The continuing dilemma of property prices
Demand appears to be staging a recovery but talk of supply constraints is worrying
Parts of Dublin clearly need lots more family homes: change the planning laws and incentivise the builders. Photograph: Aidan Crawley/Bloomberg
News that house prices are on the increase has been accompanied by confident sounding forecasts (from the ESRI) of further gains to come. If property prices do indeed rise further, is this a good or bad thing? Should we care?
A recent Central Bank of Ireland report on the housing market began by pointing out the “capacity (of property prices) to influence developments in the macro-economy, the banking system and the labour market”. We should care, a lot, about what happens next to house prices. Their capacity to be either a positive or negative influence on the wider economy should be fairly obvious.
Negative equity, for instance, has a pernicious influence at many levels. The personal hardship is painfully clear. But it also gums up the functioning of the market: until the value of the property is at least equal to the mortgage outstanding, most people simply cannot move without a very sympathetic (and therefore unusual) bank manager. So fewer houses come up for sale, contributing to the much reported housing supply problem, particularly in Dublin.
House prices are, of course, a function of supply and demand. This should, in principle, be a relatively simple matter. In practice it is fiendishly complicated, often made worse by meddling governments. Over in the UK, the latest housing bubble (at least in London) is being made worse by deliberate government initiatives to boost the buy-to-let market. It seems that George Osborne, the UK Chancellor, has given up on the structural performance of the economy and has reverted to the tried and tested tactic of juicing the property market.
Here it seems fanciful to imagine anything like a London-style price bubble occurring over the next few years. It would be a statement of the blindingly obvious to argue that we should make sure that everything is done to prevent one from happening again. While the threat of another price boom and bust seems so remote, policy-makers' attention has inevitably shifted elsewhere. But it is precisely at such moments that calm decisions should be taken, long before the storm clouds gather once again.
Why are prices rising? It is a good thing that demand seems to be staging something of a recovery, notwithstanding credit constraints and high unemployment. It is worrying that there is already talk of supply constraints.
If housing were any old financial investment we could analyse it in the same way as we look at equities and bonds. We can construct valuation measures that look at whether or not property is cheap or expensive. There are lots of ways of doing this, not all of which give the same answer, but the simplest and most widely used measure looks at rents. The ratio of house rents to house prices, the rental yield, is the best measure of value in the housing market. But there is no definitive yield that is the ‘correct’ level; it depends on a number of things. But we can get quite a good steer, if not actual precision, from rents.
For the technically minded, that Central Bank report referred to above is a good read and is based on the idea that the cost of owning a house should, in equilibrium, be equal to cost of renting. The authors concluded that domestic house prices have corrected to that equilibrium or maybe even just a bit below it. But all sorts of things can blow prices above or below equilibrium, by a long way and for long periods of time. A sudden resurgence of the euro zone crisis could easily shut down the housing recovery; UK-style policies could encourage prices higher.
As always with these things, there are issues with data; there are few good sources of long run numbers and averages can often be terribly unenlightening. My sense of the numbers (from, for example, Daft.ie) is that (gross) yields fell to about 3 per cent (or maybe even less) in late 2006/early 2007. They are now reported to be around 5.7 per cent. On the face of it, these simple measures corroborate the earlier conclusions of the Central Bank and the support the ESRI’s forecasts.
Because it seems so unnecessary, now is precisely the right time to pass laws that will help to prevent another bubble. There needs to be formally prescribed limits on the amounts people can borrow, relative to income (the old fashioned rule of 2.5 times income looks good to me) and relative to the house price (say 80 per cent of the price).
Where there are supply constraints, do something to get them relaxed. This is a huge opportunity that is in danger of being missed. Finally, we can spot a policy button that is screaming out to be pushed. Where there is clear demand for houses why don’t we build them? Parts of Dublin clearly need lots more family homes: change the planning laws and incentivise the builders. It’s not that difficult.