ECONOMICS: At a time when employment has slowed and business and consumer confidence have taken a pounding, house prices have somehow managed to remain buoyant. Jim O'Leary reports.
Recently published data indicate that house prices increased at a double-digit rate in the latter part of 2002. According to the Department of the Environment, average prices across the State in the third quarter rose by 12.3 per cent year-on-year in the case of existing houses and by 11.4 per cent in the case of new houses.
The slightly more up to date Permanent TSB index shows similar rates of increase for the 12 months to November.
The latest crop of figures, published earlier this week by estate agents Sherry FitzGerald, suggests a significantly faster rate of increase. They estimate that average house prices across the country in the final quarter of the year were 20 per cent above the year earlier level.
Whatever other differences exist, all measures are agreed that the rate of house price inflation accelerated sharply during the course of 2002. The Permanent TSB index, for example, has the year-on-year rate of increase for second-hand houses accelerating from 1 per cent in January to 13.4 per cent in November.
Other indicators point to a similar pattern, if in somewhat less dramatic form.
The recent movement of house prices does not sit comfortably with broader economic developments. The overall pace of economic activity has cooled quite a bit over the past 12-18 months, bringing with it a marked slowdown in the rate of employment growth and a rise, for the first time in almost a decade, in redundancies and unemployment.
Business confidence has been hit hard, as evidenced by the contraction of fixed investment.
Consumer confidence has also been seriously eroded - the much slower pace of consumer spending growth is eloquent testimony here.
So why has the housing market shown such buoyancy?
The most commonly-cited reason for the apparent turnaround in the health of the housing market during 2002 is the restoration of the tax deductibility in respect of rented residential properties in last year's budget.
This is held to have brought the investor back into the market, released the pent-up demand created by the earlier abolition of the incentive and shifted expectations in such a way as to stimulate first-time buyer demand.
While the restoration of tax deductibility may have been the catalyst, other factors undoubtedly helped, in particular the fall in interest rates. The fact that equity markets continued to decline may also have boosted investor demand for housing.
Is the buoyancy of the housing market likely to be sustained for much longer? The optimists point to measures of affordability as the fundamental reason for believing that it can, and there is no doubt that at current mortgage rates affordability is not a generalised problem.
Whatever measure one constructs, the graph has been moving in the right direction over the past year or more.
Notwithstanding the increases in house prices, the proportion of average household income typically pre-empted by mortgage repayments has been falling, thanks to income growth and lower interest rates. More strikingly, and for the same reasons, the absolute amount of income left to the average household after making its mortgage repayments has continued to rise.
Moreover, the threat to affordability posed by prospective interest rate movements would appear to be small. Given the state of the euro-zone economy, there is little danger of anything more than a very modest tightening of monetary policy in the foreseeable future.
The threat posed by prospective movements in the determinants of household income is a different matter. Most commentators expect the growth of real household disposable income to decelerate this year but remain positive.
However, if the labour market softens by more than expected, average disposable incomes could contract. It is hard to imagine house prices continuing to rise in such circumstances.
Probably the best way to analyse the prospects for the housing market is to think in terms of supply and demand. As far as supply is concerned, the latest official data indicate that total house completions in 2002 will be of the order of 55,000. Over the 1996-2001 period, house completions, again according to official figures, averaged 46,000 per annum or some 230,000 cumulatively.
What about demand? Well, the Economic and Social Research Insitutue (ESRI) estimates suggest that our housing requirements over the 1996-2001 period were running at about 45,000 per annum, suggesting that, taking this period as a whole, demand and supply were roughly equivalent, with the supply deficiency of the early part of the period being made good in the latter part.
For the 2001-06 period, the ESRI estimates an average annual housing requirement of 49,000 units. If the official Department of the Environment figures are correct, annual supply is now running ahead of this.
It may well be that output in excess of newly arising demand is still required to satisfy outstanding demand from the pre-1996 period. On the other hand, it has to be borne in mind that the ESRI's estimates of annual requirements for the 2001-06 period are predicated on considerably faster growth in economic activity (GDP growth of about 5.5 per cent per annum) than now seems likely.
To that extent, projected demand of 49,000 residential units a year may prove to be a generous overestimate.
Taking everything into account, it seems reasonable to conclude that rough balance between supply and demand in the housing market has been achieved at this stage.
That being the case, maintenance of the current rate of house completions (about 55,000 per annum) would result in over-supply and falling house prices, especially if the pace of economic activity were to remain subdued.
Some evidence that the market is heading into this kind of territory is provided by the housing rents component of the consumer price index.
Having increased by more than 8 per cent per annum between 1996 and 2001, the rents component has fallen by about 1.5 per cent since last spring. Not a lot, perhaps, but enough to merit the advice: watch this space.
Jim O'Leary currently lectures in economics in NUI-Maynooth.
jim.oleary@may.ie
