Irish
AIB Irish Housing Report: "They think it’s all over ... but it’s not" - Easing stamp duty burden at this stage would probably go straight into higher prices
By Finfacts Team
Oct 23, 2006, 11:00

AIB Global Treasury, a division of AIB Capital Markets, today released its latest report on the outlook for the Irish housing market and personal sector borrowing.

This latest report from the AIB Economic Research Unit highlights the health of the Irish housing market, despite some fears to the contrary. Housing demand remains well underpinned. However, deteriorating affordability conditions are impacting on buyers’ ability to realise their demand. Meanwhile, supply is increasing. AIB says that not surprisingly, house price inflation is moderating as the supply/demand balance adjusts. Further price moderation is anticipated as the market heads for the much anticipated soft landing.  House price inflation could be in a 3-6% range by end 2007.

Commenting on the report, John Beggs, Chief Economist said that “The outlook for the Irish housing market is a subject that is never far from the minds of the general public as well as the government, the Central Bank, the IMF and indeed, those involved in other sectors of the economy who question if a housing market crash could occur and what impact it would have on the economy as a whole. Average Irish house prices have almost doubled over the past six years while cumulative house completions have topped the 450,000 mark over the same period. The housing sector has directly accounted for one-fifth of the cumulative growth in real GDP of 36% since 2000. Construction employment now exceeds 260,000, representing 13% of the total workforce. Mortgage credit has more than doubled over the past three years and personal sector indebtedness now exceeds 150% of disposable income. Residential property related household wealth, however, has grown from €450 billion in 2003 to €700 billion in 2006.“

John Beggs continues “Against the background of such an impressive record, many domestic and international commentators believe that the sector could, or indeed will, suffer a severe correction. While such a correction could have dire consequences for the economy, at least in the short term, the risks are low. Our latest report on the housing market remains quite optimistic on the outlook for the sector in 2007 and 2008. We do not envisage a hard landing or crash in either property prices or in construction output. We expect new peaks in output in 2006 with house completions set to reach 93,000 units, with only a moderate downtrend thereafter. More importantly, we also see the opportunity of a deceleration to moderate price gains over the medium term.”

The Irish housing market remains well underpinned by demographic trends and by significant economic and social change. This is the key to the outlook. Employment growth has been remarkably robust, enabled by significant net immigration while the population continues to expand strongly. The level of demand from these and other sources has exerted considerable upward pressure on house prices in recent years. However, if prices get out of touch, the market will peg them back.

AIB says that it is important to remember that the housing market is not homogeneous. It is best seen as an interrelated series of sub-sectors that each have their own dynamics. Much has been made of the disappointing results at recent house auctions in the Dublin region. However, the Dublin auction market is not the Irish property market. Prices at the upper end of the second hand market in Dublin may have become too expensive in general and run into buyer resistance or affordability issues. However, this segment of the market is not representative of the first time buyers market or of other parts of the country.

The bank says that the greatest risk of overshoot in prices has always existed in the second hand market, where there are serious shortages of good quality family homes to meet demand. This is particularly true of major urban centres such as Dublin and Cork.  John Beggs notes that “In our last report, in April 2006, we said that high house price inflation running in double digits was unsustainable and that the deterioration in affordability would kill off some of the high level of demand that was then evident in the market.”

AIB says that this view was based on the widening gap between house prices and personal disposable income. This ratio currently stands at over 11:1. Of course, some financial institutions have continued to extend the terms of mortgages beyond 35 years, which has offset some of the deterioration in overall affordability. However, buyers have had to endure the ECB’s unrelenting policy of raising interest rates.

The market has had to absorb five increases of 0.25% since December last, bringing the refinancing rate to 3.25%. Though not an historically high rate, potential buyers may not be too comforted by forecasts that the ECB will stop at 3.75%.

Looking ahead, AIB says that more moderate growth in house prices of 3-5% is possible over the next few years. It sees prices in the second hand market stalling over the winter period before recovering in the spring. Inflation in this sector could rise by 0-5% year-on-year by end 2007, down from 11% in 2006. As regards new house prices, this sector is somewhat stronger, but moderation to 5-7% could occur in 2007 from 13% in 2006. Such rates of house price inflation would still exceed the projected rise in the CPI. However, with wage growth also expected to exceed the rise in consumer price inflation, this may be enough to stabilise the overall level of affordability. Furthermore, assuming that rents rise at least in line with inflation, this could be sufficient to keep investors in the market. However, the bank says that investors must make an important adjustment in accepting that capital appreciation will be smaller in real terms than in the past few years.

John Beggs, meanwhile, warns that “It would appear that the property market is once again being unsettled by uncertainty about property related taxes. Thoughts of a general election have raised concerns on the selling side about the outlook for capital gains tax. On the buyers’ side, recent speculation about possible changes to stamp duties may have persuaded some potential buyers to hold off until after the budget. Tax changes and overall government intervention in the property market have been disruptive in recent years. Though the current stamp duty regime is unnecessarily punitive, easing the burden at this stage would probably go straight into higher prices. This is an area that requires reform. However, it should be done on a gradual basis so as to minimise the effect on prices.”

In conclusion, John Beggs notes that “We are now much closer to equilibrium in the housing market. Demand has been scaled back as affordability deteriorates, while supply has increased in both the new and second hand market. However, underlying demand still exceeds supply, with the latter constrained by planning and other restrictions, most notably in the Dublin region where there has been a marked decline in planning permissions. Overall, though, the market looks to be cooling towards the much sought after soft landing.”