8/8/19: Irish New Housing Markets Continue to Underperform

New stats for new dwelling completions in Ireland are out today and the reading press releases on the subject starts sounding like things are getting boomier. Year on year, single dwellings completions are up 15.5% in 2Q 2019, scheme units completions up 2.6%, apartments up 55.6% and all units numbers are up 11.8%. Happy times, as some would say. Alas, sayin ain't doin. And there is a lot of the latter left ahead.

Annualised (seasonally-adjusted) data suggests 2019 full year output will be around 18,000-18,050 units, which is below the unambitious (conservative) target of 25,000. And this adds to the already massive shortage of new completions over the last eleven years. Using data from CSO (2011-present), cumulated shortfall of new dwellings completions through December 2018 was 125,800-153,500 units (depending on target for annual completions set, with the first number representing 25K units per annum target, and the second number referencing target of 25K in 2011, rising to 30K in 2016 and staying at 30K through 2019). By the end of this year, based on annualised estimates, the shortfall will be 132,400-162,250 units. Taking occupancy at 2.1 persons per dwelling, this means some 278,000-341,000 people will be shortchanged out of purchasing or renting accommodation at the start of 2020.

Here is a chart summarising the stats:

Let's put the headline numbers into perspective: at the current 'improved' construction supply levels (using annualised 2019 figure), it will take us between 6.3 and 7.7 years to erase the already accumulated gap in demand. If output of new dwellings continues to grow at 11.8% per annum indefinitely, Irish construction sector will be able to close the cumulative gap between supply and demand by around 2029 in case of the targeted output at 25K units per annum, or worse, by 2031 for the output target of 30K units per annum.

28/5/19: Why some long trend estimates start looking shaky for Ireland's property markets

There are many ways for analysing the long-term trends in real estate prices. One way is to use dynamics for the periods when price appreciation was consistent with underlying economic growth fundamentals and project price levels forward at the rates, on average, compatible with these periods.

And some exercises in assessing Irish house prices relative to trend are starting to sound like an early alarm bell going off.

In Ireland's case, organic growth-based period of the Celtic Tiger can be traced to, roughly, 1992/1993 through 1998. In terms of real estate prices (housing), this period corresponds to the post-1987 recovery of 1988-1990, followed by a house price 'recession' of 1991-1993 and onto the period of recovery and economic growth-aligned appreciation of 1994-1996. During this period, average price inflation in Irish house prices was 3.94% per annum.

Using the data from 1970 through 2018 based on the time series from the BIS and CSO, we can compare current price indices to those that would have prevailed were the 1988-1996 trend growth to continue through 2018. Chart below shows the results:

Several things worth noting:

1.  At the end of 2018, Irish house price index stood some 5.7 percent below where it would have been if the longer term trend prevailed from 1997 on.
2. Taking into the account moderating house price growth of 2016-2018 and projecting house prices forward from 2018 levels onto 2022 shows that by the end of 1Q 2020, Irish house prices can be expected to catch up with the longer-term trend.
3. The longer-term trend does capture quite well the effect of the massive price bubble of 1998-2007: the trend line hits almost exactly the 2009-2018 index average at 2010-2011. 
4. The pre-crisis peak levels of house prices can be expected to reach (on-trend) by 2022 implying that the house price bubble of 1998-2007 has, in effect, accelerated house price inflation by roughly 15 years, or 50-62 percent of the 25-30 year mortgage duration, which is consistent with the peak-to-trough decline in Irish house prices (53.3 percent) during the crisis.
5. The drop in Irish house prices during the crisis overshot the long-term trend by roughly 31 percent - a steep price to pay for massive excesses of the Celtic Garfield era of 2003-2007.
6. At the start of 2004, Irish house prices were 50 percent above their long term trend line, which is pretty much bang on with my estimate back in 2004 that I published here: https://trueeconomics.blogspot.com/2016/01/10116-my-2004-article-on-irish-property.html as a warning to Irish policymakers - a warning, as we all know well - that was ignored.
7. Referencing 2018 data, while the price dynamics so far appear to be catching up with the longer run trend, there is an increasing risk of a new price bubble forming, should price inflation continue unabated. For example, at an average rate of house price inflation of 11.34 percent (2014-2018 average), by the end of 2022, Irish house prices can exceed long-term trend by more than 15 percent.

Of course, a warning is due: this exercise is just one of many way to assess longer term sustainability trends in house price dynamics.  

For example, historical average rate of growth in house prices across 24 countries reported by BIS for 1970-2006 period is 2.34 percent per annum. Were we to take this rate of growth from 1998 through 2018 as the longer term trend indicator, Irish house prices would stand 32.7 percent above the long-run trend levels in 2018, implying that 

• Irish house prices reached long run equilibrium around 1Q 2015, and
• At the end of 2018, we were close more than 1/4 of the way toward the next bubble peak, in which case, by the end of 2021 we should be half way there.

Numbers are not simple. But numbers are starting to warrant some concerns. 

5/5/19: House Prices and Household Incomes

A recent note from Brookings on the nature of the ongoing housing crisis in America has opened up with a bombastic statement:

"Over the past five years, median housing prices have risen faster than median incomes (Figure 1). While that’s generally good news for homeowners, it puts additional pressure on renters. Because renters generally earn lower incomes than homeowners, rising housing costs have regressive wealth implications." 

(Source: https://www.brookings.edu/blog/up-front/2019/05/02/your-city-has-a-housing-crisis-the-answer-is-more-less-building-money-regulation/)

It sounds plausible. And it sounds easy enough to understand for politicos of all hues to take up the claim and run with it. There is is even a handy chart to illustrate the argument:

Except the claim is not exactly consistent with the evidence presented in that chart.

For starters, Case-Shiller Index covers 20 largest metropolitan areas of the U.S., which is a sizeable chunk of population, but by far not the entire country. And rents, as the Brookings article correctly says, are rising across whole states (the article, for example referencing California, which is way larger than the largest urban areas of the state alone). Second point, the article is completely incorrectly uses nominal house prices inflation against real (inflation-adjusted) income growth figures. If the converse of the article claim held, and real incomes exceeded housing price inflation, it would mean rising purchasing power for American households shopping for houses. However, that is not what the housing markets are historically, longer-term about. They are more about hedging inflation. The third, and more important point is that the article refers to the last 5 years. Why? No reason provided. But even a glimpse at the chart supplied in Brookings paper is enough to say that the same problem persisted prior to the Great Recession, was reversed in the Great Recession, and then returned post-Great Recession.

What's really happening here?

Ok, let's take four time series:

• House prices 1: Median Sales Price of Houses Sold for the United States, Dollars, Annual, Not Seasonally Adjusted;
• House prices 2: S&P/Case-Shiller 20-City Composite Home Price Index, Index Jan 2000=100, Annual, Seasonally Adjusted (same as in Brookings article);
• Income 1: Real Median Household Income in the United States, 2017 CPI-U-RS Adjusted Dollars, Annual, Not Seasonally Adjusted (same as in Brookings article); and 
• Income 2: Nominal Median Household Income in the United States, Current Dollars, Annual, Not Seasonally Adjusted

Observe that we have data only through 2017 for the last two measures due to data reporting lags.

Now, compute annual rates of growth in all four and plot them:

Blue line is the reference point here. Notice that the grey line (real household income growth) is really underperforming house price growth over virtually all periods, except for one: the Great Recession. Yellow line, however, is less so. Nominal incomes have more benign relationship to nominal prices than real incomes do to nominal house prices. Why would that be surprising at all? I am not sure. It did surprise folks at the Brookings, though.

Let's compute some average rates of growth for all four series and calculate the difference between:

1. Real Median Household Income growth rate and the growth rate in the Median Sales Price of Houses, percentage points; and
2. Nominal Median Household Income growth rate and the growth rate in the Median Sales Price of Houses, percentage points.

Instead of using an arbitrary 5 years horizon, consider instead the business cycle and longer term averages. Here they are:

Historical averages are, respectively, -3.71 percent and -1.31 percent. Across the last Quantitative Easing cycle, -2.94 percent and -1.60%, ex-QE cycle, -4.05% and -1.19%. 

So what does the above tell us? Things are not as dramatic, using nationwide house prices, than the Brookings claim makes it sound, and, more importantly, there is no evidence of a significant departure in the current QE cycle from the past experiences. When it comes to property prices, hoses inflation seems to be much less divorced from real and nominal income growth rates in the last four years (the recovery period post-Great Recession) than in the periods prior to the GFC.

12/8/17: Are Irish Property Prices on a Sustainable Path?

Some of the readers of this blog have been asking me to revisit (as I used to do more regularly in the past) the analysis of Irish property prices in relation to the ‘sustainability trend’. With updated CSO data on RPPI, here is the outrun.

The charts below show current National and Dublin property price indices in relation to the trends computed on the basis of the following CORE assumptions:

• Starting period: January 2005
• Starting index ‘sustainability’ positions: National = 82.0 (implying that long-term sustainable market valuations were around 18 percentage points below market price levels at January 2005 or at the levels comparable to Q4 2010); Dublin = 83.0 (implying 17 percentage points discount on January 2005).

Charts above use the following SPECIFIC trend assumptions:

• Linear (simplistic) trend at 2% inflation target + 0.5 percentage points margin. This implies that under this trend, property prices should have evolved broadly-speaking at inflation, plus small margin (close to tracker mortgage rate margin).

In all cases, current markets valuations are well below the long-term sustainability target and there is significant room for further appreciation relative to these trends (see details of target under-shooting in the summary table below).

Chart above shows tow series sustainability targets computed on the basis of different specific assumptions, while retaining same core assumptions:

• I assume that property prices should be sustainably anchored to weekly earnings. 

Using only weekly earnings evolution over January 2005-present, as shown in the above chart, both Dublin and National house prices are currently statistically at the levels matching sustainability criteria. There is no statistical overshooting of the sustainability bounds, yet.

Chart above again modifies specific assumptions, while retaining the same core assumptions. Specifically:

• I assume that both earnings and interest rates (using Euribor 12 months rate as a dynamic gauge) co-determine sustainable house prices. In a away, this allows us to reflect on both income and cost of debt drivers for house prices.

As the chart above clearly shows, both National and Dublin property markets are still well underpriced compared to the long term sustainability targets, defined based on a combination of earnings and interest rates. Note: correcting this chart for evolution of unemployment brings sustainability benchmarks roughly half of the way closer to current prices, but does not fully erase the gap.

Summary table below:

So, overall, the above exercise - imperfect as it may be - suggests no evidence of excessive pricing in Irish residential property at this point in time. There are many caveats that apply, of course. Some important ones: I do not account for higher taxes; and I do not factor in difficulties in obtaining mortgages. These are material, but I am not sure they are material enough to bring the above gaps to zero or to trigger overpricing. Most likely, the national residential prices are somewhere around 5-7 percent below their sustainability bounds, while Dublin prices are around 7-10 percent below these bounds. Which means we have a short window of time to bring the markets to the sustainable price dynamics path by dramatically altering supply dynamics in the property sector. A window of 12-18 months, by my estimates.

8/8/17: Irish Taxpayers Face a New Nama Bill

Ireland has spent tens of billions to prop up schemes, like Nama and IBRC. These organisations pursued developers with a sole purpose: to bring them down, irrespective of the optimal return strategy from the taxpayers perspective and regardless of optimal recovery strategies for asset recovery. We know as much because we have plenty of evidence - that runs contrary to Nama and IBRC relentless push for secrecy on their assets sales - that value has been destroyed during their workout and asset sales phases. We know as much, because leaders of Nama have gone on the record claiming that developers are, effectively speculators, 'good for nothing else, but attending Galway races', and add no value to construction projects.

Now, having demolished experienced developers and their professional teams, having dumped land and development sites into the hands of vulture investors, who have no expertise nor incentives to develop these sites, the State has unrolled a massive subsidy scheme to aid vultures in developing the sites they bought on the State-sponsored firesales.

As an aside, this June, Nama officially acknowledged the fact that majority of its sales of land resulted in no subsequent development. What Nama did not say is that the 'developers' hoarding land are the vulture funds that bought that land from Nama, just as Nama continued to insist that its operations are helping the construction and development markets.

Why? Because Nama was set up with an explicit mandate to 'help the economy recover' and to drive 'markets to restart functioning again', and to aid social housing crisis (remember when in 2012 - five years ago - Nama decided to 'get serious' about social housing?). And Nama has achieved its objectives so spectacularly, Ireland is now in the grips of a housing crisis, a rental market crisis and a cost-of-living crisis.

Read and weep: http://www.independent.ie/business/personal-finance/property-mortgages/taxpayer-to-fund-developers-with-no-guarantees-on-prices-36009844.html?utm_content=buffer39407&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer.
Irish taxpayers are now paying the third round of costs of the very same crisis: first round of payments went to Nama et al, second to the banks, and now to the 'developers' who were hand-picked by Nama and IBRC to do the job they failed to do, for which Nama was created in the first place.

Oh, and because you will ask me when the fourth round of payments by taxpayers will come due, why, it is already in works. That round of payments will cover emergency housing provision for people bankrupted by the banks and Nama-supported vultures. That too is on taxpayers shoulders, folks...

22/5/16: House Prices & Household Consumption: From One Bust to the Other

In their often-cited 2013 paper, titled “Household Balance Sheets, Consumption, and the Economic Slump” (The Quarterly Journal of Economics, 128, 1687–1726, 2013), Mian, Rao, and Sufi used geographic variation in changes house prices over the period 2006-2009 and household balance sheets in 2006, to estimate the elasticity of consumption expenditures to changes in the housing share of household net worth. In other words, the authors tried to determine how responsive is consumption to changes in house prices and housing wealth. The study estimated that 1 percent drop in housing share of household net worth was associated with 0.6-0.8 percent decline in total consumer expenditure, including durable and non-durable consumption.

The problem with Mian, Rao and Sufi (2013) estimates is that they were derived from a proprietary data. And their analysis used proxy data for total expenditure.

Still, the paper is extremely influential because it documents a significant channel for shock transmission from property prices to household consumption, and thus aggregate demand. And the estimated elasticities are shockingly large. This correlates strongly with the actual experience in the U.S. during the Great Recession, when the drop in household consumption expenditures was much sharper, significantly broader and much more persistent than in other recessions. As referenced in Kaplan, Mitman and Violante (2016) paper (see full reference below), “… unlike in past recessions, virtually all components of consumption expenditures, not just durables, dropped substantially. The leading explanation for these atypical aggregate consumption dynamics is the simultaneous extraordinary destruction of housing net worth: most aggregate house price indexes show a decline of around 30 percent over this period, and only a partial recovery towards trend since.”

With this realisation, Kaplan, Mitman and Violante (2016) actually retests Mian, Rao and Sufi (2013) results, using this time around publicly available data sources. Specifically, Kaplan, Mitman and Violante (2016) ask the following question: “To what extent is the plunge in housing wealth responsible for the decline in the consumption expenditures of US households during the Great Recession?”

To answer it, they first “verify the robustness of the Mian, Rao and Sufi (2013) findings using different data on both expenditures and housing net worth. For non-durable expenditures, [they] use store-level sales from the Kilts-Nielsen Retail Scanner Dataset (KNRS), a panel dataset of total sales (quantities and prices) at the UPC (barcode) level for around 40,000 geographically dispersed stores in the US. …To construct [a] measure of local housing net worth, [Kaplan, Mitman and Violante (2016)] use house price data from Zillow…”

Kaplan, Mitman and Violante (2016)findings are very reassuring: “When we replicate MRS using our own data sources, we obtain an OLS estimate of 0.24 and an IV estimate of 0.36 for the elasticity of non-durable expenditures to housing net worth shocks. Based on Mastercard data on non-durables alone, MRS report OLS estimates of 0.34-0.38. Using the KNRS expenditure data together with a measure of the change in the housing share of net worth provided by MRS, we obtain an OLS estimate of 0.34 and an IV estimate of 0.37 – essentially the same elasticities that MRS find. …Overall, we find it encouraging that two very different measures of household spending yield such similar elasticity estimates.” The numerical value differences between the two studies are probably due to different sources of house price data, so they are not material to the studies.

Meanwhile, “…the interaction between the fall in local house prices and the size of initial leverage has no statistically significant effect on nondurable expenditures, once the direct effect of the fall in local house prices has been controlled for.”

Beyond this, the study separates “the price and quantity components of the fall in nominal consumption expenditures. …When we control for …changes in prices, we find an elasticity that is 20% smaller than our baseline estimates for nominal expenditures.” In other words, deflation and moderation in inflation did ameliorate overall impact of property prices decline on consumption.

Lastly, the authors use a much more broadly-based data for consumption from the Diary Survey of the Consumer Expenditure Survey “to estimate the elasticity of total nondurable goods and services” to the consumer expenditure survey counterpart of expenditures in the more detailed data set used for original estimates. The authors “obtain an elasticity between 0.7 and 0.9 … when applied to total non-durable goods and services.”

Overall, the shock transmission channel that works from declining house prices and housing wealth to household consumption is not only non-trivial in scale, but is robust to different sources of data being used to estimate this channel. House prices do have significant impact on household demand and, thus, on aggregate demand. And house price busts do lead to economic growth drops.



Full paper: Kaplan, Greg and Mitman, Kurt and Violante, Giovanni L., "Non-Durable Consumption and Housing Net Worth in the Great Recession: Evidence from Easily Accessible Data" (May 2016, NBER Working Paper No. w22232: http://ssrn.com/abstract=2777320)

24/1/16: House Prices, Local Demand and Homeownership Status

House prices bust was a major dimension of the recent Great Recession around the world. Nonetheless, contrary to all evidence, many political leaders have opted to dismiss the adverse impacts of shocks like negative equity (due to price declines and pre-crisis debt ramp ups) and wealth effects on aggregate demand (first order price effects).

An interesting study based on the U.S. data tests the aggregate impacts of house prices changes on consumption, while controlling for homeownership status (renters v owners).

Titled “House Prices, Local Demand, and Retail Prices” and co-authored by Johannes Stroebel and Joseph Vavra (CESIFO WORKING PAPER NO. 5607, NOVEMBER 2015) the study used “detailed micro data to document a causal response of local retail price to changes in house prices, with elasticities of 15%-20% across housing booms and busts. Notably, these price responses are largest in zip codes with many homeowners, and non-existent in zip codes with mostly renters.”

In other words, not only impacts of house price changes are significant, they are also bifurcated across two types of home occupiers - owners and renters, with renters exhibiting effectively no sensitivity to home prices changes in terms of their demand.

The authors “provide evidence that these retail price responses are driven by changes in markups rather than by changes in local costs. … Markups rise with house prices, particularly in high homeownership locations, because greater housing wealth reduces homeowners’ demand elasticity, and firms raise markups in response. Consistent with this explanation, shopping data confirms that house price changes have opposite effects on the price sensitivity of homeowners and renters.”

Overall, “taken together, our empirical results provide evidence of an important link between changes in household wealth, shopping behavior and firm price-setting. Positive shocks to wealth cause households to become less price-sensitive and firms respond by raising markups and prices.”

So do house prices matter for aggregate demand? They do. Does homeownership smooth or amplify effects of shocks to house prices on the aggregate economy? It appears to amplify them. Should monetary and fiscal policies be asymmetric for areas with high homeownership concentration as opposed to areas with high renters concentration? Yep. Ditto for countries, instead of areas.

Of course, in the Euro area, how does one structure differential monetary policies across countries so diverse as renters-concentrated Germany vs homeowners concentrated Holland or Ireland? Err… can we check that one as yet another problem with Euro architecture?..

3/1/2015: Can LTV Cap Policies Stabilise Housing Markets?

The Central Bank of Ireland late last year unveiled a set of proposals aimed at cooling Irish property markets, including the controversial caps on LTV ratios on new mortgages. And this generated loads of controversy, shrill cries about the cooling effect of caps on property development and even speculations that the caps will put a boot into rapidly rising (Dublin) property prices. In response, our heroic property agents unleashed a torrent of arguments about supply, demand, sparrows and larks - all propelling the property prices to new levels, 'despite' the CBI measures announced (see for example here:  http://www.independent.ie/business/personal-finance/property-mortgages/property-prices-set-to-rise-despite-lending-cap-plan-30879087.html for a sample of property marketers exhortations on matters econometric).

But never, mind the above. Truth is, the measures announced by the CBI are genuinely, for good economic reasons, have low probability of actually having a serious impact on property prices. At least all real (as opposed to property agents' economists') evidence provides for such a conclusion.

A recent paper by Kuttner, Kenneth N. and Shim, Ilhyock, titled "Can Non-Interest Rate Policies Stabilise Housing Markets? Evidence from a Panel of 57 Economies" (BIS Working Paper No. 433: http://ssrn.com/abstract=2397680) used data from 57 countries over the period spanning more than three decades, to investigatee "the effectiveness of nine non-interest rate policy tools, including macro-prudential measures, in stabilising house prices and housing credit."

The authors found that "in conventional panel regressions, housing credit growth is significantly affected by changes in the maximum debt-service-to-income (DSTI) ratio, the maximum loan-to-value ratio, limits on exposure to the housing sector and housing-related taxes. But only the DSTI ratio limit has a significant effect on housing credit growth when we use mean group and panel event study methods. Among the policies considered, a change in housing-related taxes is the only policy tool with a discernible impact on house price appreciation."

On DSTI finding, the authors estimate that setting a maximum DSTI ratio as the policy tool allows for a typical policy-related tightening, "slowing housing credit growth by roughly 4 to 7 percentage points over the following four quarters." In addition, on tax effectiveness, the authors found that while "an increase in housing-related taxes can slow the growth of house prices", this result is "sensitive to the choice of econometric method" used in model estimation.

Finally, on CBI-favoured LTV limits: "Of the two policies targeted at the demand side of the market, the evidence indicates that reductions in the maximum LTV ratio do less to slow credit growth than lowering the maximum DSTI ratio does. This may be because during housing booms, rising prices increase the amount that can be borrowed, partially or wholly offsetting any tightening of the LTV ratio."

In other words, once prices are rising, LTV caps are not terribly effective in controlling house price inflation.

2/1/2015: Monetary Policy and Property Bubbles

Returning again to the issue of lender/funder liability in triggering asset price bubbles (see more on this here: http://trueeconomics.blogspot.ie/2015/01/112015-share-liability-debtor-and-lender.html), CEPR Discussion Paper "Betting the House" (see
http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10305) by Òscar Jordà, Moritz Schularick, Alan M. Taylor asks a question if there is "a link between loose monetary conditions, credit growth, house price booms, and financial instability?"

The authors look into "the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. We exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions."

Do note: Ireland and the rest of euro periphery are the prime examples of this specific case.

The authors find that "…loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era."

So let's give the ECB a call… 

16/9/2014: More of a Risk, Less of a Bubble: Irish Property Prices in Q1 2014

An interesting BIS paper on House Prices data across a number of advanced economies (http://www.bis.org/publ/qtrpdf/r_qt1409h.htm). A key chart:

Data is through Q1 2014 and is based on the aggregate of 8 data sets for Ireland. It is worth noting that data is for Ireland overall, not Dublin.

In the nutshell, in Q1 2014 Irish property prices were still at the lower end in terms of price/rent ratio and price/income ratio.

An interesting contrast to other peripheral and advanced economies in terms of dynamics:
"Year-on-year residential property prices, deflated by CPI, rose by 9.5% in the United States and 6% in the United Kingdom. Real house prices also grew, by 7% in Canada, 7.7% in Australia and 2.2% in Switzerland, three countries that were less affected by the crisis, as well as in some countries that were severely affected by the crisis, such as Ireland (+7.2%) and Iceland (+6.4%).  Real price growth remained in negative territory in Japan (–2.6%) and was generally weak or negative in continental Europe. Prices rose in Germany (+1.2%) and the Nordic countries (+1.7% in Denmark and +4.8% in Sweden), but continued to fall in the euro area’s southern periphery (Italy, –5%; Spain, –3.8%; Portugal, –1.2%; and Greece, –6%). "

So as I noted before, two points of concern and two points of solace:

• Dynamics of prices, not levels, are signalling serious problems in the markets;
• Dublin is the core driving factor for this with the rest of the country barely showing much of an improvement;
• Levels of prices remain benign in relation to incomes and to rents, especially outside of Dublin;
• Compared to other peripherals, we are witnessing much faster recovery supported by significant past falls in prices relative to income (note similar levels of prices in Iceland, although prices recovery and dynamics are more concerning there than in Ireland).

29/6/2014: London Property Markets: A Safe Haven After All

A fascinatingly interesting study looking into London property markets from the point of view of safe haven properties. Badarinza, Cristian and Ramadorai, Tarun, "Preferred Habitats and Safe-Haven Effects: Evidence from the London Housing Market" (April 17, 2014, http://ssrn.com/abstract=2353124) uses "a new cross-sectional approach, motivated by the insight that investors may have different "preferred habitats" within a broad asset class."

The study deploys this strategy "on large databases of historical housing transactions in London, finding that economic and political risk in Southern Europe, China, the Middle East, Russia, and South Asia helps explain price and volume dynamics in the London housing market over the past two decades. Safe-haven effects on the London housing market are long-lasting and significant, but temporary. The method also uncovers intriguing insights about cross-country variation in preferred habitats within London."

26/6/2014: You Might Need a Hubble to Spot That Bubble

In my analysis yesterday (here) I argued that Dublin residential property prices are simply showing signs of reversion to trend, not 'bubble' dynamics. Since then, numerous reports in the media produced opposite conclusions, with headlines forcibly putting forward an argument for 'bubble' formation in Dublin property markets.

Over long run, sustainable property prices appreciation should track closely inflation in the economy. So far is pretty much clear. While arbitrary, starting points for trend estimation for Dublin property should start from pre-bubble period of 1999-2001. This is also pretty clear.

So let us apply Consumer Price Index-measured inflation to Dublin residential property price indices and see where the trend is against current reading. The following chart, based on annual series 2000-2013 and May 2014 for current reading illustrates this exercise:

Here's a pesky problem for 'bubble'-maniacs out there:

1. If property prices expanded at the rate of inflation from 2000 on, current Dublin property prices index should read around 91.2.
2. If property prices expanded at the ECB policy-consistent inflation target of 2%, the index should read around 89.4
3. Current CSO index reading is 72.2

So we are somewhere 25-26% below 'sustainable' levels of house prices, if these are measured by inflation-linked price appreciation, or 24% below ECB-targeted rate of inflation.

You do need quite a powerful telescope to spot the bubble in Dublin markets from here. Which, of course, should not be read as 'there is no bubble', just as 'we can't yet tell anything about bubble being formed'.

26/4/2014: It's a long... long... long... road to house prices recovery...

It is a virtually impossible task forecasting long-term price movements in property markets for small economies, like Ireland. The reason is that there are simply too many moving parts all with huge volatility built into the numbers. Take for example normally stable time series such as population. In the case of Ireland, wild swings in terms of net migration over the recent years saw 2006-2008 annual average net immigration of 80,300 per annum switching into a net annual emigration of 31,633 per annum in 2010-2012. While total change in 2007-2013 population in Ireland was 108,000, net migration swing was 111,930. You get the point: what we think the potential demand might be is not an exact science and in the case of Ireland it is not really much of any science whatsoever.

So setting aside actual economic models, what can we say about future property prices trends?

We can do a couple of simple dynamic exercises. Suppose that we are getting back to pre-crisis ‘normal’. This can mean pre-2001 rates of growth in prices or it can mean Celtic Garfield rates of growth. Many would say ‘The Bubble days are over’. So they may be. But suppose they are not. Suppose the rates of growth that prevailed over 2004-2007 are to return. The logical question is: if the boom were to come back, how long will it take property prices to recover? This is obviously a wildly optimistic scenario. But let’s entertain it, shall we?

Below I provide a table of estimated years by which current (end of 2013) prices indices for Irish residential property are likely to recover their real (inflation-adjusted) peak values consistent with pre-crisis years. In other words, the table shows years by which we can expect the crisis effects to be finally erased.

Take 3 scenarios:

Scenario 1: assume that from now on, average annual growth rates for property prices run at their 2004-2007 averages and that inflation averages 1.5 percent per annum (CPI). Adjust the pre-crisis peak for inflation that accumulated between 2007 and present.

Scenario 2: assumes the same as Scenario 1, but adjusts inflation expectation forward to 2 percent instead of 1.5 percent.

Scenario 3: assumes the same as Scenario 1, except we also take into assume average rates the average for 2004-2007 and 2012-2013 to reflect the popular argument that 2012-2013 years growth rates reflect ‘recovery’ in the markets, aka a departure from the crisis.

The last line in the table shows the average duration of the period of recovery – averaged across 3 scenarios. This means that the average is ‘geared’ or ‘leans’ more heavily toward Scenarios 1 and 2 which are by far much more optimistic than Scenario 3.

Do note that all three scenarios are wildly out of line with what we should expect in the long run from the property prices – appreciation at inflation + 0.2-0.5 percentage points margin.

Click on the table to enlarge

Key takeaway:

You might think we are in a recovery, but be warned – even under very unrealistically optimistic price growth projections – the effects of this crisis are likely to prevail well beyond 2025 in Dublin and beyond 2030 nationwide. Now, enjoy the property supplements and financial ‘analysts’ op-eds telling you that everything is going on swimmingly in the markets…

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 Daft.ie 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.

BOX-OUT

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?

12/1/2013: House Prices Valuations via The Economist

An interesting table from The Economist (link) on house prices in select countries (H/T to @greentak ):

Note, obviously, Ireland. Not the bits on changes in prices, but the -1% under-valuation on rents side and -5% under-valuation on disposable income side. This is interesting because, in my opinion, the prices currently are in a 'bounce-along-the-bottom' pattern.

Here are some points of thought:

• Usually, house prices over-correct, overshooting the longer-term equilibrium levels. This implies that if we are currently close to the bottoming-out of prices (I am not saying we are), then there is a fundamentals-driven upside of small proportion. 1-5% might be a reasonable range.
• Another feature is the gap in 'under-valuation' between rents-implied and incomes-implied. We have no idea what disposable income The Economist has in mind (GNI? earnings? etc - and these are non-trivial), but we do know they have 'per person' metric. Per person of working age? or children counted in as well? Setting these and other issues aside, the gap between the two is, roughly, reflected in probably two main factors: supply of rentable accommodation relative to demand (which is keeping rents lower, relative to income) and distribution of income (with more potential renters in lower income brackets, while more existent homeowners in higher, implying that renters can't convert into purchasers, while feasible purchasers have no need to go into the market). In other words, the gap is very wide and is significant, in my view, of the tenuous nature of income-based price assessments.
• The 1-5% undervaluation today, on the slope as steep (-49.4% since 2007) is highly unlikely to be the range of reasonable overshooting of the longer-term prices. In other words, if past experiences are a guide, Irish house prices can easily fall another 10% or more even if we consider the above table-listed drivers alone.

Now, as per arguments that these under-valuations are going to drive the market up, just look at Germany. According to The Economist, German house prices have an upside of 17% both on rental valuations and income valuations bases. Good luck, if you expect that to materialise. 

In short, I am not so sure the above table is meaningful in any sense. Nice to see that someone out there thinks Irish housing markets are undervalued, but I am still to be convinced that this is (a) real, and (b) likely to lead to sustained values increases. 

If you are keen to look at some interactive charts on the above data, go here.

And if you are keen on checking out one crazy property market... look here:

18/11/2012: Housing equity and retirement dis-savings

A new paper "Home Equity in Retirement" by Makoto Nakajima and Irina A. Telyukova (September 20, 2012) looks at the effects of homeownership on savings/dissaving by retirees, using the US data for 1996-2006.

Using an estimated structural model of saving and housing decisions, the study finds that "homeowners dissave slowly because they prefer to stay in their house as long as possible, but cannot easily borrow against it. Second, the 1996-2006 housing boom significantly increased homeowners' assets. These channels are quantitatively significant; without considering homeownership, retirees' savings are 24-43% lower."

Some more details:

Figure 1 shows over the period 1996-2006, median net wealth remains high very late into the life cycle. The observation that many people die with significant savings, which is puzzling in the context of a simple life-cycle model, has been termed the \retirement saving puzzle. However, the picture changes dramatically if we consider the saving behavior of retirees who

own homes, compared to those who do not. Consider figure 2, which documents the cohort profiles of median net worth over the same period, normalized by the first observation, for homeowners versus renters.

The difference is stark. Homeowners have flat or increasing profiles of net wealth over this period, while renters display a far faster rate of asset decumulation. This suggests that housing may play a major role in determining how retirees save or dissave."

Overall, the paper finds that:

• "…high homeownership rate late into the life-cycle that we observe in the data is crucial to consider for understanding retiree saving behavior."
• "Housing-related channels are significant contributors to the retirement saving puzzle. Retirees stay homeowners late in life, but become increasingly locked into their home equity as they age; 
• "...we find that borrowing constraints on retirees tighten considerably. This means, on the one hand, that those who remain homeowners do not decumulate their home equity, thus creating the kind of flat housing profile that we see in the data, while those who face a large expense may come up against their borrowing constraint and be forced to sell the house. 
• "We also use the model to understand why people retirees choose to remain homeowners late in life. We find that the leading motivators are utility benefits of owning a house (which capture also financial benefits, such as tax advantages) and bequest motives. 
• "In contrast, precautionary motives in the face of medical expense risk do not a effect homeownership significantly, but play a role in the puzzle through financial asset accumulation, although overall this role is quantitatively modest and affects younger retirees more than older ones. 
• "Quantitatively, we find that the housing channels {utility benefits of ownership, collateral constraints, and the housing boom} jointly account for between 24 and 43% of the median net worth profile, depending on age.
• "The bequest motive accounts for up to 31% of the median net worth profile, and its importance increases with age. 
• "Medical expense risk accounts for maximum 8% of median net worth, and its importance generally falls with age, due to interaction with Medicaid.
• "..we conduct an experiment where we allow households to make a decision on whether or not to maintain their home. We want to evaluate this as an additional, possibly hidden, channel of asset decumulation, consistent with data evidence that homes of elderly owners depreciate more quickly than those of younger owners. We treat this as a hidden channel because we assume that self-reported housing values of owners who remain in their houses do not take into account the depreciation rate unless they have the house appraised for sale, for example. We find this to be a significant channel of asset decumulation. 30% of our model homeowners choose not to maintain their homes in the 75-85 year old cohort; for the younger cohort, that proportion is over 50%, while it is lower for the oldest cohort. We show that this channel affects median housing asset profiles as well."

All of this has huge implications for countries like Spain and Ireland that have undergone a massive property prices bust. Declines in property prices have wealth effects, negative equity has wealth effects. Both, however, have also direct behavioural effects that are also adverse, as outlined above. In my view, we have not even started to count the real costs of the property busts in our fiscal and economic forecasts.