For the Love of the Land

Pat McArdle, Chief Economist, Ulster Bank

9th Nov 2006

Pat McArdle is our guest blogger, analysing the Quarter 3 2006 figures.

We Irish have a love affair with property. Before the famine we split up the land amongst the children with ultimately disastrous results. Then we switched to the eldest son or, in the case of numerous bachelors, held on to it to the bitter end leaving various sundry relatives to squabble over the remains.

In time, the dispossessed children migrated from the countryside into the cities. They still, however, had a 'gra' for the land and, to this day, insist on buying a piece of suburbia with a garden patch at the rear. Combine this with avaricious developers and corrupt planners and you get urban sprawl, row after row of uninteresting identical boxes, frequently without the amenities that are taken for granted in other countries. The geographically constrained nature of our capital city and the virtual absence of high-rise-accommodation are the main reason for the elevated and ever-increasing level of house prices in Dublin.

Our newfound wealth has now enabled us to take our love of the land overseas. In this manifestation it is property rather than land, per se, that is sought after. An over-enthusiastic approach to buying has earned us a reputation as easy marks in some parts of Eastern Europe. But we don't care as long as we climb another rung on the property ladder.

We hear less about Irish forays into the overseas commercial property world. For the most part, this activity is still concentrated in the UK although purchases as far apart as the US, South Africa and even Russia are no longer uncommon. I was surprised recently to be told that the Irish were the largest source of foreign inflows into the UK commercial property market last year.

The Irish property market is unusual in that it is confined, almost exclusively, to the Irish. Leaving aside the Germans who moved in a quarter of a century ago, and the occasional Englander, it is rare to find a foreign owner. At least it was until recently. It is still the case that commercial property is snapped up by the locals - we buy commercial property abroad but foreigners do not reciprocate given our low yields and high stamp duty. In the residential market, however, things are changing.

The housing market slowed nicely in the first half of 2005 but to the dismay of many economists, myself included, re-accelerated strongly thereafter. The Minister for Housing is wont to attribute this to the effects of competition between lending institutions. An important explanation, which is seldom mentioned, was the surge in demand from immigrants. For a start, the level of net immigration was much higher than predicted. Second, the expectation was that non-nationals would rent accommodation. While many do rent, increasingly we hear that immigrants account for anything up to one-quarter of sales at new launches around Dublin.

The experience in 2006 has been the reverse, as the latest Report shows. Asking prices for residential property were rising at a 14% annual rate at the beginning of the year. By September, they were down to 6%.

The reason is straightforward. Higher interest rates have sapped the purchasing power of the first-time buyer. Since last December ECB rates and, by extension, mortgage rates have risen by 1.25% with another quarter-point rise pencilled in for early December. The main objective of the ECB is to curb economic activity so as to keep inflation below 2%. As they have not yet achieved this objective, it is likely that interest rates will be further increased next year. If this results in a slower housing market, so much the better in the eyes of the ECB.

This is cold comfort for the first-time buyer who, having inherited the genes of his/her ancestors is now struggling to get onto the property ladder. However, the situation has improved in many respects. A quarter of a century ago, the banks were not engaged in mortgage lending at all and one had to establish a regular savings record with a building society before they would even consider you for a loan. The standard annuity period was 20 years and multiples above 2.5 times income, 100% loans and interest only mortgages were unheard of. The banks are doing their utmost to assist, not for any altruistic motive but because competition is keener than ever-before and, indeed, keener than in most other EU countries.

Outsiders looking at the Irish market frequently look no further than the loan to income multiple and recoil in horror when they learn that it is now five or more. However, this fails to take into account the more sophisticated affordability measures now employed by Irish lenders. Monthly outgoings as a percentage of after-tax income are now the standard measure. This allows for the dramatic fall in interest rates that accompanied EMU entry as well as lower taxes and longer annuities. In addition, lending is stress-tested to allow for a further 2% increase in mortgage rates.

Prudent application of these principles should ensure that the slowdown in house price inflation evident in the latest Report continues but also that the housing market should experience a soft, rather than a hard, landing. A soft landing does not rule out some, temporary, fall in prices. A hard landing, on the other hand, would be associated with significant and sustained falls in prices. The way to avoid the latter is to ensure that as demand eases, supply is simultaneously curtailed.