IMF points to 'significant risk' of overvaluation on house prices


The latest report by the International Monetary Fund is bound to stimulate the recent debate on whether property prices here are in danger of a sharp fall.

A statistical analysis undertaken by the IMF shows how difficult it is to estimate the "correct" price of an asset such as housing. The property market may be in danger territory, the study by IMF analysts concludes. But on "the other hand", well-used by economists, there is also a case that economic fundamentals will continue to support the market.

Looking at house prices in relation to income levels, the analysis shows that prices have risen here just a little ahead of incomes. However, prices are now very high compared to rent levels, indicating that, on strict investment terms, property is now expensive.

Delving deeper, the IMF looks at the factors which have driven demand in recent years, including a rising population, increasing incomes and low borrowing costs. "As long as the change in demand behaviour that occurred in the late 1990s is permanent, the sustained rise (in house prices) is quite consistent with the strong fundamentals," its study finds.

However, demand may change. The IMF study warns that it is possible that "the housing boom itself spurred changes in market psychology and led to a temporary change in demand behaviour." If this is the case, and if what happened in the pre-boom 1976-97 period is a better guide, then house prices could be overvalued by up to 50 per cent, a bubble in any language.

It seems common sense that much of the rise of recent years must be due to fundamental economic changes and thus that house prices are nothing like 50 per cent overvalued.

However, the risk is that irrational exuberance, to use the famous phrase, may have set in more recently, meaning that prices in many areas are now rising to levels considerably above long-term sustainable levels. Weighing the evidence of their own researchers, the IMF executive board concluded that there was "a significant risk" that house prices were overvalued.

There is certainly cause for concern in recent trends. As the Central Bank has pointed out, mortgage credit growth of 24 per cent at the moment is hardly consistent with a slowing economy and nor is annual house price inflation of some 15 per cent

With interest rates set to remain low, the IMF understandably points to further unemployment increases as the key risk to the housing market. It might also have pointed to the danger of a loss of confidence, particularly by investors.

The IMF is not the first body to warn on the housing market. The Economist magazine recently predicted that Ireland was one of the international markets where prices were vulnerable to a sharp fall. Goodbody stockbrokers said that price increases up to this year could be justified by economic fundamentals, but that further rises would move the market in to "bubble territory". NCB stockbrokers reported softness in the buy-to-let market, in particular, and warned that investors may be particularly vulnerable.

With low interest rates and the ready availability of credit continuing to support the market, there is no sign yet of a significant slowdown in the rate of price increases. And the recent ESRI medium-term review indicated that demographic and employment trends can continue to underpin the market.

These factors support the argument that prices are not set for a sudden collapse. But there is a strong argument that the rate of house price inflation currently in evidence cannot continue much longer and that parts of the market - particularly the investment property market - are increasingly vulnerable, particularly if general economic conditions do not start to improve.