OVERVALUED HOUSE PRICES - NOT A LOT WE CAN DO ABOUT IT

IRISH EXAMINER ARTICLE DEC 16th 2024

Any claims made about the housing market are guaranteed to garner significant media coverage, such is our obsession with the subject in this country. Over the past week the ESRI published its latest economic outlook and painted a positive outlook for the economy in 2025. Modified domestic demand is forecast to expand by a solid 4.1 per cent next year; the average unemployment rate is forecast to ease slightly to 4.2 per cent of the labour force, which is close to a full employment level of unemployment; and inflation is forecast to average just 1 per cent. However, what garnered most media attention was the claim, based on its modelling exercise, that Irish house prices in the third quarter of this year are 8-10 per cent overvalued. Similar modelling would have shown that back in 2007 house prices were overvalued by close to 40 per cent and we all know what subsequently transpired. We may be bad now, but we were a hell of a lot worse back then.

The latest assertion is based on what its house forecasting model predicts where house prices should be and where house prices are. The ESRI uses an econometric model that includes affordability indicators such as household disposable incomes and mortgage interest rates; credit conditions; housing stock; and the population ratio in the key house purchase cohort of 25 to 44 years of age. The model concludes that prices are now up to 10 per cent above what the model would have predicted. What are we to make of this? I wish I knew.

The reality is that the latest CSO data show that in September national average house prices were 14.4 per cent above their April 2007 peak. Unfortunately, there is no sign of this upward trend in prices being arrested anytime soon. If the ESRI’s economic and labour market forecasts prove correct, then continued robust demand for housing looks likely to continue. On the supply side it is likely that we will see around 33,000 residential units being delivered this year, and based on commencements, close to 40,000 could be possible in 2025. Both outcomes would still be totally inadequate to satisfy pent-up demand and actual demand.

On top of this, mortgage costs are coming down and will continue to do so. The ECB delivered its 4^th 0.25 per cent interest rate cut of 2024 over the past week and the accompanying narrative from the ECB would suggest that it expects to cut rates a lot further in 2025 as the key economies in the Euro Zone are struggling and need lower rates. It is certainly possible that rates could fall by up to another 1.5 per cent in 2025 based on what we know about the Euro Zone economy now.

The Irish housing market, or indeed the overall economy, does not need that sort of interest rate trajectory. For Ireland it is a totally pro-cyclical monetary policy, but the reality is that the ECB must set interest rates for the large economies and not for the small ones like Ireland. In the period from 2000 up to 2007, ECB interest rate policy was totally inappropriate for Ireland and helped fuel the bubble that eventually popped with devastating consequence. At the moment ECB monetary policy is pro-cyclical for Ireland’s economy, but unfortunately so too is fiscal policy. It all sounds very familiar.

The ESRI suggested that the situation with house prices and mortgage debt merit consideration, which is all well and good to say. However, the real question is what can be done about the overvalued nature of prices. It did warn that a labour market shock in the shape of a decline in wages and higher unemployment would pose considerable pressure on those with high levels of debt. This to my way of thinking accepts the reality that barring a significant economic shock, it is difficult to see house prices come back down to appropriate levels anytime soon. Meanwhile, the past easing of mortgage restrictions by the Central Bank for first-time buyers, various demand side government housing supports, and ECB interest rate policy are all fuelling demand.

Granted, the ESRI’s assertion is based on a model, and we all know how reliable models can be, but the truth is that regardless of whether the ESRI is correct or not, we seem impotent in the face of this threat.