We are told houses are not over-priced. So how come they are unaffordable?

House prices may now be fully valued in comparison to incomes, according to the latest analysis by the Central Bank, but still "may not be affordable to a significant proportion of the population". And so we are faced with the problem that a market in balance may still price many people out of buying in Dublin completely.

The bank, charged with ensuring financial stability, made clear this week that it not going to adjust its mortgage rules to allow borrowers to pay more by taking out larger loans. Its latest review of the market sheds new light on the affordability crisis. It shows how more and more are hitting the affordability barrier,particularly in Dublin and how cash is still king in many areas of the market. Two groups are being heavily squeezed – aspirant first-time buyers in the big cities, many now completely pushed out and those who bought at the height of the last boom and can’t now afford to move.

The message is clear – there is no early end in sight to the accommodation crisis – unless there is a big reversal in prices. Extra supply will help, but it will take time.

One other point is notable. House prices can fall as well as rise. Everybody hopes a hard Brexit will be avoided, but the Bank of England this week warned that a no-deal scenario could lead to UK house prices being 25 to 30 per cent lower than would otherwise be the case. Ireland is also exposed to a no-deal scenario, albeit with different dynamics. We are facing into a period of uncertainty and this makes it impossible to forecast house prices, as well as just about everything else. Falling asking prices in some of the more expensive parts of the market may also raise questions about valuations some middle-ranged areas, too. This fragmentation into different mini-markets is worth watching.

Is the housing crisis now starting to threaten jobs growth?

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Brexit turmoil: what does it mean for you – and what’s the price of a no-deal?

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Why has lending for mortgages in Ireland suddenly stalled?

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Let’s talk about interest rates: How high and how fast will they rise?

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It is not the Central Bank’s job to deal with the housing crisis. Its job is to stop a new credit bubble emerging, and this is vital work. But it clearly felt it had to refer to housing in its latest report on the mortgage market. “It is noted”, the report says, “that equilibrium house prices may not be affordable to a significant proportion of the population and that only a significant expansion in housing supply can help address the affordability problem.” Its latest report – and some other recent analysis – point to some key trends in the market.

1. More people are hitting the affordability barrier

The Central Bank’s key job in relation to housing is to decide on how much people can borrow for mortgages and ensure that bank lending meets appropriate standards. Lending volumes are now growing, so ensuring that the banks – and borrowers - don’t expose themselves to future house price swings is vital. Looking at a new measures of mortgages to disposable income, the bank calculates that we are not in danger territory, but could slip into it quickly enough. So the bank has decided to keep its current limits, ensuring that first-time buyers can get a mortgage of 3.5 times income, with just 20 per cent of loans allowed to stray above this. First-time buyers, meanwhile, must generally save 10 per cent of their purchase price, with this rising to 20 per cent for those moving home.

Importantly for the market, the bank says that there is evidence that more and more borrowers are going right up to the allowable limits, indicating that they are a big factor in how things work. In particular, more first-time buyers are going right up to the 3.5 times limit ( more than 30 per cent now, compared to 22 per cent a year ago ) and more are also taking advantage of the exemptions available to borrow more than four times their income. More second and subsequent buyers are also up against the limit.

Not surprisingly, the figures for Dublin show more borrowers right up at the loan-to-income limits; three out of every ten first-time borrowers in Dublin had borrowed more than 3.5 times income – in other words they availed of the special exemptions, versus just over one in ten outsider Dublin. This confirms – no surprise – that affordability is now a crunch issue and the Central Bank rules are increasingly a key factor.

2. The rules are here to stay – and unless house prices fall this means many will remain unable to buy in Dublin

The Central Bank has made it crystal clear that it is not going to allow borrowers to take on bigger loans, beyond the exceptions built into the rules. Some bankers and brokers argue that the rules are too restrictive. Rachel McGovern of Brokers Ireland,which represents 1,250 mortgage brokers, says the income limits are “contributing to a lost generation” unable to buy their first home. She argues that the limit should be raised to 4.5 times income for all borrowers, similar to the UK. A number of brokers also argue that the requirement for second and subsequent buyers to have a 20 per cent deposit is unfair in the case of those who bought during the boom and are now deeply in negative equity. Without any equity to bring into a new deal, many are simply stuck.

The other issue is the nature of the exemptions, with the banks given annual targets for the percentages which can exceed the normal limits. This has contributed to a slowdown in mortgage approvals, with the latest figures for September showing a 3.4 per cent drop on the same month in the previous year and a 10 per cent fall from August.

As discussed in a previous Smart Money, it is not clear how much of the slowdown is due to banks using up their exemptions for 2018 early – a number have indicated that this is the case – and how much is just due to plain affordability problems. Sharply slowing house-price growth in parts of the Dublin market and cuts in asking prices in some areas are further evidence of prices having run ahead of incomes.

A key indicator to watch will be whether there is a big rise in mortgage approvals moving into next year, as the banks get new allowances for 2019. (Update: The October mortgage figures showed a rebound in approvals. Was thing banks giving approval on foot of 2019 exemption allocations? An interesting one to watch)

The financial industry has argued that the targets should be set on a rolling basis rather than annually.

“The exemptions should have been done away with,” says McGovern. “They lead to quite crazy situations whereby someone may have got an approval in January and then the same person with the same circumstances could go into the same lender later in the year and not be able to get approval.” However for now the Central Bank is not for moving on this.

Whatever the argument about the details of the rules, affordability is clearly the more fundamental factor. The latest CSO figures show that the best-paid sector is the tech sector, with average earnings of €61,000 per annum. A single employee in the sector is limited to a €214,000 house price under the 3.5 times rules and even with an exemption won’t get far in Dublin for €270,000 or so, with average prices in Dublin now around €100,000 higher. A couple both working on average salaries in the sector might find somewhere in the €400,000 bracket, but remember this is the best-paid sector. For builders, teachers, nurses and those in jobs paying closer to the average of around €40,000, the sums, even for a couple, are now impossible. And we know that rents are generally even more taxing in terms of income affordability at the moment.

3. Cash remains a big factor in the market

Measuring the prevalence of cash purchasers has always been tricky in the Irish market, though new data sources such as the Property Price Register are making it more possible now. The latest Central Bank data suggests that around half of transactions are completed without a mortgage. When purchases by investment funds and other non-household players are netted out, the Central Bank estimates that cash buyers represented around 30 per cent of property purchases by households. Separate research by Edward Gaffney, an economist at the bank, points out that purely cash transactions are – not surprisingly – less common as house prices rise. The exception, interestingly, is for very expensive properties, with one remarkable conclusion being that for houses over €1 million, fewer than half of purchases are funded by mortgages. For a small class of people, affordability will never be an issue.

Research by John McCartney at Savills has come up with similar figures on cash buyers at around half of the total. Interestingly, he found that 57 per cent of second-hand homes are cash-funded, whereas the proportion is much lower for new homes, at around 21 per cent cash buyers in the latest quarters. This clearly points to the exposure of first-time buyers to the mortgage rules and the availability of credit. However McCartney believes that credit availability is also a big factor in the second-hand market, where price growth has slowed significantly.

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The bottom line is that the Central Bank’s analysis and its lending rules highlight that the affordability crux is here to stay. Supply is rising and prices are moderating, but if economic growth continues to boost demand, people on average and many on above-average earnings will continue to face problems in city centres, particularly Dublin.

Increasingly demand is being pushed to areas of Dublin where houses are cheaper – prices rises are greater at the lower end of the market – or out of Dublin completely. Of course a shock to the economy via a hard Brexit could change everything, hitting house prices but also incomes. How this would balance out is impossible to predict.

If the economy remains strong, incomes will continue to rise, but house prices in Dublin are not at a level where you would need static or falling prices on one side and strong income rises on the other to make housing affordable. Perhaps rising supply and slowing growth will lead to falling prices for a time – who can tell?

In the meantime, a note from Goodbody Stockbrokers on Thursday summarises it nicely.

“The tighter constraints in Dublin require a focus from housebuilders on affordable offerings in the years ahead. With the rules here to stay, private ownership will also be outside the reach of a significant proportion of earners, pointing to a need for other forms of tenure.”

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