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Are house prices undervalued? Not in the Dublin area

Estimates by the ESRI that Irish house prices are up to 27pc undervalued need to be treated with extreme caution.

Despite average Dublin house prices having risen by almost 24pc over the past year, the ESRI economic think-tank calculates that average Irish house prices are still between 12pc and 27pc undervalued.

I'm not convinced.

The ESRI uses models which incorporate a number of factors including income levels, interest rates and the total stock of housing.

Depending on which model you use, the ESRI report, authored by Kieran McQuinn (below), reckons that actual house prices are between 12pc and 27pc lower than "fundamental" house prices.

So have house prices even further to rise?

The first thing to bear in mind is that the ESRI model showing the largest apparent undervaluation of house prices is the one that assigns the greatest weight to interest rates and the availability of credit.

Eurozone interest rates are currently abnormally now with the official ECB interest rate standing at just 0.15pc - the lowest it has ever been.

This can't last. Already the Fed and the Bank of England are getting ready to jack up rates. And the ECB will soon be pressed to do the same.

vulnerable

Although it is counter-intuitive, borrowers are far more vulnerable to rising interest rates when rates are low than when they are high.

Before Ireland joined the euro at the beginning of 1999 Irish official interest rates were about 8pc. Add in the banks' then 2pc mortgage margin and repayments of principal, and this meant that the monthly repayments on a 25-year mortgage were the equivalent of about 11pc a year of the full amount borrowed.

By comparison, the repayments of someone with a 25-year tracker at 1pc over the ECB rate are a mere 4.6pc of the full amount borrowed, while someone on a 4.5pc variable rate would be paying the equivalent of 6.7pc.

You don't have to be a genius to work out that a 1pc rise in interest rates translates into a far higher proportionate increase in your monthly repayments when interest rates are low than when they are high.

While the ESRI doesn't completely discount the possibility of an increase in interest rates and its impact on house price affordability, I believe that it should have attached far greater importance to this danger.

Even if the banks, who have cut mortgage lending by 93pc since 2006, were to resume lending on a significant scale, buyers would still find themselves dangerously exposed if, or when, interest rates start to climb.

capital

There is also another potential weakness in the ESRI's calculations. While house prices outside Dublin may still be undervalued, it is almost certainly a different story in the capital where prices have been rising sharply, with a 23.9pc increase recorded by the CSO during the 12 months to the end of June.

The average Dublin second-hand house price stood at almost €330,000 in April, more than seven times average public sector earnings and more than ten times average private sector earnings.

This almost certainly means that any undervaluation in Dublin house prices has already disappeared.


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