Monday 20 November 2017

We must build upwards to fix abnormal housing market

Stock photo: Reuters
Stock photo: Reuters

Dermot O'Leary

New policies are needed to return Ireland's housing market to a normal state. Cycles are par for the course for housing markets around the world, but Ireland's experience over the last 20 years stands out in particular. Following one of the biggest booms in international history in the 2000s, the biggest bust then ensued. Since 2013, prices have grown strongly, and having accelerated recently, talk is now widespread of a housing boom once again. Given this rollercoaster ride, one could be forgiven for believing that "normal" is an elusive state for the Irish housing market.

Equilibrium is described as a situation whereby housing demand matches supply, resulting in only very moderate price rises, somewhere close to general price rises in the economy overall. This is housing nirvana, but it is an extremely rare occurrence.

This is especially true in the commercial property market, which experiences even more severe boom and bust episodes. In this market, the time lag between the start and finish of a project of up to two years partly explains the volatility, as demand conditions at completion may be very different at the end of a project to those at the beginning. This is only a small part of the explanation for the volatility in house prices. Other factors have dominated and no two cycles are the same.

The boom in the mid-2000s was very much driven by excess demand, mainly due to loose credit conditions and inappropriate policy decisions by the Government and the Central Bank. This time, a chronic supply shortage is to blame for the abnormal state of the market. That is why policy efforts to stimulate supply are key to returning price growth to a more normal level.

Assuming that "normal" is achievable over the coming years, what would this look like and how would we get there?

For a start, the number of homes built annually would be somewhere between 30-40,000. The current level of housebuilding is currently the source of some debate, but is likely to be in the range of 10-18,000 units this year. In other words, housing output needs to grow two or three fold to keep up with the expected level of household demand.

The fact that housing supply has remained abysmally low over recent years has created some unusual trends that have been illuminated by the 2016 Census results. One is that the average household size in Ireland, which was already one of the highest in Europe, rose for the first time in decades in the five years from 2011 to 2016. In reality this manifests itself in two ways. One is that more people are cramming into single rental properties. The other is that kids in their 30s are having to spend longer living with parents. For all the benefits that this brings, it is hardly reflective of a housing market that is working as it should.

Another feature of a normally-functioning housing market is that the turnover of the stock is occurring relatively frequently. In Ireland, this is not the case, despite some improvement over the past three years. The number of housing transactions last year amounted to just 2.6pc of the stock. This compares to a turnover rate of 4.5pc in England, which, incidentally, is quite low in an historical context.

Reasons for the low turnover in Ireland include the scale of negative equity that still remains and the 44pc of mortgages that are on very attractive tracker mortgage rates. The primary reason though is the lack of available homes for sale. While in normal housing market, former first-time buyers would be trading up to make way for the first-time buyers of today, this cannot happen in a supply-constrained market. Effectively, the system is stuck.

A lot has been said recently about the boom in mortgage approvals. Indeed, the trends here have been exceptionally strong, with new lending expected to grow by up to 30pc this year. This has caused some to question the decision of the Central Bank to ease back on its lending rules at the beginning of this year and the Government's decision to introduce a help-to-buy scheme.

Before getting carried away with these strong trends, some context is required. Mortgage lending is growing strongly, but from an exceptionally low base. While it is dangerous to compare it to the crazy 2006 period, lending this year is expected to be just €7.5bn, some 80pc below that mid-2000s level. Put another way, the number of mortgages being paid out currently is close to levels seen in the early 1980s, but the population of Ireland is 40pc higher than it was then.

While €40bn was far from normal, the current level of mortgage lending is well below where it should be. On the basis that housing completions get to 30,000 units per annum, mortgage lending could get to €13.5bn. This would mean that the banks' loan books would return to growth after a seven-year period of deleveraging, in our view, thus the end of deleveraging in the Irish banking system.

Another feature of a normal market would be that rental properties would be affordable and thus maintain Ireland's position as an attractive location for footloose international workers, a situation that is crucial to a country that has built its entire economic model on attracting multinationals to sell to markets abroad. Currently, one cannot describe rents as competitive, especially in urban areas that will attract these skilled workers.

To achieve this state of normality, policy efforts should clearly focus on supply side measures. The Department of Housing has made laudable efforts in this regard over the past 12 months, including the positive recent announcement on the release of state lands for housing purposes. However, given that housing demand is now higher than we expected a year ago and the supply situation is arguably worse, a redoubling of efforts is now required to solve the crisis.

A number of relatively quick wins come to mind that could form part of a new housing initiative.

First of all, we need to embrace height. While land is expensive, air is free. We need to use it.

Secondly, strict regulations around car parking, the number of lift shafts and the number of studio apartments need to be eased back sensibly. In both cases, this will have the impact of making apartment building economic again.

Thirdly, an extension of the local infrastructure fund that allows builders to get on with building homes would be welcome.

Fourthly, the Government needs to embrace the build-to-rent sector and ensure that they are a key plank in the delivery of new housing in the country.

The costs of not returning Ireland's housing market to normality are enormous, in economic, social and political terms. Under a new Taoiseach and, perhaps, a new housing minister, policy efforts need to be reviewed and renewed with a new sense of vigour.

Dermot O'Leary is chief economist with Goodbody. Brendan Keenan is away.

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