How real is risk of a fall in property prices? Even recession might not do it
The Central Bank's warning is good. Blindness to risk was the greatest error before the crash, writes Dan O'Brien
Is there "a material risk" that the value of your home will fall? The country's top central banker warned as much last week. As Philip Lane also happens to be an internationally respected economist, his words carry weight. Those same words led to a frisson of fear running down the national spine.
The longer-term national obsession with property prices is matched only by a more recent paranoia about property crashes. The trauma of the depression this country suffered in the half decade to 2013 has scarred the national collective consciousness. Anything that has echoes of the frenzy up to 2008, or the calamity thereafter, causes unease, if not near panic.
Since both the economy and property prices turned around five years ago, there have been periodic bouts of here-we-go-again hand-wringing. We are in one of those bouts now, despite prices nationally remaining 22pc below the peak recorded over a decade ago (they are also around a fifth below peak in the capital, where affordability issues are greatest).
Last week, the latest property statistics from the CSO showed that the price of the average home was almost 13pc higher in March this year than in the same month last year. Double-digit price inflation, which has been recorded every month since last May, was a feature of the property bubble. Rises of this kind can portend painful crashes.
Are we heading for another crash and how great is the material risk of a reversal in prices?
First, consider the Central Bank governor's motives for sounding a warning. One is a desire to calm a widening belief that property is a no-lose bet. The truth is that there is no such thing as a risk-free investment. When people come to believe there is, it is time to worry. Lane's comments last week will, hopefully, give the more irrationally exuberant pause for thought, thereby easing demand pressures somewhat.
A second, less other-servicing, motive may have been Lane's desire to protect himself and his institution from reputational damage. Before the crash, the Central Bank and other authorities underestimated the risks to the economy and sometimes downplayed them. Many reputations suffered as a result. If property prices were to fall in the forseeable future, Lane will be able to say he flagged the dangers.
So, what could trigger a reversal over the next two to three years, the time-frame the governor mentioned in his appearance before the Oireachtas Finance Committee last Thursday?
The biggest risk is a recession. If the looming trade war with the US were to get serious and if Britain crashes out of the EU next March with no deal, the Irish economy's huge export engine will stall. Even with the strong momentum that currently exists in the domestic economy, a double trade whammy from the country's two largest export markets would almost certainly trigger a recession, and probably a deep one.
A recession in the near term would be made worse by the Government - it has not readied the public finances for a slump, something Lane also hinted at last Thursday, and would have to introduce at least some austerity measures to prevent a slide towards another bailout.
All of this would push up unemployment, increase emigration and deter immigration. Demand for property would fall. That would certainly bring down the rate at which prices have been rising recently.
But even in the event of a recession, it is not clear by any means the prices would actually fall - in the grim 1980s, for instance, available data suggests that prices in cash terms continued to rise.
In recent years, population growth has generated almost all of the additional demand for housing. Only if the number of people living in the country falls is there a significant likelihood of property price reductions. It should be recalled that the population has grown by half a million over the past 10 years and even in the depths of the 2008-2012 depression, the swing to net emigration never caused the overall numbers living in the republic to dip (unlike the 1980s).
That suggests it would take an even deeper depression than the one experienced recently to cause net outward migration of a sufficient magnitude to reduce the overall population. It would take extreme trade war and Brexit scenarios to generate such an outcome.
Another reason to believe the downside risk to prices is limited is the role of bank lending. The major difference between 2018 and 2008 is the absence of a credit bubble.
In the years up to 2008, excessive bank lending drove prices. Over the past five years, since prices began to rise, over-lending has not been fuelling the market. The contrast with the past is stark. In the first quarter of this year, banks lent home-buyers €1.7bn, according to data compiled by the Banking and Payments Federation. In the same period in 2006, the high point for the opening three months of any year, it was five times more. The trauma of the crash and rules on lending introduced by the Central Bank's last governor, Patrick Honohan, are preventing a repeat of the recklessness of the bubble period.
Lane mentioned two other factors that could ease property price inflation over the next two to three years: an increase in the supply of new houses and higher interest rates. Both should work to dampen price rises, but the effects will probably be limited.
The property crash devastated the building industry. Many construction firms went out of business. Others shrank drastically. The slow recovery in the capacity of the sector has been hampered by the banking system that was once far too willing to lend to developers, but is now too cautious.
Even when all these factors are accounted for, it has been surprising how slowly the residential construction industry has recovered, particularly given the full recovery in the non-residential part of the sector. But regardless of the reasons, it is hard to see a radical change taking place over the next couple of years. More houses will certainly be built, but a doubling or tripling of numbers - the sort of increase needed to meet supply - is very unlikely. Continued under-supply will keep upward pressure on prices.
The second factor mentioned by Lane was higher interest rates. The European Central Bank in Frankfurt has signalled clearly that the era of ultra-low interest rates is coming to an end. With the Eurozone economy growing healthily, there is a strong likelihood that rates will begin to go up next year. The ECB would hold fire only if the mild softening of growth across the continent currently being experienced were to turn into a slump.
But even if the ECB does begin a cycle of hikes next year, rate rises are expected to be small, gradual and well spaced out, as they have been in the US, where recovery began much earlier than in the Eurozone. Higher debt servicing costs will dampen demand for property, but again the effect (on its own) is unlikely to slash property price inflation, which is the highest in Europe at the moment.
All told, Lane was absolutely right to warn of a risk that prices will fall, even if the risk is currently limited. As he said last Thursday, the Central Bank's role is more about managing risks than forecasting economic outcomes, something that economists have never been any good at.