Macroeconomic developments in the Irish housing market

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Macroeconomic developments
in the Irish housing market
DATE
21st June 2018
Event
Exploring developments in
the Irish housing & mortgage
market
VENUE
ESRI, Whitaker Square,
Sir John Rogerson’s Quay,
Dublin 2
AUTHOR
Kieran McQuinn
Research completed as part of ESRI/Dept of Housing Research Programme on Housing Economics

www.esri.ie @ESRIDublin #ESRIevents #ESRIpublications@ESRIDublin #ESRIevents #ESRIpublications www.esri.ie2 21 June 2018
This paper
• First part of the housing research programme
• McQuinn K. (2017): Irish house prices: Deja vu
all over again? Special article, QEC.
• Results here are an update of this paper

Outline
• Addresses “stability” of current price levels
• Using a number of approaches
• Cross-country comparisons
• Econometric estimates of:
- Fundamental House Prices
• Conclusions

Cross-country developments
Country Q4 1995 – Q4 2007 Q4 2007 – Q4 2013 Q4 2013 – Q4 2017
Ireland 431 -49 57
UK 240 -7 28
Spain 199 -30 6
France 157 -1 2
US 96 -12 25
Italy 89 -16 -8
Germany -5 13 21
Source: Federal Reserve Bank of Dallas
Percentage Change in Nominal Cross-Country House Prices

House price to disposable income ratios (2000-2017)
Source: Author’s Analysis
40
50
60
70
80
90
100
110
120
2000Q1 2001Q3 2003Q1 2004Q3 2006Q1 2007Q3 2009Q1 2010Q3 2012Q1 2013Q3 2015Q1 2016Q3
Germany Spain France UK Ireland US Average

www.esri.ie @ESRIDublin #ESRIevents #ESRIpublications21 June 20186
• Take the average cross-country ratio
• 𝑃𝑡
𝐼𝑡
𝐴
• Multiply it by the Irish index of disposable income
• 𝑃𝐼𝑡
𝐶𝐹
= 𝐼𝐼𝑡 ×
𝑃𝑡
𝐼𝑡
𝐴
• Scenario suggests:
- Overvaluation in 2006/2007 period followed by
- Undervaluation from 2008 onward
Counter-factual analysis

Irish house prices (2000-2017)
40
50
60
70
80
90
100
110
120
130
2000Q1 2001Q3 2003Q1 2004Q3 2006Q1 2007Q3 2009Q1 2010Q3 2012Q1 2013Q3 2015Q1 2016Q3
Counter-factual Actual

Irish house price to rent ratio (1990 – 2018)
7.5
9.5
11.5
13.5
15.5
17.5
19.5
21.5
1990Q1 1992Q1 1994Q1 1996Q1 1998Q1 2000Q1 2002Q1 2004Q1 2006Q1 2008Q1 2010Q1 2012Q1 2014Q1 2016Q1 2018Q1

Comparison with certain US cities
0
5
10
15
20
25
30
35
40
45
50

House price to rent ratio (Dublin v National)
15
16
17
18
19
20
21
22
2008Q2 2009Q2 2010Q2 2011Q2 2012Q2 2013Q2 2014Q2 2015Q2 2016Q2 2017Q2
Ireland_RTB Dublin_RTB

Fundamental house price estimates
• Common within Irish house price literature;
Murphy (2005), Roche (2001; 2003), McQuinn & O’Reilly (2007),
Kelly & McQuinn (2014), McQuinn (2014).
• Three different econometric specifications
i. House prices = ƒ(demographics, disposable income
and unemployment rates)
ii. House prices = ƒ(affordability and ratio of housing stock to
population)
iii. House prices = ƒ(disposable income per capita, user cost of capital
and housing stock per capita)

• Results are closely correlated
• At present market is ≈ equilibrium
• Expected developments in
• Affordability, demographics, monetary policy
• Low supply response
• Continued upward housing demand
Fundamental house price estimates

Actual and fundamental house price estimates
4
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
5
2000Q1 2001Q3 2003Q1 2004Q3 2006Q1 2007Q3 2009Q1 2010Q3 2012Q1 2013Q3 2015Q1 2016Q3 2018Q1
InLogs
Actual Model 1 Model 2 Model 3

Deviation from fundamental prices (%)
-40
-30
-20
-10
0
10
20
30
40
50
60
2000Q1 2001Q3 2003Q1 2004Q3 2006Q1 2007Q3 2009Q1 2010Q3 2012Q1 2013Q3 2015Q1 2016Q3 2018Q1
Model 1 Model 2 Model 3

• Error-correction model:
• Examine future price movements
• Forecasting from 2018 to 2020
• Values for capital stock, population levels, disposable
income (QEC),
• Interest rates (two scenarios); constant & gradually
increasing rate
Future scenario

Future interest rate scenarios (%)
2.50
3.00
3.50
4.00
4.50
5.00
5.50
6.00
2000Q1 2002Q1 2004Q1 2006Q1 2008Q1 2010Q1 2012Q1 2014Q1 2016Q1 2018Q1 2020Q1
Scenario 1 Scenario 2

Historical and future house price levels (index)
50.0
60.0
70.0
80.0
90.0
100.0
110.0
120.0
130.0
140.0
2000Q1 2002Q1 2004Q1 2006Q1 2008Q1 2010Q1 2012Q1 2014Q1 2016Q1 2018Q1 2020Q1
Scenario 1 Scenario 2

• Prices fall due to
• Collapse of a bubble
- No sign of one yet
• Significant deterioration in “fundamentals”
- Increase in mortgage rates?
- Sudden decline in income levels?
- Sharp rise in unemployment
• Most unlikely
Could house prices fall in short-run?

• If prices are in equilibrium
• Should move in line with fundamentals?
• Across countries:
- Income elasticity of house prices ≈ 1.5 – 2.0 %
• Most commentators:
- Forecast income growth of 3.5 to 4 %
• Suggests house price increases of 6.5%?
Back of the envelope assessment

Where are recent price increases coming from?
-30
-20
-10
0
10
20
30
2011 2012 2013 2014 2015 2016 2017
Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5
Figure: Annual Growth (%) in average purchased property prices per quintile
Source: Property Price Register

Housing demand now:
• Price increases
• More significant at the lower end of the distribution
(prices)
• Affordability challenges now more pressing
• For the lower end of the income distribution?
• Macro prudential regulations
• Limiting demand at the high end of the price distribution?
• If so
• Similar to other markets – London for example

How elastic are prices w.r.t. supply?
• Forecast assumes:
• Sensitivity:
• Keep supply fixed at 18,500 units per annum
• House prices only 0.5 per cent higher than baseline
• Point to note:
• Estimates generated during Celtic Tiger era
Year Supply
2018 23,400
2019 29,700
2020 36,700

The role of credit:
• Models assumes a steady-state relationship wherein
credit conditions do not change
• Any changes in mortgage credit availability would have
a strong influence on future house prices
• Models can be augmented to include an indicator for
mortgage credit supply (Duca et al. 2014)
• 1.0 per cent increase in credit supply estimated to
contribute towards a 0.4 per cent increase in prices

Influence of Credit Provision
• This responsiveness to credit provision should vary
over time as credit conditions change
• McQuinn (2017) provides an alternative indicator of
mortgage credit provision, producing a time-varying
estimate
• Enables the observation of responsiveness of house
prices to changing credit conditions under an Irish
context

Influence of Credit Provision
Credit Elasticity of House Prices

• House price levels converging to fundamental value
• High growth due to
• Past overcorrection in prices &
• Recent improvements in economic variables
• Given the likely strong increase in housing demand
• Economic growth, labour market and demographics
• Policy should avoid further stimulating demand
Specific conclusions

• Irish market characterised by significant volatility
• Since 1995:
• Significant fluctuations in prices and supply
• Gives rise to speculative behaviour
• Which, in turn accentuates the cycle
• Policy needs to smooth the cycle
• Land market management
• Macroprudential policy (credit)
• Tax treatment
General conclusions

Macroeconomic developments in the Irish housing market

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