This is an extended version of a column published in the Irish Examiner on 7 January 2012.
http://www.examiner.ie/business/uncertainty-over-end-of-fall-in-house-prices-179355.html
In the last week a number of publications have emerged which indicate that far from the house price crash reaching the bottom it appears, at least if you believe Daft.ie, to be accelerating. Daft.ie suggest that the asking prices for houses are now 52% below the peak, showing 18% fall in 2011 alone. Myhome.ie, owned by the Irish Times, is a little less apocalyptic, suggesting that Asking prices are only 43% down. The CSO, and Alsop properties, basing their data to November on paid prices, suggest that the declines are 46 and 67% respectively. Prior to the difficulty in interpreting exactly where we are is that the indices used are based on different constructions. For example the Allsop data reflect distressed properties at auction, while the CSO data represent purchases based on mortgages. We are, in other words, still unsure as to exactly where we stand. And not knowing where we are it is hard to know where we are going.
There is a proposal that in June 2012 we will, if all goes to plan, finally see a official government house price index based on settlement prices. To say that this is long overdue is akin to saying that the Titanic had a slight damp problem. It is arguable that a large part of the crisis which we are in now is as a result of people not knowing where we were, how we got here, and therefore not being able to make an intelligent prediction about where we would likely go. Note that this did not prevent people, including myself, from making predictions, nor did it hamper some form making more cogent and less erroneous predictions. However, I think it reasonable that the absence of an official house price index contributed in large part to the lack of coherent analyses. Moreover, as I understand it, the initial publication of this will only be back to 2010. While there will be data available back to 2001, covering therefore the end of the house price boom and the start of the house price bubble, as well as the crash, it appears as though this will not be published at least not initially. Why this is so is baffling, as giving a full picture of the noughties house price dynamics would be invaluable. There is a plethora of administrative data on house prices available within Revenue. While it is not their job to disseminate it, they do hold it. The CSO have run seminars on using administrative data, but as far as I can see the issue of house price data has not been a topic.
Coming off the reports noted above the consensus is that far from seeing a leveling out, the market reaching the bottom, in 2012 house prices will continue to decline throughout this year and into next year. Indeed, one commentator has suggested that the average house price fall from peak could be as high as 90%. But this perspective is even gloomier, and founded in decent analysis, than the analysis by Morgan Kelly that we could see price drops of up to 80%.
Part of the difficulty in relation to ascertaining when we will see the bottoming out of the market is that the dynamics, both statistical and psychological, of turning points and not particularly well understood. In there is a reasonably large body of research on the dynamics of house price booms. It is a pity that more cognizance was not taken of these reports by the relevant authorities, and indeed by commentators including myself. However, in Ireland we tend not to engage in that foreign continental vice of evidence-based policy making, and therefore one can’t but wonder as to whether or not any amount of analytical evidence into 2004-2007 period would have made the blindest bit of difference to government policy.
Be that as it may the consensus in academia is now that three major elements exist in the dynamics of house price booms.Firstly, these tend to be self-perpetuating, in that rising house prices in one period leads to expectations being formed of house prices rising in the next period. There is a limit to this however, with the not unrealistic finding that as the boom lasts longer and longer it is more likely to collapse.. A recent excellent paper on this is here . Secondly, and this is particularly case in Ireland, the credit conditions are important, with some evidence suggesting that credit laxity can fuel house price booms. This has been discussed here. Thirdly the general economic conditions are of course important, including in particular the conditions and rental market and the overall health of the economy. Income, rental issues, interest rates, unemployment , inflation have all been seen as important drivers. See here for Central Bank analysis on this, here for an analysis of the importance of unemployment. The most recent IMF analysis suggests that deviations from trend national income and a Bundesbank study suggests similar dynamics with deviations from fundementals taking “several years” to correct.
If we then consider all of these we cannot come up with the conclusion other than that house prices will continue to fall through 2012. Daft.ie have noted on a number of occasions that falling house prices are not necessarily a bad thing, if they get house prices back to where they should be based on fundamental economic conditions. I agree with this, but they have also noted that the very self-fulfilling nature of booms also operates for crashes. Expectations of falling house prices will feed into falling house prices, and in the Irish context this is going to be exacerbated by the aggressive deleveraging of banks in general and in particular in relation to mortgage credit. A naive conclusion would be then that we need simply to pull on a happy face and think positive thoughts, and if we really really believe house prices will rise then they will. The reality is that that is both unlikely to happen in an economy grinding to a halt, nor should we want prices to rise until and unless they have reached at or below fundemental value. Outstanding mortgage credit to Irish households is now only 62% of what was at peak, and has continued to decline steadily by 2 to 3% per month. There is no reason to expect that in the near future this will change. The acknowledgement that credit drives the housing market in ireland is evident from the calls for banks to lend more (see same from Sherry Fitzgerald here) and even the astonishing suggestion that the (bankrupt) state should take on board the negative equity of future borrowers.
The evidence is that the longer the boom not only the more severe but also perhaps the longer the crash. There is relatively little research on the macroeconomic determinants associated with house price crashes, and such research as does exist seems counterintuitive, suggesting for example that increases in national income reduced the likelihood of exiting a crash. This may be partially explained by households faced with an increase in disposable income in using these to pay down existing debts rather than to re-enter the housing market. However, much research remains to be done on house price crash dynamics, as opposed to house price boom dynamics. A valuable investment by a mortgage lender would be a couple of postdoctoral researchers focused on this area.
It is quite astonishing that despite the massive wealth created in Ireland over the boom and bubble, from property, there is I would suspect less academic research capacity in property now than there was in 2001. Perhaps in an effort to ensure that this time really is different, and we dont make the same mistakes again and again, one of the estate agencies might consider endowing a lecturer or three in the third level?
A reasonably comprehensive analysis of property bust determinants is given in a 2009 ECB working paper. The determinants of crashes/busts are analysed in the table reproduced below
What can we take from this? That busts are positively associated with short-term interest rates (thankfully low in prospect), increases in property taxes (coming soon) , exchange rate strengthening (hard to call) and banking crises (oh yeah, we have one of them all right…), and are negatively related to the health of the government balance (poor in this case) , monetary growth and credit growth (both poorly here ) , population growth (slowing if for no other reason than due to emigration) and growth in national income (we wont be seeing that for a while). Thus, there is really little cheer from the research such as we have.
Where then might prices go? the CSO data suggest a house price peak of some €331,000 for new houses in Q2 2007. Ronan Lyons uses some relatively simple extrapolations to look at the possible future dynamics and suggests that the market will bottom out in 2014 at approx €150k, representing a fall of 55-60%. In early 2010 I suggested that we could hit €130k region in 2013, a fall of some 60% plus. Cormac Lucey suggests (see his last paragraphs) a fall in average new house prces to perhaps as low as €75k on the basis of overshooting, with a trough perhaps at 2017. Morgan Kelly in his seminal analysis suggested a fall of between 40-60% with a possibility of up to 85%. Recall also that if houses are to fall by say 75% from peak and have already fallen by 60% that does not mean a 15% fall is in prospect: . You are going from 100 at a peak to 40 now and down to 25…. do the math. While NAMA may have declared november 2009 as its valuation date, implicitly suggesting that the crash had then ended (and the ongoing crash has implications for NAMA to which I will return), it seems that in the words of De Bert, when it comes to house price fall, while there is a lot done there is more to do.
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