What will stop house prices rising at double-digit rates from here?
First, the banks might not partake in extending credit. Without credit, the recent house price surge can only be sustained by a massive switch from money on deposit to money in housing – as this is a finite amount, eventually the momentum would taper off.
A second way would be a dramatic rise in interest rates, which by driving up the cost of borrowing might cause people to think twice about the monthly cost of going into massive debt.
A third aspect may be a rapid increase in housing supply, which may flood the market in precisely the places where people want to live, puncturing the buyers’ panic and coaxing more sellers to sell before this new supply swamps the market.
The fourth might be the State deciding that accommodation is a utility like electricity, some of which should be provided at a reasonable price by a large company that isn’t always looking to maximise profits.
How likely, in the near term, is any of the above?
The first is highly unlikely because banks lend. Banks make profit by taking money in at a certain rate and lending money out at a higher rate. Unless you think that the banks will decline the opportunity to profit, it’s hardly likely that the banks will do anything but lend now. Lending leads to over lending and we may be back to banks driving housing markets that in turn drive lending.
The reason one feeds on the other is that once house prices start rising, the balance sheet of the bank itself plays tricks on the bank. The bank feels that the collateral against which it is lending is going up, so it feels able to lend more against it. But this just means that each time house prices increase, the very increase makes legitimate a bigger loan and we are on our way to a house price/credit spiral.
Because the State wants to get rid of the banks it owns, it wants them to be profitable in order to sell them. So the quickest way to profitability is more loans. This means that the State has a short-term strategic interest in more lending for housing.
So it is hardly likely that reason one above will change dramatically.
The second issue: are interest rates going up any time soon to dissuade people from taking on more debt?
The categorical answer is no. The eurozone economy is heading for deflation and the head of the ECB, Mario Draghi, has stated that he will keep rates low for as long as necessary. This could last years. We have seen in the US that rates can head downwards for three or four years and the US’s problems are nothing like Europe’s. The better model is Japan after the 1990s crash. Interest rates remained very low for a generation. This is an enormous opportunity to refinance Ireland’s productive sector but if we channel all this cheap money once again into property, we will only have ourselves to blame.
Unfortunately, with bank lending for mortgages rising rapidly, it doesn’t look like this cheap money is going anywhere else.
Interest rates will remain low and this will continue to lull people into a false sense of how much their huge loan actually costs. Remember, mortgages are 20-30 year commitments and some time in the maybe distant future, rates will rise and people will be walloped.
What about the third reason? Will there be a huge, rapid surge in supply, flooding the market and pushing down prices? Maybe, but where will this come from? Does NAMA have a significant portfolio of turnkey properties waiting to be sold? Or are there builders and developers building houses today that will come on stream next year? In fact, although construction is up, the number of housing permits is still way below demand.
As for what is decomposing in the entrails of NAMA and whether there are estates there ready to be sold and which need nothing more than a civil servant’s signature to boost supply, well, your guess is a good as mine. If there were, wouldn’t you think that the Government would have leaned on NAMA to make these available to prevent the buyers’ panic that is out there?
The one thing we know about housing supply is that it is slow to adapt but once it gets going, it is hard for builders to stop building. The reason is because of the same inflationary dynamic that is implicit in the housing market. Developers buy land in order to build, so the land is only worthwhile as long as they are building. The one thing they need to avoid is being Paddy last, that is the last builder, because that’s how they get caught when the market turns. As a result, once they start there is a group dynamic, which leads to all of them building as much as they can at the same time.
If supply adapts, it will do so well after prices have risen because prices rise much faster and instantaneously. This is what causes people to panic.
Now let’s look at our fourth reason to be optimistic about a tapering off of house prices. This reason involves a change of heart in the Government and a move to see accommodation as a utility, which is provided, in some cases, by a company, which aims to provide accommodation like electricity. This would cap the increases in the price of accommodation at the rate of inflation. Could this happen?
It could, but will it?
It is difficult to see the Government giving up the electoral aphrodisiac of higher house prices Because so much personal wealth is tied up in housing, rising house prices give people in negative equity hope for the future and give those on the right side of the property market the sense that they are wealthier this year than last year.
Coming into the acute phase of an electoral cycle, the feelgood buzz is too much for an incumbent Government to turn down.
None of the four main reasons that the property market might slow down look likely to come to pass. We will get a phase where buyers react to rising prices with more, not less, demand because they are afraid of being left behind. In addition, existing homeowners may say to themselves, ‘if there’s another 20pc in this, why not sell later?’
The State could nip this in the bud by instructing the banks to lend not against the last price but the average of prices for the last five years. By using this average, you break the link between the last price increase and new credit. This would stall price rises and allow supply to catch up but would mean that bank profits become disentangled from housing.
But don’t bank on such a simple solution!