Sunday Indo June 2014 by Jim Power
It has traditionally been the case in Ireland that the first thing most of us want to do once we go into paid employment is to buy our own house and spend the next 25 or 30 years paying back the mortgage. Such behaviour might seem irrational in a European context, where there is typically much more of an appetite to rent rather than own. Spending one’s life paying back a mortgage does tend to soak up a lot of financial resources that could be used for other more productive purposes. However, we are what we are and it is likely to remain the case that most of us will desire to own our own home once we can remotely afford it. Personally, I bought my first house when I was 23 and had to sell my car in order to service the mortgage, but being typically Irish, I felt that was a price worth paying to own my own bricks and mortar. The creation of a properly functioning rental market where rent controls are in place and where there is real and decent regulation might possibly change our attitude towards owning and renting, but that appears some distance away.
Whether we own or rent where we choose to live does matter. The high level of home ownership has its advantages in a rising property market. As home owners become wealthier on paper, the positive wealth effect encourages more spending and creates a virtuous cycle. This wealth of course is just on paper and is not real as it cannot be realised unless one trades down or exits home ownership altogether. Hence there are dangers involved in spending and borrowing on the back of paper gains. However, the flipside is also true. As house prices fall, there is a negative wealth effect which depresses consumer spending and economic activity. This becomes a particular problem when the value of the property falls below the level of the outstanding mortgage, or in other words, when one moves in to a negative equity situation. At one level, negative equity is not a problem unless one is forced to sell the property, in which case the negative equity loss is crystallised. However, in a real sense going around realising that your mortgage is bigger than it should be and that your mortgage repayments are larger than they should be, is a horrible feeling and one that will undoubtedly impact on one’s economic behaviour in a negative manner.
One of the problems with any analysis of the Irish housing market is the lack of a proper data set, particularly in relation to regional property markets around the country. However, it is still a very interesting exercise to try to analyse the impact that rising property prices will have on the negative equity situation.
According to CSO data, which are based on houses that have sold and on which a mortgage has been granted, national average property prices have increased by 8.5 per cent in the year to April and are now 9.4 per cent off the low point seen in March 2013. Outside of Dublin, property prices have increased by 1.3 per cent in the year to April and are now just 2.6 per cent off the low point in March 2013. Property prices in Dublin have increased by 17.7 per cent in the year to April and are now 20.9 per cent off the low point in August 2012. Hence any discussion of the impact that rising property prices have on negative equity is really only relevant in Dublin at this juncture.
According to the CSO data, average residential property prices in Dublin Declined by 57.2 per cent between the peak of the market in February 2007 and the low point in August 2012. This dramatic decline in prices pushed a lot of mortgage holders in to a negative equity situation. Just how many is difficult to calculate based on data availability, likewise just how many have been lifted out of negative equity since the recovery commenced in August 2012 is also difficult to calculate. However, if one makes certain assumptions, estimates can be made.
I have looked at mortgages taken out by First Time Buyers, Investors and Movers based on IBF data. I have assumed an average Loan to Value (LTV) of 90 per cent between 2003 and 2011, and 80 per cent since 20111; based on Census data I have assumed that 30 per cent of new mortgages drawn down were in Dublin; I have applied a representative mortgage rate to calculate how much of the decline in the outstanding mortgage is due to normal repayment. Based on these and other assumptions, I estimate that the negative equity mortgages peaked at just over 94,000 in 2011 and have subsequently fallen by around 24,000 to stand at around 70,000 at the moment. If one uses different assumptions one will come up with different answers, but it is clear that the trend in house prices in Dublin is lifting a lot of mortgage holders out of a negative equity situation. This is good.
Such a reduction in negative equity is obviously good news for those involved and will have some positive wealth effect on consumption. For the balance sheets of the banks it also represents good news as it does reduce potential loan loss pressures. However, for those who want to buy a house in Dublin, the magnitude of current price rises is not good news. A strong supply side response is necessary in Dublin, but that will be slow to materialise. Hence in a market with significant pent up demand and limited supply, the risk to prices appears to be on the upside over the next couple of years. The good news is that if the price appreciation seen since August 2012 were to be repeated over the next couple of years, the number of mortgage holders in negative equity in Dublin could be almost halved.