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. 

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)

8/5/15: Irish Residential Property Prices: Q1 2015

Updating residential property price indices for Ireland for 1Q 2015:

• National property prices index ended 1Q 2015 at 80.7, up 16.79% y/y - the highest rate of growth in series history (since January 2005), but down on 4Q 2014 reading of 81.4. Latest reading we have puts prices at the level of October 2014. Compared to peak, prices were down 38.2% at the end of 1Q 2015. National property prices were up 25.9% on crisis trough in 1Q 2015.

• National house prices ended 1Q 2015 at index reading of 83.8, which is down on 84.6 reading at the end of 4Q 2014, but up 16.55% y/y - the highest rate of growth in the series since September 2006. Relative to peak, national house prices were still down 36.5%.At the end of 1Q 2015, house prices nationally were up 25.5% on crisis period trough.
• National apartments prices index finished 1Q 2015 at 66.4, up on 4Q 2014 reading of 64.2 and 25.5% higher than a year ago. Apartment prices are down 46.4% on their peak and up 45.3% on crisis period trough. Y/y growth rates in apartments prices is now running at the highest level in history of the CSO series (from January 2005).

• Ex-Dublin, national residential property price index ended 1Q 2015 at 75.3, marking a marginal decline on 4Q 2014 reading of 75.5, but up 10.74% y/y - the highest rate of growth since May 2007. Compared to peak, prices are down 41.5% and they are up 13.9% on crisis period trough.
• Ex-Dublin house prices finished 1Q 2015 at the index reading of 77.1, which is virtually unchanged on 77.2 reading at the end of 4Q 2014. Year-on-year prices are up 10.78% which is the fastest rate of expansion since May 2007. Compared to peak prices are still 40.6% lower, although they are 14.2% ahead of the crisis period trough.
• Dublin residential property prices were at 82.5 at the end of 1Q 2015, down on 83.8 index reading at the end of 4Q 2014. Annual rate of growth at the end of 1Q 2015 was 22.77%, the highest since October 2014. Dublin residential property prices are down 38.7% compared to peak and up 44% on crisis period trough. Over the last 24 months, Dublin residential property prices grew cumulatively 40.3%.
• Dublin house prices index ended 1Q 2015 at a reading of 86.9, which is below 88.8 index reading at the end of 4Q 2014, but up 22.05% y/y, the highest rate of growth in 3 months from December 2014. Dublin house prices are down 36.9% on pre-crisis peak and are up 42.93% on crisis period trough. Over the last 24 months, cumulative growth in Dublin house prices stands at 39.5%.
• Dublin apartments price index ended 1Q 2015 at a reading of 73.7, up on 70.2 reading attained at the end of 4Q 2014, and up 29.75% y/y - the fastest rate of growth recorded since September 2014. Compared to peak, prices are still down 42.2% and they are up 59.2% on crisis period trough. Over the last 24 month, Dublin apartments prices rose cumulatively by 51.3%.

Longer dated series available below:

And to update the chart on property valuations relative to inflation trend (bubble marker):

As chart above clearly shows, we are getting closer to the point beyond which property prices will no longer be supported by the underlying fundamentals. However, we are not there, yet. Acceleration in inflation and/or deceleration in property prices growth will delay this point significantly. One way or the other, there is still a sizeable gap between where the prices are today and where they should be in the long run that remains to be closed.

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.

27/8/2014: Irish Property Markets: Some Foam Under the Cork...

Time to worry is… about now… or rather in a couple of months...

Irish residential properties price index for July was released by CSO. The data is showing continued established trends in prices recovery with further amplification in the worrying trends of double-digit y/y increases in Dublin property prices. While I generally prefer to provide more detailed analysis on a quarterly data, which will be available at the end of October, the current rates of increases in prices are now worrying and deserve at least a brief comment.

Overall, National Residential Prices Index rose to 75.3 in July 2014, which is up 13.4% y/y. July marks third consecutive month of double-digit y/y increases in prices. And the rate of increases is accelerating for the fourth consecutive month. This is worrying. The level of index remains low - 42.3% off its pre-crisis peak and only 17.47% up on crisis trough. But cumulated 24 months gain is now 16.0% (an annualised rate of increases at 7.71%). Thus, as I noted before, the main concern is not the level of prices, yet, but the the rate at which prices are moving up.

Furthermore, the rate of price increases in the Apartments segment of the market is clearly outstripping price increases for houses in all months since June 2013, with exception of February 2014. This too is worrying as this suggests investment motives buying acting strongly to push prices up for rental properties. The result will likely be misallocation of investment and rising rents.

In Dublin, the growth rates are even of greater concern.

Once again, levels are not a problem: Dublin residential properties index currently sits at 76.6 which is 43.5% lower than pre-crisis peak and 33.68% higher than crisis period trough. Dublin fell hardest and fastest of all markets in Ireland during the crisis, so it is bouncing back now faster too. So much is fine. But the rates of increase in prices y/y are now running at double digits for 12 consecutive months in a row, with last three months the rates of prices increases in Dublin at above 21 percent. sooner or later it will be time to call this a 'feeding frenzy' and if the credit supply to the sector were to improve, all stops will be pulled out of the buyers. Psychology here is not pretty.

So is it 'finally' time to call this a bubble? Not yet. I will make my next call on this on foot of September data (due in October), but in general, the levels of prices are still benign compared to pre-crisis peaks, pre-bubble trends and the 'natural rate' of price increases that can be expected to prevail from the 1990s on. But I am beginning to worry that a combination of:

1. Tight supply of suitable properties
2. Rising rents and lack of retail investor professionalism in structuring functional investment portoflios
3. Psychology of the buyers, reinforced by the media and real estate agents commentary, 
4. Expectations of further tax easing in the Budget 2015, especially targeted to property markets, and
5. Continued accumulation of cash in certain sub-sectors of economy

are all adding up to a rising pressure on the investors and buyers to go into the market to secure 'any' deal at 'any' valuation as long as it is remotely affordable.

This is not a 'champagne cork' moment, yet, but we have lots of foam in this market, with little to slow down the cork for the moment...

24/7/2014: Residential Property Prices: June 2014 Detailed Breakdown

In the previous post I covered Residential Property Prices Index data from the point of view of the 'bubble' dynamics. Monthly data is covered in the CSO report here. So to avoid doing what every one else in media is doing (regurgitating the press release), here is the analysis of data based on quarterly aggregates and longer-term changes. This strips-out some of the monthly-level volatility and is probably better suited to comparatives across time.

Starting with the RPPI nationwide:

• Q2 2014 average is at 76.9 which is well ahead of 69.4 average for Q1 2014 - a rise of +3.55%. 
• Cumulated 24 months growth is now at 13.9% or 6.72% annualised. This is robust, but very much in line with what can be expected in a recovery phase, given the rates of market collapse during the crisis.
• Compared to Nama valuations, we are still down 24.8%
• Compared to pre-crisis peak we are down 43.5% and compared to crisis trough we are up 15.1%.

Here are the annual growth rates in the series:

• National Houses series are driving the overall National Index. Houses series are up 3.55% - same as National - in Q2 2014 compared to Q1 2014. 24 months cumulated gain is 13.6%, slightly below National gains. Compared to crisis peak, National Houses index is 41.8% lower, while compared to crisis trough it is 15% up.
• Apartments up 3.62% q/q in Q2 2014 and cumulated gains are 19.8% over the last 24 months. Relative to peak these are down 54% and relative to crisis period trough they are up 24.7%. There is a lot more volatility in Apartments Index than in the Houses Index.

Ex-Dublin:

• Ex-Dublin Properties Index is up only 0.1% q/q in Q2 2014. There is basically no growth in the series. Over the last 24 months, series rose just 2.35% cumulatively. Compared to peak, ex-Dublin national prices are 45.8 down and compared to crisis-period trough they are up only 5.6%. This is very anaemic. 

Dublin:

• Dublin All-Properties Index is up 7% in Q2 2014 compared to Q1 2014. This is fast. Cumulated gains over last 24 months are 29.1% (annualised rate of 13.6%) which is also very fast. Compared to peak, prices in Dublin are down 44.5%, which is worse than National (-43.5%) and relative to crisis period trough prices are up 30.2% (which is better than National at 15.1%).
• Nama valuations are off 17.2% in Dublin, which is much better than outside Dublin.
• Dublin Houses Index is up 7.2% q/q in Q2 2014 - very fast rise. Cumulated gains over 24 months are 28.9% (annualised rate of 13.5% - also very fast increases). Compared to peak, Dublin Houses prices are off 42.7% and compared to trough they are up 30%.
• The above dynamics are starting to concern me - we are witnessing very fast increases from very low levels, so while we are not yet in over-pricing territory, we are converging toward long-term equilibrium prices at a break-neck speed. The next 3 months data will be probably non-representative due to two late-Summer months, but September-December data will be crucial. 
• If we witness gradual de-acceleration in growth rates, things are out of excessive exuberance zone - for that we need rates of growth y/y to decline to 7.5-14% range.
• If we witness stabilisation in rates of growth in excess of 14% we are likely to see serious risk of over-pricing emerging in the medium term.
• So watch this space... especially the last chart below...

24/7/2014: Looking for that Property Price Bubble: Dublin, June 2014

Irish Residential Property Price Index for June is out today. Headlines are burning hot with

• 12.5 hike in prices nationwide (y/y);
• June m/m rise of 2.9% - faster than 2.3% in May
• Dublin property prices up 3.3% m/m and 23.9% y/y
• Dublin House prices up 3.1% m/m and 24.4% y/y

There is no avoiding the talk about a 'new bubble'.

In the past, I clearly said that in my view:

1. Current levels of prices are not signalling bubble emergence in Dublin
2. Rates of increases in Dublin prices are concerning, but levels are yet to break away from the national historical averages
3. Trend-wise, we are way below the levels of Dublin prices consistent with normal long-term behaviour in the series.

Here are updated charts on long-term trends.

First, looking at annual series and applying two trend assumptions: actual inflation and ECB target (long-run inflation). By both metrics, we are still below (using 3mo MA through June 2014 as 2014 figure) equilibrium, but rate of convergence is accelerating:

On monthly basis, here are historical series, linking ESRI and CSO data sets:

As above clearly shows, Q2 2014 levels of prices in Dublin are barely above 2000-2002 average.

So the dynamics can signal a bit of an exuberance on the market demand side, but levels are still very much conservative compared to longer-term trends.

17/11/2012: A tradeoff Ireland does not have an option of facing

"Banking Competition, Housing Prices and Macroeconomic Stability" by Oscar Arce and Javier Andres (The Economic Journal, Vol. 122, Issue 565, pp. 1346-1372, 2012 | http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2174836):

The paper develops a macroeconomic model "with an imperfectly competitive bank‐loans market and collateral constraints that tie investors’ credit capacity to the value of their real estate holdings".

The model shows that "lending margins are optimally set by banks and have a significant effect on aggregate variables." [Something that can be potentially magnified by the market structure, such as, for example duopolization of the market, as in the case of Ireland today].

"Fostering banking competition increases total consumption and output by triggering a reallocation of available collateral towards investors." In other words, that 'creative destruction' works - flows of collateral are made more efficient by a competitive banking system.

"Also, stronger banking competition implies higher (lower) persistency of credit and output after a monetary (credit crunch) shock."

"In the short‐run, output, credit and housing prices are more responsive on impact to shocks in an environment of highly competitive banks." "…Key to this last result is the reaction of housing prices and their effect on borrowers' net worth. The response of housing prices is more pronounced when competition among banks is stronger, thus making borrowers' net worth
more vulnerable to adverse shocks and, specially, to monetary contractions."

"Thus, regarding changes in the degree of banking competition, the model generates a trade-off between the long run level of economic activity and its stability at the business cycle frequency."

Of course, the problem for Ireland in the current crisis is that
1) we have an ongoing monetary crisis (with interest rates and FX rates policies out of synch with the economy needs);
2) a solvency crisis (debt overhang); and
3) a liquidity crisis

We are also experiencing a dramatic collapse of competitive forces in the banking sector just when we would hope for the competition in banking to start generating those efficiencies in funding allocations and thus sustaining recovery.

In other words, we have - per paper above - the worst of both worlds, we neither had a cushion of the rigid downward shocks responses in the economy going into the crisis, nor do we have the salvation option of using a competitive banking system to drive up recovery. All that, plus no controls over monetary policy.

And we are still hearing the drivel about a 'Lost Decade' for Ireland? Try decades...