As interest rates rise residential property prices have come under pressure, but the Central Bank raising the mortgage limit from 3.5 to 4 times income from the 1st of January this year may open up significant new demand and prop up prices longer term.
This will cause concern for some but, are house prices the real issue or are policy makers and opposition parties missing the point? A study published by economist Ronan Lyons earlier this year, throws new light on the link between building costs, house prices and supply.
Simply put, the larger the gap between house prices and costs the greater the new housing supply. If a developer can make a tidy profit, then they will develop more units until eventually supply catches up with demand and prices fall. In a free market there are then just two ways to make more houses available.
- Reduce building costs
- Increase house prices
Lyon’s analysis suggests that for the country to hit anything like the 30,000 completions target in the government’s Housing for All strategy building costs would have to reduce by nearly 40%. With rising energy costs recently sending material and labour costs spiraling out of control, this seems unlikely.
Sure the government can introduce tax reliefs on development to put a brake on rising costs, but putting them into reverse seems a very tall order. They could nationalise house building, but the cost problem doesn’t go away and since when did the state being in charge make things more efficient?
So with reducing costs ruled out as an option, let’s turn instead to increasing house prices to get supply back on track. The real issue with the housing market isn’t house prices, it’s housing affordability and that’s not quite the same thing. What if we could raise prices in the housing market without reducing affordability?
Although this sounds counter intuitive there are many ways to do this, one is to increase the effective income of house buyers through grants or tax reliefs. This is the thinking behind the First Home scheme. Yet there is one other significant weapon to increase housing affordability.
Credit.
Simply loosening the current Central Bank mortgage lending rules increases house prices, increases developer profits and in turn is likely to increase the supply of new homes. While also increasing housing affordability for many who previously couldn’t buy a home.
The reason for this is that the Central Bank mortgage rules have locked out thousands of potential homeowners and trapped them in the rental market. This has driven monthly rents way above monthly mortgage repayments.
In fact, our research [1]indicates that the average rental household would save over €1,000 a month if the Central Bank rules allowed them to apply for a long term fixed rate mortgage at current rates. So by lifting the 3.5 times lending cap imposed by the Central Bank, three things are likely to happen.
- Housing affordability will rise as currently trapped renters move to a monthly mortgage
- House prices will also rise as renters can now compete with investors for property
- Housing supply will increase as developers greenlight projects that didn’t make financial sense previously
Hang on a minute though, doesn’t that just create a credit fueled housing bubble with people buying houses they can’t afford just like back in 2008?
That seems unlikely for a couple of reasons.
Firstly, we already know people can afford to pay these mortgages as they are already paying way more every month in rent.
Secondly, even if you removed the Central Bank limits completely the barriers to getting a mortgage are still way higher than back in the day. That’s because the rules imposed on Irish bank’s by the European banking regulators post 2008 already stop Irish bank’s lending willy nilly.
That’s why the Central Bank lifting the lending limits is a move to be welcomed, but should also raise the question. Why on earth was one of the tightest restrictions on mortgage lending across Europe put in the first place?
Given the hames the Bank made regulating the Irish banking sector last time around it was only natural for it to take a safety first approach.
The issue with the limit is that it put the kibosh on many lower and middle income families owning their own home. Thereby trapping them into paying spiraling rent, making them poorer and increasing social inequality.
We should be glad to see the back of the 3.5 limit, property investors will welcome the increased purchasing power it creates in a time of rising interest rates and the public will welcome the inevitable result, more homes being built than there would be otherwise.
Author: Mark Coan – Is a Financial expert and Founder of online finance guide moneysherpa.ie
[1] www.moneysherpa.ie
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