This week the influential magazine the Economist suggested that Dublin’s house prices are 25 per cent overvalued relative to long-term income. The Economist was one of the early sirens last time out, warning loudly about the Irish property market in 2003, so it has good form.
More worryingly, in the list of 22 cities, although Dublin was not the most overvalued capital city, it is the one that has experienced most rapid house price growth since 2012.
In the past seven years Dublin prices have increased 72.9 per cent, compared with 63 per cent for Berlin, 54 per cent for Sydney, 56 per cent for Auckland and 60 per cent for Vancouver. Although cities such as London and Paris are significantly overvalued, the British capital has seen falls in the past year, while Paris has always been expensive and has seen prices rise only 6 per cent in the whole of the past seven years.
The reason Dublin’s rapid recent house price rise has not led to greater overvaluation is because prices fell so significantly in the bust. The question now is, with these sorts of dynamics, is another crash on the cards?
A good rule of thumb when talking about the future is the past. And, given that I was one of those warning in the past about the crash, it’s reasonable to explore the crash possibility this time.
But there is also one other general observation or caveat: being right once doesn’t imply being right all the time, or even the next time.
When thinking about the future and markets, it is essential to have a framework in your head as to how you think the modern, leveraged, inter-related economy works.
A good framework, which I have used for years and that proved effective in analysing the Celtic Tiger property market, was the Minsky or Kindleberger framework. These were two American economists who believed that once you introduce credit and herd behaviour, most house price cycles follow similar boom-to-bust patterns.
They cited a seven-stage cycle. Stage one is displacement. Stage two is take-off. Stage three is gearing. Stage four is euphoria. Stage five is bubble. Stage six is distress, and stage seven is panic, followed by bust. And then we start again.
So stage one, called displacement, is when something real changes in the economy. This, in the context of our current housing cycle, was the crash itself when prices fall dramatically, providing an opportunity for someone to pick up houses cheaply. This leads to take-off when prices start to rise from the trough, and those lucky enough to pick up bargains see their balance sheets improve dramatically.
The next stage is gearing, where the banks get involved and start extending credit. This pushes prices yet higher, leading to euphoria, where people get giddy and trade stories of great fortunes made and great possibilities all around. Success itself breeds a healthy disregard for the possibility of failure. And off we go to towards the bubble.
At the top of the market some players sell out, taking their cash off the table, driven by the relentless logic that no one ever lost money by selling too early. This causes distress in the herd as they see others selling, then panic, leading to the final meltdown. At this stage lots of money is lost and out of the rubble we start again.
The key fuel that drives the market from one stage to the next sucks people in and makes the entire system extremely fragile is credit.
Unlike last time, up to now at least, credit has been largely absent from the latest Dublin house price jamboree. This doesn’t mean a crash is not possible, but it means it is less likely for now.
Let’s look at the details of debt in Ireland right now. Total household debt stood at €140.5 billion in late 2017 and has been falling more or less continuously from a peak of €204.2 billion in the third quarter of 2008. This is a total decline of more than 30 per cent. Household debt had fallen to €29,307 per capita at the end of 2017 from €45,536 in 2008.
Looking at the years leading up to the crash, household debt averaged €127.2 billion (€30,765 per capita) in 2005, €159.4 billion (€37,657) in 2006 and €185.2 billion (€42,319) in 2007.
Irish households remain among the most indebted in Europe, but debt as a proportion of disposable income has fallen to its lowest level since 2004. Irish household debt to disposable income fell 10.6 per cent over the course of 2017 alone, the largest decline among Europe’s highly indebted countries.
Total credit extended to Irish households for house purchases edged up slightly to €74.9 billion in the first quarter of this year, but remains well below the peak of €125.1 billion in early 2008. This is also comfortably below the average levels of debt seen in the years leading up to the crash – €85.8 billion in 2005, €106.3 billion in 2006 and €118.6 billion in 2007.
So it’s clear that the “gearing” phase identified by Minsky and Kindleberger is not present in this cycle – yet. This means that this house price cycle is very different from the last one. But it doesn’t mean a local crash can’t happen. You might remember the dot.com crash, which happened without any credit.
People invested real cash between 1998 and 2002, and when the mania evaporated that money was lost. However, because there was no leverage, there was a modest impact on the general economy.
The one area where there is leverage, but foreign leverage, is the Dublin commercial property market. As this has become more and more the property of leveraged international funds, any serious slump in international financial markets could prompt a “Minsky moment”. This is when good assets have to be sold to come up with cash to pay for bad assets.
Interestingly, this could be good for Ireland, as we would get much lower commercial property prices, without a hit to our national balance sheet.
With markets at all-time highs, interest rates on their way up and emerging markets in serious trouble, that’s one worth thinking about in the near future – rather than an imminent, locally generated crash in Dublin’s residential market.