Houses of cards

Housebuilding:Calculations that real house prices will fall between 2007 and 2009 by 21 per cent may be conservative, writes James Wrynn.

Housebuilding in Ireland has scaled unrealistic heights in recent times, reaching almost 90,000 units last year. This is a rate of more than 20 units per 1,000 of population, The European norm over long periods of time is two to four units per 1,000. The phenomenal rate of housebuilding has been justified in commentary by population increase, largely brought about by inward migration.

But while the number of households has increased significantly over the past 10 years, the scale of new building has more than compensated, with the number of vacant houses almost doubling to 216,000 over the same period.

The increase in vacancies makes it very clear that we have been building houses way in excess of our needs. Still, prices increased by 22 per cent in the two-year run-up to the peak average price level of €311,000 in February of this year. Why?

The increase in the number of households accounts for over half the extra units built. For the rest and the price frenzy, it can be argued that it is largely down to expectation. House prices began to rise with significant drops in unemployment, rising incomes and reduced interest rates that allowed buyers to increase their borrowings for a given level of repayment. Once this pattern of rising prices emerged, speculation started on the future trend in prices.

With the decline in prices, the expectation of capital appreciation has now collapsed.

This leads to consideration of the future. House prices peaked at an average of €311,000 in February 2007, according to the ESRI/Permanent TSB survey. By November, they had declined to €292,000, a decline of 5.9 per cent. The rate of decline is accelerating and will probably reach 10-12 per cent at least for the year to February 2008, giving an average price of around €280,000 at that point.

A significant factor in the rate of decline to date is that new house prices have declined at a slower rate than old houses. But there is substantial evidence that some developers are unwilling to reduce prices or are offering incentives valued at €20,000, such as new cars. Effectively, the nominal price is held, but the real price is dropped, but it is not showing up yet in the data.

If we look ahead to the 12 months from February 2008, a very conservative price decline forecast falls in the range of a further 6-8 per cent. Taking the lower of these figures, this would bring the average house price to €263,000 by February 2009, two years after the peak.

A factor masking the real rate of decline is inflation. Inflation from the peak house price month of February 2007 to February 2008 is likely to exceed 4.5 per cent and, with higher oil and food prices ahead, it is difficult to see inflation below 3 per cent for the 12 months from February 2008.

On that basis, the peak average house price of €311,000 in February 2007 would have to rise to €335,000 by February 2009 to simply hold its real value. This means the real house price fall over the two-year period 2007-2009 may be a fall from €335,000 to €263,000, a fall of 21 per cent. This may be a conservative estimate.

The inevitable effect will be to diminish the expectation effect in the market for a number of years. The housing market will begin to experience a demand level more appropriate to real need as distinct from real need amplified by speculative expectation. It is difficult to establish what this might be. It will be significantly affected by any changes in inward migration, which may slow down with a more sluggish economy.

It might be argued that, given the European norm of two to four new homes per 1,000 population, even the level of seven to eight units might be still optimistic. This would imply a level in the region of 30-35,000 new homes per annum - and that ignores the overhang of 216,000 vacant housing units.

SO WHO ARE THE winners and losers in all of this? Firstly, sellers of land for development purposes have had massive windfall gains. So too have most developers, with sometimes extraordinary levels of profit per unit of housing. While these groups were cracking open the champagne, few commented on the fact that every extra €100,000 added to the unit price of a house, burdened young house buyers with an extra monthly repayment of about €600 for a 20-year period.

Existing house owners who purchased houses over 10 years ago are sitting on undreamed of levels of equity. It may be reduced, but they will still have very high levels of equity. Those approaching retirement might be well advised to find sensible ways of releasing that equity, for example by trading down. Those who bought recently will have to grin and bear it for at least five years, with little hope of any worthwhile capital gain and, in some cases, negative equity.

This is particularly so for the 20,000 first-time buyers who bought with 100 per cent mortgages since January 2006.

New entrants to the market will have the prospect of needing a smaller proportion of their income to acquire a house as real prices are falling and real incomes will, at worst, stay the same. The big issue for them is to decide when they should enter the market.

The larger builders and developers who have been part of the system since the mid-1990s or earlier will easily ride out the storm. The most vulnerable builders are the smaller ones who entered the arena late in the day. Some are now badly caught, particularly in rural areas, with unsold stock or partially completed houses. Even if they can exit on a break-even basis, their future is not bright.

It is argued that National Development Plan (NDP) projects will take up the slack created in housebuilding, but small builders do not have the capacity or expertise to work on NDP projects that tend to be large-scale.

The ordinary construction worker will be the biggest loser in the downturn. Many of the sector's mobile immigrant component may be destined for the Olympics site in London.

The exchequer was another great beneficiary of the housing boom. Stamp duty and taxes on the building process such as VAT, created huge inflows. We may yet regret not channelling more of these inflows into our non-road infrastructure such as school buildings and urban public transport systems. That way, we would have had a permanent legacy of worth.

Some are arguing for a tax-related boost to the housing sector. The recent stamp duty changes will have little effect, given the significance of other factors in the downturn. The last thing we need is a further round of tax incentives to sustain activity at an unrealistic level. We need to adjust to a more realistic equilibrium level.

James Wrynn is a lecturer in marketing at the Dublin Institute of Technology