What a difference a few months can make.
Back in June, EY was predicting continued price growth for the UK housing market into 2024. Now lenders are withdrawing mortgage products, homeowners fear swingeing hikes in monthly repayments, and there is talk of a potential major sell-off in UK property as new-mortgage rates reach 5-6 per cent, with expectations that they may yet go even higher — so much so that analysts are suggesting UK house prices might drop by as much as 20 per cent.
And it’s not just the UK. Capital Economics is predicting a price drop of 20 per cent in New Zealand and 15 per cent in neighbouring Australia, while in Canada prices are expected to drop by as much as a quarter.
The common denominator behind the forecasts? Rising interest rates.
While there are other factors behind the changing outlook — the cost-of-living crisis, energy fears and recession expectations are all feeding into faltering property markets across the world — interest-rate increases are nonetheless causing a sharp shock.
So far the Irish market has been shielded, as the main lenders have been slow to move on interest rates, but common sense would suggest that it’s only a matter of time. After all, the European Central Bank has already shifted rates up by 1.25 per cent since July, with further increases seen as likely.
So what impact might this have on the Irish property market over the coming months?
Property will become more expensive
When looking at a home, people often tend to look at the sticker price, which is to say the price you buy it at, rather than the “carrying cost”, or the price once the cost of funds is factored in. However, it is the latter that reflects the ultimate cost of a home, and the higher the interest rate, the more expensive the home will ultimately be.
Consider a home on the market for €350,000. It’s bought with a down payment of €50,000, resulting in a mortgage of €300,000. In the first instance, let’s give an average interest rate of 2.2 per cent over the life of the 30-year mortgage. Given the purchase price (€350,000), plus the cost of finance over these 30 years (€110,076), the actual price paid for this home is about €460,000.
But how about if the average interest rate over the life of the loan is 4 per cent? Then the total cost of the home jumps to about €565,000 – or about a fifth more expensive.
So unless you’re a cash buyer, rising interest rates will make buying a home more expensive.
Buyers will be able to borrow less
Higher rates also mean that some people will be able to borrow less, which will put pressure on price growth.
“Borrowing capacity will be impacted, I’ve no doubt about that,” says Michael Dowling, of Dowling Financial.
Already Bank of Ireland has indicated that it will tighten up its affordability criteria, while ICS has capped the amount homebuyers can borrow to 2.5 times income, and introduced deposit requirements of 20 per cent for first-time buyers and 30 per cent for second-time buyers.
As part of the mortgage process, lenders consider borrowers’ repayment capacity by applying a stress test, which is a higher rate of interest.
“The important point is that the stress test is 2 per cent above a standard variable rate,” says Dowling. This means that, based on current rates, lenders such as Avant will stress test at a rate of about 4.7 per cent, while Bank of Ireland (which has a high variable rate) tests at a higher rate of between 5.9 and 6.5 per cent.
To put this into numbers, Dowling gives an example of a couple on €85,700 borrowing €300,000 over 30 years. To pass Bank of Ireland’s stress test, for example, they’ll have to show evidence that they are saving, and/or paying rent of, €1,779 a month, or €1,566 in the case of Avant.
And these rates have not yet increased, but it surely is only a matter of time before they will be, which means tougher tests to pass to borrow the same amount of money.
“A 1 per cent increase in stress test rates will add anything from €175 to €200 per month to required stress repayment to be evidenced,” says Dowling. “Obviously, it impacts lower-income earners more than higher earners.”
Rate rises may also make people think twice about over-extending themselves; a 30-year mortgage of €300,000 will cost €1,139 a month to service at an interest rate of 2.2 per cent, but €1,432 with a rate of 4 per cent — so 25 per cent more.
Already, mortgage approvals are stalling; figures from the Banking & Payments Federation of Ireland show the number of first-time-buyer mortgage approvals rose by just 1 per cent in the year to August, while second and subsequent buyers fell by 5 per cent.
Bank of Mum and Dad might cut back lending
With interest rates starting to rise, this may present parents with alternative investment opportunities that are less risky than the ones they faced in the years of low interest rates.
This may mean that parents withdraw funding for their children.
In south Dublin for example, Brian Dempsey of DNG’s Stillorgan office estimates about 50 per cent of transactions in the area are funded with as much as half of the purchase price in cash.
Some of this comes from downsizers paying for a property in cash outright, “but the bank of Mum and Dad is also a huge source”, he says, pointing to the prevalence of negative rates for so long.
But will this continue? Moreover, against a background of rising costs and fears of energy shortages etc, parents may be less willing to hand over money they may need themselves one day.
Price growth will soften
So what does this all mean for prices?
As the early signs from the UK illustrate, interest rates can have a big impact on the direction of a housing market. Indeed, as a recent note from Fitch states, the boom in Ireland in the run-up to 2007-08 was in part fuelled by “declining mortgage interest rates with Ireland’s entry into the European Monetary Union”.
So a moderation in price growth at least would not be unexpected at a time of rising interest rates, with Fitch forecasting a “cool-down” in Irish house prices, and growth in the range of 0-2 per cent in 2023.
This view is echoed by Marian Finnegan, managing director of Sherry FitzGerald Residential.
“We don’t expect that level of price increase to continue,” she says, pointing to recent double-digit hikes, adding that interest rate hikes “will contain price growth”.
“We wouldn’t expect house prices to continue growing as they were,” agrees Rodrigo Conde Puentes, a senior analyst at Moody’s.
However, he notes that Ireland is at a different starting point from where it was in the financial crisis, pointing to more robust price-to-income and price-to-rent ratios.
“In that respect, we don’t see other red flags,” he says, adding that it may take a greater shock on the demand side, such as soaring unemployment, to push house prices down.
Indeed a downside scenario analysis from Moody’s, which assumes high single-digit inflation through 2023 across markets, and a more aggressive rise in interest rates, suggests that the proportion of distressed borrowers in Ireland would rise to just 2 per cent. And this would not necessarily translate, even among distressed borrowers, to arrears and defaults. This compares to a much higher rate of distress in the UK, of about 13 per cent, due to a greater proportion of non-conforming loans.
Finnegan agrees that it would likely take something more than rising interest rates for a price crash.
“For prices to fall significantly you would need to see a very significant fall in demand,” says Finnegan, adding that this could come from high unemployment/net migration.
Part of the reason why the mortgage shock – if and when it comes – may not be as great in Ireland as in the UK is that the market is undoubtedly better structured to withstand a shock than it was back prior to the financial crisis.
In 2006, for example, about 20 per cent of new lending was carried out at loan-to value ratios (LTVs) of above 95 per cent, which meant that one in five new homeowners had equity of just 5 per cent in their homes – so when prices slid by 6 per cent for example, they fell straight away into negative equity.
Similarly, 60 per cent of loan to incomes ratios were above 3.5 times at the time. These days the Central Bank’s mortgage rules mean that borrowers are much better-placed to withstand shocks.
Moreover, generally speaking, the greater the proportion of variable rate mortgages in a country, the more exposed homeowners are to interest rate rises, and thus the more likely price falls might be. But in Ireland, rates have swung firmly in the direction of fixed rates, with banks offering the best deals for those who are prepared to lock in.
But fundamentals apart, perhaps the biggest downside impact might come from declining confidence.
“There is a sense that there will be a reassessment of people’s requirements,” says Finnegan, adding that this will impact on sentiment.
“Once interest rates start rising, sentiment changes,” says Dowling, adding that this can impact on people’s decision as to whether to look to buy a property or not.
Already, figures suggest that selling has slowed; there were 4,742 properties for sale in Dublin in September 2022 compared to 3,586 at the end of September 2021, according to figures from myhome.ie. This represents an uptick of some 32 per cent, and the highest figure since pre-pandemic times, back in October 2019, when the market was said to be slowing.
But while supply might be increasing, declining sentiment can put a squeeze on new-homes development.
“New homes haven’t delivered,” says Finnegan, adding that the level of stock delivered in recent years isn’t as high as had been expected.
Now, with rising interest rates, this much-expected supply might be delayed further, as developers figure out sales prices against a background of declining affordability and rising input and construction costs.
For reasons such as this, Finnegan would like to see the Central Bank’s lending rules modified, particularly with respect to the 3.5 times income rule.
“There would be an argument as to whether or not it’s appropriate for the current environment,” she says, adding that the rules worked well at a time of low interest rates, but may not be appropriate to a time of higher rates.
For now then, the residential property market looks likely to be able to weather the storm of rising interest rates. But, given the pace at which the UK market changed, a winter of discontent could yet be on the cards.