €220,000 with the balance exceeding that at an LTV of 80pc.

Rejecting pressure to abandon the proposals, Honohan kept his nerve, illustrating refreshing Central Bank independence from Government and vested interests. Critics questioned how the bank arrived at the lending caps, asked about the timing of the move and claimed that the limits should be gradually phased in.

Honohan countered by pointing to LTV and loan-to-income caps already in place in Norway, Sweden, Denmark, Italy, Canada, New Zealand, Hong Kong, Singapore and the UK. So why not Ireland, especially given our recent experience?

The Central Bank stated explicitly that those in negative equity are not in the "scope" of the proposals, so the new lending caps will not apply to them. It decided not to apply the rules to this group, so as to "not unduly limit the mobility of these borrowers".

This group comprised, according to the bank quoting an ESRI report, a staggering 268,000 households at the end of 2013. It's just as well the new rules don't apply, as the bank went on to state less than 300 new mortgages were issued to those in negative equity in all of 2014.

He needn't be worried about their mobility. Which would you prefer - being prevented from buying a house you couldn't afford in 2005 or, to be in negative equity to the tune of €100,000 (or more) today with very limited options?

You also need to consider the 117,889 mortgage accounts in arrears (you may be in negative equity, but continuing to pay your mortgage). How many of these people were told to buy a home "to get on the property ladder"?

Recently published CSO data show Dublin house prices are still 36pc off their 2007 peak, while apartments in the Capital are 45pc of their 2007 levels.

So why did the Central Bank feel it needed to move now? It's generally accepted the house price recovery was driven by cash buyers and investors, not the re-emergence of a lending spree on behalf of the banks. We know this from observing the monthly private sector credit data, which continues to show a contraction in credit conditions as monthly loan repayments exceed drawdowns.

Those opposed to the new measures say the Central Bank didn't need to move now, as evidence was emerging cash buyers were sated. The expiry of the capital gains tax exemption for investors on December 31, would also have a dampening effect.

The deciding factor was simply the rate of house price growth was beginning to alarm the bank, as it was approaching its pre-crash peak. Which would be worse? Not acting? Risking a repeat of past mistakes and ultimately (as house prices continued to rise) an even higher deposit being required, when some form of cap would inevitably be implemented?

Let's remind ourselves that while you can borrow on the basis of gross earnings - you have to fund debt from net earnings. Recall the disappointment when you looked at your first annual mortgage statement in the initial years of a home loan, only to see how little of the outstanding loan balance had changed? And that's a principal and interest loan, not the exotic varieties of the Celtic Tiger. With ECB rates at 0.05pc, new mortgage borrowers can rule out potential windfall gains from prospective interest rate reductions.

Also, our tax code means employees pay the top rate of tax comparatively early, making the job of paying off new debt from net earnings that much more difficult.

Finally, adding insult to injury, the Q1 2015 Central Bank Quarterly bulletin shows interest rates on new mortgages in Ireland are almost 1.0pc higher than the equivalent rate in the euro area - and that the difference between the two rates (the spread) has been steadily increasing since 2012.

So not only are we finding loan access difficult, when we do get access - we're paying more than our European peers.

Consider the anatomy of a 30-year mortgage loan and its payment structure. For the first 10 years, your monthly payments are roughly 66pc interest and 33pc capital. As you approach halfway stage, interest and capital payments equalise. Only in the final third of the loan term, do mortgage payments start to largely represent capital repayments off the loan balance. You don't have ultimate "security" in the context of home ownership (even when you buy right) until you pay off your last mortgage payment and collect the deeds from the bank.

However, buying a house (one you can afford, at the right time) with a mortgage and all the discipline that entails is a great idea, as you gradually accumulate an asset over time.

But, as we've seen, debt is onerous and inflexible and the bank holds all the cards. A 20pc deposit means that if house prices fall 20pc, the home owner's equity is blown away, while the bank remains entitled to 100pc repayment.

A novel idea would be to force the banks to issue a proportion of the loan on a non-recourse basis. If banks were "on the hook" for a portion of the outstanding mortgage (if they faced the prospect of losses in the same way as the borrower does), it might be more powerful than a lending cap - as they'd then be automatically doing what banks should be doing in the first place: lending money prudently.

Given the higher deposit requirements and the increased burden it will place on home buyers, we urgently need to reform our rental sector and rapidly bring available housing units on stream.

Potential home buyers who want to buy a home but are now not able to afford the higher deposit need to be accommodated in the rental market.

This will be a gargantuan task, as all aspects of our housing supply needs to be expanded simultaneously. We also need to refocus on the provision of social housing programmes such as renting with an option to buy from local authorities.

Home ownership in Ireland is changing as outlined in the National Economic & Social Council (NESC) report Home Ownership and Rental: What Road is Ireland On? (2014).

The report illustrated Irish home ownership hit a peak of 80pc in 1991, whilst private renting was 8pc of total households. By 2011, owner-occupiers had fallen to 71pc and those in private renting totalled 19pc.

But some European countries have substantially lower levels of owner occupation with Germany at 53pc, Austria (57pc), Denmark (64pc) and Switzerland (44pc). Why?

The excellent report, The Future of the Private Rented Sector, produced for the Private Residential Tenancy Board (PRTB) in October, provides some potential answers.

Our European neighbours have a preference for greater flexibility and mobility than we do. Very long lease arrangements are available (indefinite leases in some countries) providing tenants with the right to stay in their choice of accommodation for long periods of time.

The other main drivers are the fear of negative equity; a better tax treatment for landlords and better certainty on rental levels, with rents typically rising in line with inflation.

The establishment of the PRTB in 2004 marked the beginning of the professionalisation of the Irish rental market. Good progress was made in bolstering tenant rights (such as establishing the right to a four-year lease once six months of occupancy had passed) and all tenancies were required by law to be registered.

However, the PRTB has been toothless to prevent ballooning rents and its mandate needs to be strengthened.

My words shouldn't be interpreted as a tirade against property, as I believe Irish commercial property is in strong recovery mode. Nor am I advocating renting over buying, as each to their own. But if we don't remember the mistakes of the past, we will repeat them.

Dr Conor Skehan, head of the Housing Agency, wrote an article in this paper in reference to residential property on September 7, 2014.

"The next generation will begin to use property, as is common in other countries, as a service and not an investment and our society will have compassion for people at the centre of housing policy," he wrote.

Maybe we are already seeing the signs of his forecasts coming to pass.

Donnacha Fox is an executive director with wealth management firm Quilter Cheviot. The opinions expressed in this article are those of the author personally and do not necessarily reflect those of the firm.

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