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Morgan Kelly - legend, tells it as it is.....
The Irish Housing Bubble: Chronicle of a Death
Foretold
Morgan Kelly
?
April 11, 2007
Now that “For Sale” signs have become permanent fixtures on the landscape,
and even the dimmest paid cheerleaders for the property sect or have given up pre-
tending that there is going to be a soft landing, it is worth asking how far house
prices are likely to fall, and what effect this will have on the Irish economy.
It is hard to be optimistic. Based on the experience of other economies that
have had similar bubbles, we can expect the real price of houses to fall by around
half over the next 8 or 9 years, and possibly by a good deal more . This fall in house
prices will cause a sudden collapse in house building activity which now accounts
directly for an astonishing 15 per cent of our national income.
First we need to dispose of the transparent myth that the boom in Irish house
prices simply reflects the strong fundamentals in the market . To see that this is
false we need only look at what has happened to rents.
If fundamental demand for housing were strong we should have seen rents rise
along with house prices. In fact, while real house prices doubled since 2000, rents
have remained more or less static. You can rent a million Euro house in Dublin for
well under e2,000 a month. Were you foolish enough to buy it, the interest alone
on the mortgage would cost over e4,000.
The average rent to price ratio in Dublin has fallen to around 4 per cent—a
low return on what people are starting to discover to be an ass et with considerable
fundamental risk—and barely above 1 per cent at the top of the market. This recalls
price-earnings ratios at the peak of the dotcom bubble. And rents are likely to fall
as vendors realise they are unlikely to sell anytime soon and start to let properties
to pay some of the mortgage.
By how much can we expect house prices to fall? Looking at 40 housing booms
and busts since 1970, I found a remarkably consistent pattern across very different
economies (you can download the report, “On the likely extent of falls in Irish
house prices”, from my website in UCD). Adjusting for inflati on, housing markets
typically give up 70 per cent of what they gained in a boom during the subsequent
bust.
For Ireland, where real house prices in the mid-1990s were on ly 30 per cent of
what they are now, this would imply a fall in the range of 40 to 60 per cent. This is
a prediction for average prices: typically properties at th e bottom, and, especially,
the top of the market fare much worse than those in the middle.
Falls of this magnitude are far from unprecedented internat ionally: both the
Netherlands in the 1980s and Finland in the early 1990s saw real house prices fall
by half.
Unlike stock price crashes, housing busts are extremely pro longed: more like
the flooding of New Orleans than a tsunami. And just as Republican officials kept
denying there was anything wrong until the water was up to their necks, we can
start looking forward to estate agents telling us that the worst is over, a necessary
correction to an overheated market has taken place, there ha s never been a better
time to buy, and so on until most of them go out of business.
Busts of the magnitude that we are beginning to experience typically last 8 to
10 years. Assuming our inflation rate goes back to around 2 per cent, a halving of
real house prices would entail annual falls in the selling price of houses of around
6 per cent, lasting for about 9 years.
Aside from the anguish that will be endured by those who have been conned
into mortgaging their lives away to buy houses at grotesquel y inflated prices, the
macroeconomic reason to be terrified of a housing crash is its effect on the building
industry. Most economies, including Ireland until a few years ago, get only around
5 per cent of their income from building houses: less than households spend on
recreation.
In Ireland now, house building accounts for almost one sixth of national in-
come. And that is not counting the jobs processing new mortgages, insurance and
title transfers; retailing furniture and carpets; or adver tising houses; or the indirect
effects of these incomes on the rest of the economy.
When house building returns to its equilibrium level of 4 to 5 per cent of in-
come, the effect on employment and government finances can only be catastrophic.
And building contractions are sudden: in Arizona, whose bui lding boom looks
eerily similar to ours, between May and November last year housing starts fell
from 8,000 per month to 3,000.
Given the recent 25 per cent fall in planning applications, we can expect large
falls in building employment once current projects are completed. Contrary to
popular belief, over 80 per cent of building workers are Iris h: they are not going to
get on a plane to Gdansk and disappear from the unemployment statistics.
The fact that the Irish economy has come to be based on building houses for all
the people that have got jobs building houses means that our estimate of a fifty per
cent fall in house prices may be unduly optimistic. Other economies that experi-
enced large housing bubbles had stocks of houses that were more or less fixed. By
contrast, we have 15 per cent of our housing units lying empty, bought by specula-
tors to realize capital gains, while the supply of housing is growing at around 5 per
cent a year.
The supply of houses on sale is likely to explode as speculators scramble to
unload the 210,000 empty units they are holding, along with the 80,000 or so new
houses that will be built this year. As this enormous supply collides with falling
demand caused by expectations of further price falls, and falling employment in
building, Ireland may be heading for a fall in house price that is without interna-
tional precedent.
Along with our sharp fall in competitiveness and the structural problems of the
IT and pharmaceutical sectors, the likelihood of further ri ses in interest rates, and
the possibility of a hard landing for the US economy, the Irish economy is sailing
blithely into something that is starting to look like a perfect storm.
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