Thursday, March 6, 2014

6/3/2014: A New Property Building Boom for Dublin? Not So Fast...

This is an unedited version of my Sunday Times column from March 2, 2014.

Much has been written about the alleged turnaround in the Irish house prices and property markets fortunes. With first-time buyers reportedly priced out of the market by the cash-rich investors, the commentary has been focusing on the need to deliver new supply of properties to the markets. Enter the wave of recent calls on the Government to create incentives to restart a new building boom.

Alas, new construction can do preciously little to alleviate the property markets pressures. Instead of calling for more construction permits, those interested in delivering a sustainable long-term recovery should be focusing on the resale markets. Given the causes of the current under-supply of and uneven distribution of demand for second-hand properties, it is hardly surprising that this requires dealing with the problems of legacy debts and the structure of the Irish mortgages pool.

The latest data published this month shows that the overall levels of new mortgages issued to the first-time and mover purchasers in 2013 came in at a disappointingly low level of EUR2.3 billion – the second lowest since the records began in 2005. This is almost nine times lower than at the pre-crisis peak, and around half the average levels of lending recorded in 2008-2012.

Yet, by all accounts, there is a build up of demand for properties within the first-time buyer segment of our population. This assertion is supported by empirical evidence.

In 2005-2008 average number of first-time buyer mortgages issued in Ireland stood at 7,062 per annum. In 2011-2013 the number was 1,202.  Even if we accept that half of the pre-crisis mortgages were issued to households with unsuitable risk and financial profiles, since the onset of the crisis, penned up demand for FTB mortgages has cumulated to some 9,342 or EUR 1.65 billion.

As the result of the penned up demand, rents are up, especially in Dublin and major urban areas, where jobs are now being created and where jobs destruction during the crisis peak was less pronounced. The most recent data showed that Dublin rents were rising at 11% a year at the end of 2013, the fastest rate of inflation since mid-2007. This implies that Dublin rents are now almost 18% above the crisis period trough. Meanwhile, outside the urban areas, jobs remain scarce and long-term unemployment is running at higher levels. Thus, excluding Dublin, rents are either stagnant or growing at significantly slower rates.

Property prices are also confirming the ongoing bifurcation in the markets between Dublin and the rest of the country. Dublin residential property prices are now 18 percent higher than at the crisis period trough. Excluding Dublin, property prices are up just 2.6 percent compared to crisis period low.

However, looking at the peak-to-present changes, residential property prices in Dublin are 49.2 percent below their peak. Excluding Dublin, the figure is 46.8 percent.

Thus, data on rents, property prices and volumes of transactions, suggest that to-date, Dublin property market has been driven by the delayed convergence to national trends. Beyond the on-going catching up, however, the property market in Ireland will remain dysfunctional.

This mis-match between demand and supply drivers will likely push the property prices even higher in Dublin over the next 24-36 months. However, absent any significant improvement in the underlying household finances, this price inflation will start flattening out in years ahead.

The reason for this conclusion is the presence of two concurrent drivers of the market.

Firstly, Dublin's demographic and economic fundamentals suggests that equilibrium prices should be somewhere around 30 percent below their pre-crisis peak. This would require prices for Dublin houses to rise by roughly a third on their current averages. Apartments prices should gain some 25 percent over the next 2-3 years to deliver equilibrium level pricing at around 45 percent below the pre-crisis peak.

Secondly, we are also witnessing separation of prices from underlying household incomes and credit supply. Ongoing long-term changes in employment and earnings push purchasing power toward urban centres and are turning rural communities into focal points of emigration for younger and more skilled workers. At the same time, the financial position of established and middle-age Irish households remains severely constrained. The overhang of legacy mortgages debts, lower after-tax earnings and continued jobs insecurity are all weighing on the credit supply, depressing the funding available for house purchases.

Parallel to these trends, we are witnessing gradual increases in the cost of funding mortgages. Based on the data from the Central Bank, retail rates on loans for house purchases over 1 year fixation in Q4 2013 averaged 4.5 percent, or almost 1 percentage point above their Q4 2009 levels. Were the ECB return its policy rates to their historical averages, current lending margins would require new mortgages interest costs in 6.5-7 percent range

Mean-reversion in the interest rates will mean that the majority of the first-time buyers in the market will not be able to secure a mortgage sufficient to cover house purchases without relying on large (ca 30 percent of the property value) down payments. Another problem is that with the cost of funding rising disproportionately for adjustable rate mortgages, keeping legacy tracker mortgages becomes more attractive to current homeowners. This, in turn, implies reduced willingness to trade up or down, depressing supply of existent properties to the market.

Supply of properties in the market is further adversely impacted by the nature of banks' solutions to the arrears crisis. Irish banks 'permanent' restructurings of arrears predominantly involve increasing the levels of debt carried by the households.

The cost of suppressing foreclosures and debt write-downs in the existent mortgages pool is the severely constrained ability of households to trade in the property markets. On the demand side, the knock-on effect is that younger households cannot rely on their parents to fund their down payments for FTB purchases.

The above problems also contribute to tighter supply of new homes to the market, especially in Dublin.

In 2013, new dwellings completions and commencements were running below those recorded in 2011-2012, based on data through Q3 2013. The overall weakness in the residential construction activity is confirmed by the CSO-reported indices. With data covering the period through Q3 2013, both value and volume of residential buildings construction and the number of planning permissions granted in Ireland are down year on year.  Estimates suggest that since the onset of the crisis penned up demand for first-time and mover purchasers has totaled around 25,000-32,000 dwellings. At current rate of new buildings completion, this is equivalent to up to 15 years of new construction supply.

Lack of funding from the zombified banks means that developers and builders cannot launch new projects. In addition, uncertainty about the future tax status of vacant sites and completed properties, as well as the dominant position of Nama in controlling access to land and development finance, are weighing heavily on potential new supply.

But beyond these supply constraints lies an even bigger problem: we simply cannot expect to build any meaningful quantity of new family homes in the areas where we need them.

In Dublin, new construction implies either building apartments blocks or redeveloping existent neighborhoods to increase density. Apartments are hardly in demand by the growing families beyond serving as a first step on the property ladder. In other words, no matter how much our planners dream about building a mini-Manhattan on the Liffey, Dublin property buyers still want individual homes with own gardens. Just as they did so at the times when property prices were double their current levels.

Demographics also stack up against us in the hope of significantly expanding apartments ownership. After 6 years of depressed volume of transactions, the new generation of First-Time Buyers is older and has larger families than their predecessors in the early 2000s. The one- and two-bedroom apartments developments that we used to produce in the past are no longer suitable for them. Furthermore, the city infrastructure – schools, crèches, shopping and family amenities – that accompanies these developments is not fit for purpose in Dublin City.

On the other hand, redevelopment of existent tracks of housing is a costly proposition that requires rapid inflation in selling prices for new homes. Crucially, it demands high turnover in the market to secure suitable redevelopment sites – something that we are unlikely to witness anytime soon. The very same constraints that hold back supply of second hand homes to the market are also holding hostage large-scale redevelopment projects.

This means that for Ireland to generate significant enough uplift in buildings supply we need to incentivise developers to build suitable apartments and for buyers to opt for these apartments. Even assuming we are successful, the resulting uplift in supply will be unlikely to enough downward pressure on property prices inflation in Dublin. In contrast, to support non-speculative demand and to free the supply of properties, we need to restructure our pool of mortgages away from tracker loans, reduce overall debt levels for current borrowers and improve after-tax incomes across the workforce. Until we do, the polarization of Irish property markets between Dublin and the rest of the country will continue.

Calling for more new construction is a naïve exercise in seeking a quick panacea to a very complex and dynamic malaise permeating every corner of our property markets.


In recent written answers to questions by Michael McGrath, TD, Minister for Finance, Michael Noonan, TD stated that the Irish State has received €10.24 billion in various proceeds from the banks since 2008. At the same time, the State shares in AIB, Bank of Ireland and Permanent TSB are currently valued at €13.35 billion. These numbers prompted some commentators to suggest that the net cost to the State of rescuing banks currently stands at EUR40.5 billion down from the originally paid-in EUR64.1 billion. Alas, this accounting misses some major points. Firstly, there is cost of funding. Based on current interest rates, the total costs of funds made available for banks recapitalisations is some EUR1.5 billion annually, with full expenditure at the peak of the capital injections running at more than double that. Tallying up these costs cuts the gross receipts by around EUR7.2 billion. Secondly, the EUR13.35 billion estimated value of the banks shares held by the Exchequer is nothing more than an estimate. Selling AIB and Ptsb shares will be an uphill battle. Even realising the value of the Bank of Ireland equity without destroying the bank's balance sheet is a hard task. Adding insult to the injury, the 'repayments' by banks claimed by Minister Noonan came at the expense of the economy at large. Instead of writing down unsustainable mortgages, restricting viable businesses' loans and supplying credit to the economy, the banks were tasked by the State to sell non-core assets to pay down state funds. Any wonder why the credit keeps shrinking, while Minister Noonan keeps talking about the need for banks to support the economy?


Unknown said...

Additionally, the option price associated with large scale developments mean that prices need to go higher for a sustained period than they otherwise would if lower density developments for developers to consider building them....assuming that there is demand for apartments anyway. The banks are in no way facilitating any movement in property markets, so you will continue with the two tiered property market, as you suggest.

Sandymount said...

'Alleged' turnaround in prices?,?

Will you remin bearish all the way up too?

Anonymous said...

what about repossessions or the lack of? if long term non-performing mortgages were repossessed we could see a large quantity of houses hit the market. Will this happen and if so when?

Anonymous said...

what about repossessions or the lack of? if long term non-performing mortgages were repossessed we could see a large quantity of houses hit the market. Will this happen and if so when?

Brian O' Hanlon said...

What we have in Ireland is the worst of two conditions.

Here we experience both residential rent volatility, and residential property undersupply in the the geographical areas of highest demand, owing to an apparent lack of appetite by politics to deal with the lack of control over land price volatility on the island of Ireland.

The 'shoe box' apartment concept, which the journalists and urban theorists in Ireland, are so fast to criticise, was the only viable solution available to generations of Irish young people to mitigate the risks which threatened to destroy them and their existences.

The onus upon commentators and critics of the 'shoe box' apartment, is to discuss the underlying problem, which made the 'shoe box' apartment one of the very few solutions left (in the absence of ability to define the real problem on the part of its posh, middle class critics).

If we are going to talk about 'shoe box' apartments at all, we might as well get one thing clear from the start. People who bought 'shoe box' apartments, weren't buying property, they were trying to purchase a 'hedge' against the kinds of risks, which would threaten to cancel out their career and development as young people, in a high expense and enterprise unfriendly place such as Ireland.

It is an excellent measure of the inability of Irish society to define and solve its own problems that the 'shoe box' apartment became as successful as it did, and not a fault of the 'shoe box' concept in itself.

When Vincent Browne on his television program talks about how the journalists and newspapers fuelled the property bubble in Ireland, this is one point that supports his argument. Journalists in Ireland did fail miserably, in their inability to define the underlying problem, that led to the development of the 'shoe box' apartment concept to begin with.

The big misconception first of all, is with the Irish banking and financial system. A huge proportion of people in Ireland aren't attempting to 'buy' homes or even buy property, but unfortunately they are forced down into that avenue, by organized efforts in Irish society to prevent alternatives from growing into a reality.

In Ireland, we suffer from an over-influence of 'property professionals' (to use a polite term to describe them), upon society, politics and banking (the ‘toxic’ Irish triangle, and source of most wrongs). They continue to influence control, by influencing the whole conversation and manner in which we as a society, attempt to define our problems.

The property professionals in Ireland, as they like to describe themselves, actively suppress any and all attempts to define problems in ways, other than in a way, in which 'buying a house' can become the be all, and end all solution.

What people in Ireland would really like to purchase, is not 'property', but rather insurance of some kind against the risks that they face in real life in Ireland, of over-sized exposure to risk of income and residential rent volatility, and the vicious combination of those two risks when they merge into one and become realized.

Young people in Ireland are always getting ravished by one or the other of these two. When their salaries improve, their residential rents take a hike. When the economy slows and their rents or salaries relax, the young people face a real risk of losing their income as employers shed numbers.

Brian O' Hanlon said...

How is one supposed to cope with that condition?

In other words, people have to search around for a 'hedge' against that excessively risky environment. The problem in Ireland has to do with inability of young people to lock in fixed costs on their personal balance sheet, and having too many risky variable costs. This state of balance un-health is widespread across whole generations of the under forty year olds (assuming that most people over the age of 40 in Ireland who find the going just too hard, will have bailed ship, and gone to England anyway).

At least, in places such as Great Britain, the risk of income loss is easier to monitor and manage. In those a larger, less giddy residential real estate markets as in Britain, the volatility of residential rents is not as bad. There is more inertia built into larger markets, where the trends of personal income and residential rents are more positively correlated, instead of being negatively correalted as we witness here in Ireland, . . . where the tides can turn rapidly against the young person in a way that can only be described as savage.

If one does face a bad combination of reduced or non-existent income, combined with residential rent inflation, there are very few real solutions. The 'show box' apartment, became one of them. And all of the writers and critics about the 'plague' of 'shoe box' apartment development in Dublin city, never quite understood this. The 'shoe box' apartment is a truly vernacular solution, to a truly vernacular Irish problem.

Buying of property was used as an instrument, to mitigate risk exposure to rent volatilities. It is a bit like how RyanAir would be sensible enough to purchase an instrument to reduce his company's exposure to a risk, which may threaten its future growth and prosperity. In the absence of any other viable insurance, or risk mitigation solutions, young people in Dublin would be crazy not to avail of it, from a 'piece of mind' point of view alone.

When things hit the fan in Ireland, governments or society won't care a fig about them. So why should young Irish people care a fig about the form of our built environment? Personal Income volatility is terribly bad in Ireland. Policy is generally designed from the point of view of three hundred thousand people in public service, who constitute ‘the core’ of what we call an economy. Loss of income following loss of employment in the private sector can be quite difficult to replace. Individuals in places such as Dublin in Ireland, are trying to find some solution, by which to combat the risk and volatility that they are facing on two sides.

The 'cheap', under-sized apartment, might not be an elegant solution, or instrument, to combat that risk, and a modern, first world society should be able to generate alternatives. But in the absence of such effort on the part of a society, the 'shoe box' apartment 'gets the job done'. Full stop. In fairness, it was the only solution available for the last twenty years of the 'Celtic Tiger' generation, living in a society that was as politically corrupt and rotten, as it was unstable and unsafe.