Ronan Lyons Transcript

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Welcome to the Dublin City Public Libraries and Archive Podcast. In this episode economist Ronan Lyons talks about the Irish property market, the changes over time to house prices in Ireland and what might happen in the future. This talk, one of a series on the Irish Economy, was recorded in front of a live audience in the Central Library on 15 March 2012.

Thanks very much.  I’ve got a good bit to get through and because obviously it’s a topic we are all very interested in, but I also am conscious that it’s a topic that everyone has a lot of opinions about.  So what I might suggest is that if you have questions do put up your hand.  I’ll try and avoid getting into very detailed discussions during the talk, but I do want to let you guide the talk as well as obviously my own thoughts on Ireland’s property market, and how we got here and where to next. 

In terms of what I hope to cover today, really there’s just a few simple rules that I want to get out into sort of the general discourse when we think about the property market.  And this is from the point of view of buyers or sellers of property, or renters of property, but also from the point of view of policy makers.  If we can get these types of rules or stylised facts as the social scientists like to say, if we can get them in to government thinking, it’s unlikely we’ll find ourselves in the similar situation again.  So the four stylised facts that I’m going to base the talk around, the first is that real estate is a bad investment.  The second is that the property market is imperfect.  Third is that a combination is a service and we need to remember that.  And then the last is that governments actually can have a proactive role in managing the housing, the property market.  But it needs to view itself as an organisation or a regulator that is managing a market rather than I suppose, intervening for the sake of intervening, or not intervening for ideological reasons. 

The context of this, given that it’s the Dublin City Libraries, the context of this is that we’ve seen it all before.  If you look at the price of a Mountjoy Square townhouse after it was built in the 1790’s, in all its grandeur before the Act of Union, it would have sold for around 8,000 pounds, back in the day.  Less than a lifetime later, it had fallen by 94 per cent, to 500 pounds.  So, we’re not living in unprecedented times from the point of view of the property market.  Certainly the crash that we’re seeing in Ireland now is among the biggest in the developed world at a national level, and it’s certainly in the top tier, the premier league of property market crashes if you start counting for example, cities or states within US as their own economies comparable to Ireland.  Ireland is certainly mixing it among the countries that have had the most violent bubble and crash.  But certainly if you keep your perspective long enough, this is not something that is unprecedented.  Property prices rise and property prices fall, and we’ve seen pretty dramatic episodes of that in Ireland in the past. 

So going back to the, sort of the four, this will be the sort of an outline of the talk as well.  So real estate is a bad investment.  It’s sort of odd and particularly if you associate me with a sort of a daft.ie hat on and for me to be coming up here saying, you know, don’t get your hands on property, it’s not a very good asset to have.  And particularly when you see the conventional wisdom if you go online you’ll see either Mark Twain said this buy land they’re not making any more, or occasionally you’ll see either attributed to a Don at an Oxford college or a Cambridge college, saying well we’ve done pretty well, they’re not making any more land, let’s just hold that.  So that’s the sort of conventional wisdom around property and around real estate, is they’re not making any more of it, grab it now because the price is going to go up.  But I suppose an economist would say, well if everyone knows that, then surely the price would already reflect that rather than nobody realising this and you’re sort of ahead of the curve.  And in fact, we can have a look at it over the long run, I’ve already mentioned something from the 1800s and this is the Herengracht which I think means the gentleman’s canal in Amsterdam.  And this was built just in the heyday of the Netherlands, I suppose the early heyday of the Netherlands in the 1620’s, just after it had broken with Spain and it was the global financial centre.  And they built this canal and one of the reason that I mention it is, that they have every transaction ever on the Herengracht, they have recorded in the archives.  All the way from 1628 right through to 2012.  And in the 1990’s an economist did a study of transactions on this one street, so you know you’re not comparing sort of, different cities or you know you’re not comparing different house types.  You’re actually looking at sort of 50 properties traded over and over again for hundreds of years.  And at first glance you could make the case that you know, property prices seem to go up and there’s ups and downs there, but definitely if you look and this is indexed so, the price when it was built, when these houses were built is set to 100, and you can see that it goes up and it seems to go up albeit with a wild swing, it seems to go up there towards the end of the period.  And if you actually extend that a little bit, that goes to 1962.  If you extend it a little bit more to 1972 you’ve to reset the scale and you can see, well actually you know, those final twenty years prices did seem to rise dramatically.  So what am I here saying that you know, property prices don’t go up over time, it’s not a good asset to have.  Well, this guy who did the study, what he also included was, this is nominal prices and this is just what you see on the accounting ledger.  But he also included real prices, so controlling for inflation.  And obviously general inflation comes and goes, and it’s also sort of swings and roundabouts.  But when you adjust for inflation this is property prices in the Herengracht in Amsterdam over almost, well certainly 350 years.  And soon when they update this it will be nearly 400 years.  And you can see there’s certainly ups and downs and there was a long period there where it was above the average and then there was a long period, that’s about a lifetime, this is about a lifetime as well, but it was below the average.  But certainly that red line is the average for the whole period and as of 1972 you can’t really see any difference from the long run average.  There’s a little bit but not a lot.  And in fact if you were to just take a simple trend and say what’s the trend in this?  the trend is actually down.  And the real price of property goes down.  Now clearly it’s not a line, there’s sort of peaks and troughs.  So there are property market cycles.  There’s certainly no evidence from this one street in Amsterdam for which we’ve really just information that real property prices, once you’ve accounted for inflation are that they go up.

Participant 1:  Sorry Ronan, a very quick question.  Are you including rent in that?

That is property prices relative to the cost of living.  Now the cost of living as you measure it going back into the 1600’s it is probably going to be based off a simple basket of goods.  I don’t think rent is in that.

Participant 1: No, no, no what I mean is, this is an investment on which somebody was getting a rental return on.

Oh yeah, let me come to that a bit later on, yeah, yeah.  So this is, this is just the conventional wisdom that if you buy your own property that you can make lots of money out of that.  And that when you die your property will be worth an awful lot more than when you bought it.  And what this is saying is that, well certainly you can make the case that house prices match inflation.  So your house is a good store of value.  So if you were to get all your savings now, let’s say you have 100,000 in savings and you put it all into property now, what this is saying is that at any given point in the future, we don’t know what’s going to happen in the future, but our expectation is that in 20 years time or in 50 years time or 100 years time, that 100,000 would have kept its value.  So if we’ve switched to the new Irish punt or if we’re in a Euro 2 or if we’re in the Euro or whatever happens that property will more or less keep its value.  But it certainly won’t increase its real value.  And if you look at the literature, there’s not a big literature on this.  Studies like the one for Amsterdam are kind of rare.  And one of my research ambitions is to construct something similar fore Ireland over the same period.  But certainly there’s evidence from the US over a shorter period, say 100, 150 years that the same thing happened.  If you look at, there’s one on commercial real estate in New York and there’s one on house prices in Boston.  And again and again on these studies, you find that property is very good at matching inflation but never really beats inflation.  And by contrast, if you have a savings account that will typically beat inflation.  Now this is obviously not taking into account any explicit rents.  If you’re a landlord rather than an owner/occupier, a landlord will get rents and that might change the calculus.  But certainly if you’re just looking at it for capital gain, you’re unlikely to get it in property. 

But surely Ireland is different? And this is, you know, what if this would be the slide I would have shown in 2007.  You know, is Ireland going to be any different? And it looks there, you’ve got this very nice sort of expediential curve of house prices.  This is based off the, I should have put the source at the bottom, this is based off the Department of the Environment statistics, merged with later data points like the Daft index and the CSO index.  So that gives us one index going from 1975 to 2007.  But again, this is just without correcting for inflation.  And also, it’s ignoring what happened after 2007, which we’re obviously all very familiar.  So if you do both those adjustments, if you add in the extra couple of years, but more importantly if you correct for changes in just everyday crises, what you see is a very different picture emerges.  This is in current euro terms.  So the figures there are what, 100,000 euro is now or what 400,000 euro is now today.  And you can see that the average house price was about 100,000 euro in 1975, got up to sort of 375,000, and has fallen right back down to about 175,000, as of the last quarter of 2011.  And what’s particularly interesting in this graph, we can come back to this bit later on, is the first bit.  That looks a bit familiar, doesn’t it? That looks exactly like the Amsterdam picture.  Up to 1995 you had sort of bubbles and crashes, or booms and busts maybe if we want to have a boom to be a small increase and a bubble to be a big increase.  We had sort of booms and busts here.  But certainly the overall trend is flat.  So again, I don’t want to be too repetitive on this, but from a policy maker point of view and from our everyday lives point of view, we shouldn’t be expecting anything more than house prices to match inflation.  And this has big implications if you bought during the bubble.  If you bought in 2004, 2005, 2006, what is your expectation about the value of your property in 10 years time or in 20 years time or in 50 years time.  Typically, certainly up to 2006, 2007 people would have said well property sort of increases at 5 per cent a year, we’re a bit above that now, but that’s what we think property prices do.  That’s sort of the conventional wisdom.  But what I’m saying to you is really we should be thinking more like 2 per cent a year.  Because that’s what the rate of inflation is, well that’s what we’re targeting as the rate of inflation.  So that’s what we should be targeting as the rate of increase in house prices.  It also has an impact for everyone in Ireland in some sense.  If you bailed out a bank, which we all have, and if you took over some of these loans, and if you now manage these loans, as we do through NAMA, what is our expectation for the value of property in 10 or 15 or 20 years time.  What’s our expectation about long term economic value which is NAMA’s watchword.  Well, really you know, if we’re thinking 2 per cent a year growth in property prices, that’s very different to perhaps what Brian Lenihan envisaged originally when he introduced the NAMA legislation.  I think he had, sort of a 5 per cent a year model in his head. 

And this graph just takes a scenario where property prices fall by about 60 per cent to 150,000, in next year, and then increase by 2 per cent the year after that, nice and smoothly.  Now obviously we know there’ll be future bubbles and future busts, but we don’t know when they’re going to be.  So without knowing them, let’s just say okay 2 per cent a year.  And it’s a useful exercise because it tells us when we might see property prices reaching their peak level again.  And they reached their peak in 2007 and by this stage I will be hopefully retired in the 2050’s.  We don’t know how long people my generation will have to work before we get to retire.  But I hope to be retired by the time we see prices reach the same level again.  And that’s important for policy, as well as important for our own everyday lives, when we buy property. 

That’s the first sort of bullet point.  The second one is that the property market is imperfect.  And here I’ll talk a little bit about, sort of economic theory.  In a way I was implicitly giving out about policy makers, for the last few minutes, saying what their plans were about NAMA, and so on.  Now I get to give out about economists.  So economics is about assumptions in a way.  That might sound like a bad thing, but obviously we need to make assumptions.  If we want to make any sort of model of the world around us.  If we want to understand how the economy works, without actually just replicating it completely, we need to make some sort of assumptions.  The issue around assumptions is that, some assumptions are made just to simplify, to strip out unnecessary detail we don’t need to know every last little bit of, so we’ll just simplify and assume that, whatever it might be.  The other category of assumption is made not out of simplification, but out of necessity.  We actually don’t know how something works, so in the absence of knowing how it works, we’ll just assume that this happens.  And the danger in economics is when you mistake one for the other.  When you say for example, that oh well there’s no mark-up that producers when they sell their goods don’t enjoy any mark-up.  You might think that’s just stripping away unnecessary detail and there is going to be some mark-up, but let’s say it’s 10 per cent, but that 10 per cent doesn’t matter.  When we want to understand markets, we’ll just assume that there is no mark-up that producers enjoy.  Well maybe the mark-up matters in a way that affects the outcome.  So if we’re looking at equilibrium or if we’re looking at disequilibrium or a market in flux, maybe these things matter.  And, I think a lot of what went wrong in economics was this mistake.  Mistaking a simplification out of necessity for one out of luxury.  We don’t need to worry about this detail, but actually if was detail that was crucially important, we just don’t understand it.  And an obvious example of that in sort of very big macro models is that most models, this is going to sound funny, but most models in economics, most macro economics models don’t have any money in them.  Because money is regarded as an unnecessary detail.  And that you can express prices in something else.  Money is just a form of wealth or a unit of account.  Let’s just say there’s something over here called wealth, and we know how to express the price of goods and services anyway, so we don’t need money.  That’s all well and good until you’ve got a crisis in your financial system, until banks stop lending to each other and to households and to businesses.  In which case, understanding how money works is very important.  And that was a classic mistake that macroeconomics in particular made, over the sort of period up to 2007.  And it’s really just sort of getting on top of all this now.  Realising, one guy in Oxford has a paper called, putting Goldman Sachs into a model of the economy, you know it’s this idea about how do you put investment banking, how do you put liquidity crunches and liquidity traps in credit crises, when do you put these into a model of the economy? That’s all very highfalutin.  How does this relate to the Irish property market? Well, one of these expectations that economists like to make is called rational expectations.  And rational expectations means that people aren’t stupid.  That’s its motivation and that sounds like a reasonable assumption to make.  But de facto what it means is that consumers and firms, but in particular consumers can process all the information that’s out there, and come up with a completely balanced judgement out the other side.  And this might be the case 30 years from now when we’ve got super computers that can take all these market signals and give us an answer whether to buy or sell.  But certainly now and definitely 30, 40 years ago people didn’t have little models in their head that were crunching these types of regressions and coming up with out with coefficients, we just don’t do that.  And the question is do we not do this to an extent that affects the outcomes? And the argument that I would make is that in property, yes.  In property what we tend to do, not just in Ireland but generally in property is take the last 5 years, or maybe a longer period, but certainly the last 5 years, and use that as the basis of our expectation for the future.  And this obviously gives the property market some sort of like, it’s an extrapolative path.  That because we buy now, based on what we think prices are going to be in the future, that has an impact in terms of the prices today.  So if you think property prices are going to go up by 5 or 10 per cent a year, over the next 5, 10 years, you’re going to pay a lot more now than if you think prices are even going to maybe stable or even fall.  So our expectations are hugely important in the property market.  And if our expectations aren’t rational in that economic sense of the word, if they’re adaptive that has a big implication for boom and bust cycles.  Boom and bust cycles will tend to be amplified if we have rational expectations.  That’s really just that point there in the headline.  In terms of, I suppose one of the questions in the title was how did we get where we are? We got where we are, we got such a vicious bubble and crash cycle by managing to tick every box in the sort of theoretical bubble.  There’s a book by a guy called Kindleberger (Manias, panics, and crashes: A history of financial crises), I presume there’s copies in the library and it’s a classic text and it’s reissued every sort of 5, 10 years to update with the latest bubbles.  And the start it outlines what is in a crash, what’s in a bubble and what’s in a crash.  And one of the first things that happens in a bubble cycle is something comes along, some shock comes along.  It could be, traditionally it was you know, a new king is put on the throne or maybe a new government is elected.  More recently we tend to think of technological shocks that we discover something we didn’t know before and this changes peoples’ expectations about the future.  Ireland’s sort of favourable change in conditions was moving from 1980’s stagnation to 1990’s growth.  This sort of changed the path of the economy.  If you asked people in 1987 what they thought the economy would be like now in 2012, they would have had a very different answer than if you asked people in 1997 what they thought 2012 would be like.  So that was an initial change and that gave us an initial momentum in the mid 1990’s both in terms of economic growth and employment, but also in the property market.  Now, that in and of itself is not enough to cause a bubble.  To sustain a bubble you need an increase in the supply of whatever you’re having the bubble in, be it tulips or property or shares of a particular company.  And you also need some way of getting credit.  Because really prices only get crazy when people can borrow, otherwise there’s only a limited amount of income.  If people are borrowing and leveraging up, so that they’ve got savings of 20,000 and they can borrow 200,000.  That’s really what adds fuel to the fire of a bubble.  And in Ireland we managed to tick both those boxes really, really well.  So entering the Eurozone gave Irish banks which had a history of never really being able to get credit on international capital markets.  They found it very difficult to borrow because Ireland was a small economy and was quite volatile and susceptible to attack by speculators or the markets in general.  All of a sudden these Irish banks are in the Eurozone and had access to, in particular German savings, but just generally access to credit.  So that was the accelerant and then to really seal the deal, to suck everyone into the bubble you needed a fresh supply of houses because if there was only a set amount of houses then not everyone would have been able to take part in the bubble.  It might have been bad in a price way, but wouldn’t have been bad in terms of sucking in as many people.  So they suck in as many people as possible you need an increase in supply.  Typically bubbles are about shares, so the company issues new shares.  What we did in Ireland was we managed to have a huge increase in the supply of property.  And that brought a lot more people in, and when that ran out we just brought property abroad.  So there were all these factors, there were all these boxes we were ticking about the stereotypical bubble and crash cycle, but as of 2005, 2006, 2007 all these factors were here - that’s not the clearest is it? there’s three different shades of grey there - but it’s analysis of the ESRI and IIB, which is now KBC.  They did consumer sentiment surveys.  And they did them every month.  But in January they asked them, what were their expectations about the property market.  And you can see it doesn’t really matter which group you look at, long term owners, recent owners, people who want to but, people who are looking to invest, people who aren’t in any way interested in buying property.  They all didn’t see the end of the bubble.  They saw a slowdown, particularly optimistic were the people who wanted to buy.  They said no I think property prices are going to increase by just 3 per cent rather than 7 or 8 per cent.  But all of these factors that I mentioned on that slide, they were there throughout this period, and yet people just looked at the last five years and said, what happened over the last five years is the best guess for what will happen over the next five years. 

Participant 2:  Sorry could I just ...

Sure.

Participant 2: ... is there one factor that might be left out, an important factor.  Because of the sort of hierarchical or inequitable nature of the society, that a lot of people both in the media and in the economics area had a vested interest also in speaking up the market.  And sorry I don’t want to mention because taxes and, you know, everybody’s getting cut.

Yeah.  I think the weakness there is not so much that they wanted to talk up the market knowing that they were talking up the market, I think it was a blind spot.  So they were talking up the market because they honestly believed it.  I think if you were ... let’s say you’ve got the sort of, when things go wrong, it’s either because people were evil or people were stupid.  So either we didn’t see something coming, or we saw it coming but still went that way anyway despite knowing the consequences.  And I think of it as a stupidity rather than the evil.  Yes there was a vested interest, but I think it was blindness, that the people who were or had a vested interest couldn’t see any weakness.  And if they were able to see the weakness, they would have got out of it.  They would have kept talking it up but they would have got out of it.  But all these people, and you still meet them.  I meet people now and they, some of them saw a bubble in property but sold their house and bought bank shares.  So instead of seeing a 60 per cent fall they saw a 99.9 per cent fall.  You know, it wasn’t that, and it wasn’t that no one saw it, Morgan Kelly turned his attention in 2006, but David McWilliams had been saying it since 2001.  The people who were talking it up honestly believed it.  Otherwise they would have sold out and they didn’t sell out.

Participant 2: So that seems, you know, there were so many could believe so strongly in it, where does that come from?  It sounded like a mania, a madness or fanaticism attached to a particular idea.

Yeah, and maybe that’s a bullet point that’s left out of there.  I don’t know if it’s fourth on that list or if it’s just a separate point that needs to be made, but part of what makes a bubble and a crash so bad, is its intoxication.  Is that if everyone is seen to be making money then everyone does start believing that this time it is actually different.  And the best example I can come up with for that is Isaac Newton wrote about this bubble, I think it was the South Sea bubble in the 1720’s.  My timing could be all off, he could have been long dead by that stage.  No, but I think it was the South Sea bubble of the 1720’s.  And he wrote about how stupid it was in 1721 and said he couldn’t believe that everyone was being sucked in by the South Sea bubble.  And in 1724 he took his life savings and invested in the South Sea because he thought maybe he was wrong.  And in 1725 he lost all his money and for the rest of his life you weren’t allowed mention it in his presence.  So if it can turn really, really smart people stupid that just shows the power of the bubble.  And it also shows why we should be so vigilant in doing the best we can to prevent, as bad a bubble from happening again.  And a lot of that was at an EU level, but also at a domestic, regulatory level it was about getting used to life within the Eurozone.  We prepared for entering the Eurozone, but we never prepared for life in the Eurozone.  And what it would mean for our Irish banks to have access to practically infinite credit.  And what would it mean for the Eurozone, for all these banks to be able to deal with each other without any currency risk.  Nobody really prepared for that.  And certainly if you could have tackled that, you could definitely have tackled this.  And you would have taken the sting for the last five years out of the bubble.  You wouldn’t have been able to prevent the bubble entirely.  That was, there was always going to be some element of increasing credit, increasing property and increasing growth that would have led to a, some sort of bubble.  But perhaps maybe no more than, sort of this kind of bubble.  Maybe a little bit bigger, but that kind of bubble and crash. 

Participant 3: Sorry, there didn’t seem to be an analysis or study of the situation that had changed, like they didn’t go in and analyse the situation, the people, say government?

Yeah, so government should have been aware of Kindleberger’s book for example and should have been saying rather than, obviously Bertie has his famous quote about how he doesn’t know how people don’t go off and commit suicide.  But there was another quote where he, in 2006 said because of all these experts telling us house prices are going to fall people didn’t buy in 2005 and now house prices are even more expensive in 2006, and I hope those experts you know are ashamed of themselves, basically.  You don’t want that kind of attitude among your elite.  You don’t want them for whatever reason, to be just picking some bizarre, arbitrarily picking some asset and telling people to buy it.  And that’s not the kind of country you want.  You want a country where if there’s dissent, that dissent is factored into policy making decision.  And that wasn’t the case and, if not for this talk but a broader talk about public service reform would be getting dissent into the system.  If someone disagrees, get them in, get them to explain why they disagree and see if you need to strengthen your policy proposal on the basis of their disagreement. 

So people didn’t see the end of the bubble and currently people find it hard to see the end of the crash.  So recently, this is with my Daft hat on, we surveyed 2000 users of the site about their expectations of the property market.  And they perhaps correctly, feel that average prices are going to fall by about 10 per cent in 2012.  But then you ask them about the next 5 years, what do they think, where will house prices be in 2017 relative to now.  And only about 1 in 6 saw house prices being any way higher in 2017 than now.  And that’s only slightly bigger than the proportion of people who thought house prices would be at least 35 per cent lower in 2017 than today whereas than January when they were doing the survey.  So there’s a, that works on the upside and the downside.  As prices are increasing people find it hard to see the end of prices increasing.  And when prices fall, people find it hard to see the end of property prices falling.  And we are going to, we’re going to turn around one day and realise that the crash is long over.  We won’t turn around and realise the crash ended yesterday.  It’ll be a situation where only after a year or 18 months do you realise, do you know what actually, the crash ended about 18 months ago.  And that’s the way it works because the statistics are murky.  It’s difficult to know exactly when things turn.  And also because of adaptive expectations people find it difficult to change their sentiment towards the market.  So a combination is a service.  So I’ve said that, you know, when we think about the property market in our day to day lives, don’t think of it as investing in real estate, think of it as buying accommodation and accommodation is a service.  This is, for those of you who know your national accounts, we calculate our GDP by adding up consumption, investment, government and trade so leave out the government and trade for the moment, housing is consumption it’s not investment.  Building houses is investment, that’s fine.  But we need to think of property as a service not as an investment.  And I would caution against, you know, sort of we talked about Newton there a few minutes ago, I’d caution against Newton style economics, what goes up must come down, it seems appealing but in terms of what we should expect in terms of house prices I’m not saying that real house prices necessarily have to go back to 100,000, that’s what we did see in Amsterdam and that’s what the literature generally points to but we shouldn’t just think that is always going to happen.  If we go back to that Amsterdam graph there were periods when the average was higher and periods when the average was lower.  So economics is not what goes up must come down economics is supply and demand and we can pretty much take supply as fixed.  The sort of urban economists and housing economists tend to do this anyway, the supply of housing is quite slow to move, even if people start building now it takes a number of quarters, maybe even a number of years, to get a real change in the supply of housing but specifically in relation to Ireland there’s so little construction activity at the moment and that’s unlikely to change any time soon that we pretty much know the supply of housing in Ireland for the next 5 years.  So if supply is fixed then we need to look at demand and typically people look at sort of the income to house price ratio, that’s the easiest for an individual household to do because they know their income and then they just multiply out and say okay well let’s say four times our income and then we get a house price and that’s our budget for housing.  And that’s about affordability and if we look at house prices relative to incomes we can go back to 1988, I haven’t yet found good income data before 1988, but if you look at 1980 to ’95 and ’95 is sort of that cut off before things changed the average house price was about 3½ times household income.  And household income is different to the average industrial wage, household income is if you’ve got let’s say 12 jobs for every household that means every fifth household has two people working in it you need to factor that in and that did change a bit, we went from sort of every sixth house having a second income to every third house having a second income, a second full income, between 1990 and 2005.  Now that’s sort of a ...  that’s just for your own ...  that’s more sort of like a postscript or a footnote that when you’re calculating your household income we’re looking at the country you don’t get sidetracked by the average industrial wage, you do actually know that you’ve to multiply it up by something.  Anyway that’s for the mathematicians among you.  The point of this slide was that up to ’95 you were talking about 3½ times household income was the relationship between the average house price and the average income.  In 2005/2007 we’d gone to twice that, we’d gone to about 7½ times the average household income.  And what you can do is you can actually do a nice exercise and say well if we had never gone above sort of this long run average what would house prices have been in Ireland.  And that’s the dotted line in here.  So how should house prices have evolved if you believe that this income ratio is the best way of calculating house prices?  And you can see that it was roughly right up until about 1996 and then house prices increased a lot faster than they should have but the fall has been a lot greater because the fall of income hasn’t been as large as the ... even taking into account unemployment, it hasn’t been as large as the fall in house prices and perhaps optimistically we can see that the gap here in 2011 quarter 4 is actually quite small.  Now if you believe this house price to income ratio is what matters.  What I would say is that we need to be careful with the income ratio, it’s a symptom, as I say its affordability, it’s not actually the route of what gives a property a value, it’s not the cause it’s the symptom.  And some of the increase in house prices may actually be due to the fact that Ireland went from a high interest rate environment to a low interest rate environment.  Suppose incomes never changed but we went from Ireland having an average interest rate, as you can see there of, say 12 per cent to Ireland having an average interest rate of let’s say 6 per cent, 12 per cent and 6 per cent, then you would expect house prices to possibly double because the affordability ... banks ultimately go by what you can afford on a month-to-month basis and if the interest rate is half of what it was then those first few mortgage repayments are going to be, roughly speaking, half, not quite but something like that.  So maybe some of the increase we saw in house prices is just to do with the fact that we’ve gone from being our own economy battling against all the odds to being a bit like one of the US States safe in the comfort of the Eurozone, of course we all know it’s not as straightforward as that, but let’s say safe inside the comfort of the Eurozone.  And really when we think about the value of property ultimately it comes from rents, it comes from the value of the service that someone is enjoying.  So, for example, income multiples won’t tell you why two houses next door to each other are very different in terms of price or why one city is more expensive than another city.  So when we’re calculating the GDP figures and we’re adding up consumption and investment and government and trade one of the most important services is what’s called imputed rent and this is what owner occupiers enjoy as they hold some of their wealth in property.  They enjoy a rent that they never have to pay.  But what is that rent?  Can we understand what that rent is?  How much it would be if you were to try and rent out the same accommodation you currently own, if you own accommodation.  And in that sense the ratio of rents to house prices is much more fundamental to what property is worth than the ratio of incomes to house prices.  This is just a summary of some of the academic research I’m doing, it’s trying to figure out what gets capitalised into house prices and there’s all these different services that we have that are reflected in the price of houses but how to read this is if this is going from one kilometre away from a particular property to 100 metres away so if you move a property from a kilometre away from the coast to a 100 metres away from the coast the effect is about 10 per cent, you increase the value of the property by 10 per cent.  These are the different services.  Coast is one.  If you’re close to a polluting factory or facility you get like a 1 or 2 percentage point penalty for being close to a polluter.  Being close to a primary school seems to have a big negative impact which is about counterintuitive, you know, why would being close to a primary school be ... it’s noise, it’s congestion, it’s the lack of parking spaces.  These things get factored in.  Part of my next phase of research is to separate out small schools and big schools and with secondary schools progression rates to third level education, see if people are willing to pay for good schools rather than schools which have a poor record or which are maybe large classes or whatever it might be.

Participant 4: What’s the second one the list?

That’s bathing, that’s actually beaches and bathing facilities, so being close to a beach rather than the coast or in addition to the coast has a huge impact especially in the bubble but also in the crash.  And then there’s a comparison of urban versus rural and then prices versus rents as well.  So as I say a lot of the detail here is superfluous in today’s talk but the point of this slide is to show that an awful lot of things get factored into house prices and into rents because these are services that we’re paying for and the value of a property is the number of bedrooms, it’s the type of property it is, it’s the size of the garden, it’s the amenities that it has access to and that’s, if we can think in those terms we’re much less likely to ever get caught out with bubbles and crashes in the future.  We will never be able to prevent them entirely but we certainly won’t accelerate them as we did in the past. 

So this is maybe if there are any potential first time buyers in the crowd this is maybe the most important slide, think like an investor.  If you have a property that rent for 800 euro a month that’s annual rental cost or annual rental income, if you’re the tenant or the landlord, of about 10,000 euro and what’s happening in the fire sale auctions at the moment is people are looking at these 10,000 euro rental income apartments or houses and saying right okay that gets me 10,000 a year I will give you ten times that, I’ll give you a 100,000.  In a healthy property market they may say I’ll give you fifteen times that.  I’ll give you 150,000.  But they work it out as a multiple of the annual rent and that’s a very sensible way for a first time buyer to think.  It’s easier to think in terms of your own income because you know what your own income is and you can multiple that by four pretty easily but if you lose your job how much is someone else going to be prepared to pay for that property, it’s nothing to do with your income it’s to do with how much it would rent for, the services that that property offers you.  Yeah?

Participant 5:  What about the effect of Rent Allowance on it?

Yeah, yeah that is ... it was the ... if I had an hour and a half I would have gone into Rent Allowance.  So the Rent Supplement Scheme is potentially keeping rents higher than they otherwise would be in most parts of the country with the sort of honourable exception of Dublin, south of the Liffey it seems, if you look at the thresholds for Rent Supplement and you look at prevailing rents they seem very close and Minister Joan Burton is actually reducing the thresholds for Rent Supplement and the idea there is to try and let rents determine themselves naturally.  Find out what people are willing to pay and then give people assistance based on what the natural price is rather than the tax payer footing the bill and keeping rents higher than they otherwise would be.  And that obviously has an impact of competitiveness as well if accommodation costs are higher than they need to be.  But it’s a very good point; it’s something to be aware of.  If you are looking at a particular property is Rent Supplement keeping the rent higher than it otherwise would be?  We should find out in the next 6 months.  But, I don’t know where I’m going with this, is that you can also look over the last sort of 50 ... not 50, would it be 35/40 years and see well what is this relationship between rents and house prices look like and does that tell us anything about the bubble. 

So this is the ... the yield is just the annual rent for the average property relative to the house price, the purchase price, that’s the blue line.  And the interest rate is the prevailing interest rate for mortgage borrowing in Ireland and these go from 1978 so that’s why we start then.  And you can see there seems to be, I don’t know, something weird happening in 1978, the CSO is just getting on top of its various indices, I wouldn’t worry too much about that, but what you can see is generally speaking particularly the crucial period, comparing say the 80s and the early 90s with the late 90s and noughties, you can see that the yield is very closely related to the interest rate and in fact maybe rising house prices in 1996 were actually justified by Ireland being in now instead of this 12 per cent interest rate country by being something like a 6 per cent interest rate country and that’s what you’re seeing here.  Interest rates go down significantly and house prices rise but you can see there with ... you can’t really see it easily with the yield but we know from the last graph that house prices start rising in ‘96/’97.  The damage was probably done, in my own opinion, when interest rates were kept lower than would normally have been the case because the German and French and Italian economies were anaemic when Ireland was booming.  So this, I would argue, the 6 per cent is where interest rates will probably be in the Eurozone in the long run but we had interest rates of sort of 4 per cent rather than 6 per cent and that lured the yield down from where it seems to have been quite comfortable, down for at least a couple of years.  But then people said well hang on a second it looks like we’re going to have really low interest rates, not 6 per cent we’re going to have 4 per cent interest rates, so that then sucked the yield further down.  And the problem is as soon as interest rates when back up to normal levels, this is the green line going up here, the property market was hugely exposed because prices had increased relative to rents far more than they should have.  And you can do a ... you can add in a third column, not just the income ratio and actual prices, you can add in a third column which says what should house prices have been sort of since 1978 or whatever, what should they have been, and you can track that and you can see that yes quite a good bit of the good bubble mightn’t actually ... certainly when you think back to should they be at 100,000, quite a good bit of the bubble was probably just Ireland changing from a high interest rate environment to a low interest rate environment but certainly there was a substantial chunk of the bubble left over that was pure bubble, it was nothing to do with incomes, it was nothing to do with rents.  I could go ... if anyone is interested in the mechanics of exactly how it’s worked out I can do that, it’s probably well beyond what we’ve got time for today. 

Okay so this is maybe why you’re here, some crystal ball gazing, I don’t know, when is it all going to end in terms of price falls ? Well asking prices are down by 52 per cent certainly they were down by 52 per cent on average by the end of 2011 from their peak in mid 2007.  And that sort of hides an average of ... it masks difference between Dublin and the rest of the country, Dublin is something like 56 per cent and the rest of the country is something like 48 per cent and there will be a Daft report actually - get the plug in - a new Daft report in the first week of April which will have the figures for January, February and March.  But let’s say that house prices have fallen by a further 5 per cent since the end of 2011 and let’s say that when people actually trade, when you go and you buy a house, now you don’t go ‘I’ll give you your asking price’, you say ‘I’ll give you your asking price less 10 per cent’ and there is some research that I’ve been doing with the Central Bank that says this is roughly accurate and certainly up to the end of 2010 the average discount between the asking price and the closing price is about 10 per cent.  I mean if those two things are the case then the average price is down actually 58 per cent and this, for those of you who were avidly watching our news yesterday, Brendan McDonagh the Chief Executive of NAMA was in to an Oireachtas Committee and he used the same figure, he said 57/58 per cent is what he thinks house prices are actually down, property prices are actually down at the moment.  I know there was another report that said more but that was based only of cash sales and mortgages are still an important part of the market.  So that means based off the ...

Participant 6: Was the transaction price in 2007 not actually higher than the asking price?  And wasn’t there a trend in ’05, ’06, ’07 auctioneers put houses in the paper at 250,000 ...

And got more.

Participant 6: ... and then people starting bidding 260,000, 270,000, 280,000.  That would suggest the fall is even bigger.

Yeah that is certainly ... certainly in 2005/2006 that was the case.  2007 you have period where you’ve got the transaction prices started to fall but asking prices don’t realise this and asking prices go up to where transaction prices were and stay there for a while and then come down.

Participant 6: So in 2007 there was a 10 per cent.

Yeah, so, sorry so as of ... really asking prices were completely static throughout 2007, technically the peak was the middle of 2007 but you’re really talking about very small differences throughout the whole calendar year but transaction prices had already got to that level and had started to fall so it was taking time for sellers to realise that buyers weren’t paying as much.  So there may be a small element of that but I’d argue that, you know, 58 per cent is roughly right.  So that means the average transaction price which has as you can see peaked there, at whatever, 365,000, so it’s down at about 155,000 now, so now meaning April, May, June this year maybe.  Well 155,000 doesn’t look too bad at all relative to these income multiples or if you don’t like income multiples rental multiples, both of those would suggest that we should be in or around that.  So am I saying that, you know, house prices are going to level off as early as April, May or June?  Well I think I’ll give the typical economist answer the two hands, on the one hand I think yes, I think prices are quite close to the fundamental level, there’s a caveat there about Rent Supplement, if rents go down a lot that will affect this red line here and there’s obviously a caveat about incomes.  Yeah?

Participant 7: Just with prices stabilising, if you’re looking at say just the best job security and then in the public sector where there is job security there’s no income security.  Almost everybody expects to be earning less in 2 years time than they are now one way or the other.  Surely it’s going fall due to that.

Yeah.  So it comes down to statically we don’t look like we’re too far away from fundamental property values.  There’s a caveat about Rent Supplement and that would affect the red line and then there are people’s perceptions of what their income is going to be and that affects the dotted line here, so if you feel that your income, if you feel that incomes in general are going to be maybe 10 or 20 per cent lower then that’s the correction we still need from where we are.  Or if you feel that rents are going to fall, for example due to Rent Supplement revisions by 10 or 20 per cent, well then there’s further downside.  Perhaps the more important thing that whatever happens say on incomes, I actually don’t think incomes are going to fall, I don’t think this figure, the dotted line, is going to change by too much.  I think on average like we are where we are, you know, on average I think incomes are going to be roughly the same, they’re going to maybe plus or minus 2 or 3 per cent on the average but I don’t think they’re going to change dramatically.  I think the big correction in incomes has already happened.  I think there is scope for rents to fall and that will probably have an impact but I think much more important than that is that whenever we get to ... I think we’re there now and we may have to move as the fundamentals move, but I think we’re close to fundamental value.  But the problem with housing markets is they’re boom and bust and they overshoot on the way up and they overshoot on the way down.  I would never recommend trying to gain on market and find out when it’s overshooting on the way down and buy really low in the hope that you’ve got quick gains, I’d recommend looking at the fundamentals but I do think we are going to have a situation where property prices overshoot relative to the fundamentals, they go down just because of that momentum because people look at the market now and say I couldn’t possibly see prices increasing over the next 5 years so I’m going to hold off and that has an impact.  So in terms of the crystal ball gazing, you know, are we close to fundamental value?  Yes.  Does that mean property prices have bottomed out?  Probably not.

Participant 8: Isn’t there some rational in the sense that there’s no great confidence in the economy because of the debt, money being taken out of the economy and the state of the banks, you know, so there’s no great sense of, you know, that you could base that, you know, because if there’s money taken out it’s probably there’s going to be less jobs and, you know, they’re going to be cut back in spending power which is a vicious circle.

Yeah and that’s ... yeah, and that is sort of affecting these fundamentals.  If people’s income is cut it will actually be reflected in the red line as well, that rents fall when incomes fall, and it will also obviously affect this line here and the more you believe or anyone believes that our fundamentals are going to be affected, it’s not just a cyclical thing, that we are actually going to have to step down then that is going to get reflected in the property market.  So just because I think they’re close to fundamentals doesn’t mean that anyone has to, the fundamentals can easily move, as things get worse the fundamentals obviously are getting worse.

Participant 9: I think there’s a big difference between rural and the city in Dublin, urban, like people say that in Dublin they seem to be getting help from their parents like with mortgages, down the country there’s not as much money there, prices are probably half of what they are in Dublin.

The interesting thing is that when you look at how far they’ve fallen from the peak prices in Dublin have fallen by a lot more than prices in say Tipperary.  Prices in Tipperary and in Limerick and Mayo and Kerry I think are the most reluctant to fall, they have fallen by perhaps 48 to 50 per cent, whereas ... no sorry, 40 to 42 per cent, whereas prices in some parts of Dublin are down by 60 per cent.

Participant 9: But perhaps on a bigger figure is it, no?

Yeah now I actually would be of the view that the cities are going to recover first for a number of reasons, (a) they seem to be further down the adjustment process but more importantly over supply is tiny in a relative sense in the cities compared to some counties.

Participant 9: That would be true yeah.

Yeah and that’s going to have an impact on the supply obviously and an impact on the price.

Participant 9: Yeah.

The other side of the demand, people want to live in cities because cities are better job creators than small towns and villages so if you are young now and you’re looking at setting up your future you’re unlikely as you were ... we’ve sort of got a buy, we got like a 10 year pass on the economic laws of gravity about cities, cities suck people in.  During the sort of last 10 years of the Celtic Tiger we got a reprieve and people were able to live wherever they wanted and work but that’s not going to be the case over the next 10 years and that’s going to mean that demand in the cities is greater than demand rurally.  And supply is worse, the oversupply is worse rurally.  So I actually think if I were to map it out I would see Dublin and Cork city levelling out first and remember recovery is levelling out not increasing, if you go back to the very start.  I’ll just go over to the ... yeah go to that slide and then we can ...

Participant 10:  Can you clarify on your income graph there a lot of people that work their salaries are frozen at the ’07 level and so in absolute terms they’re still receiving the same amount but in inflation terms they are short by about 4½ per cent, how is that income graph factored and is it absolute or is it inflated?

I was aware of this point and the short answer is one of them (laughs) ... the first graph was actually inflation adjusted but the second one wasn’t because it’s harder to do when you’ve got rents in there as well.  So for ease and comparability I ... so you can see that it doesn’t really matter when we’re looking at 2011, the gap doesn’t really change, the inflation thing is certainly relevant when you’re looking at the past and it might be relevant in the future depending on your belief about inflation.  But it doesn’t really change the conclusion too much about where we are now if you use nominal or inflation adjusted. 

I know I’m pushing quite close on time so I’ll ... I mean you’ve got a sense of my overall view on, you know, getting these ideas into the policymaking system so this doesn’t happen again.  Very briefly, in terms of quick ideas for what the government can do proactively, one thing is to be aware that intervention was part of the problem and the Irish property market was one of the most intervened property markets as of 2006.  The tax incentives were so skewed that’s not what that’s ... intervention for the sake of intervention is not a solution but you can do things.  The market does need to be managed because it’s not a very good market, it’s got boom and bust cycles because of adapted expectations.  Sensible land use you can promote via site value tax, that penalised people leaving land banks empty, penalising bad or inefficient or socially unrewarding use of sites and it encourages people to use the land as best as possible.  You could encourage sensible lending by requiring banks to do covered bonds, this is what the Danish system does, if you want to lend over 30 years you’ve got to go out and borrow over 30 years and when you go out and borrow over 30 years you find out pretty quickly what people believe the interest rate over that period is going to be and therefore you pass that on to your consumers and it means that we’d be a lot less susceptible to what happens in the ECB in terms of month-to-month decisions.  And the last one is sensible borrowing, and this is softer, this is about sort of the information  infrastructure that people have but the publicly available house price register will be a large part of that, giving people the information to make the decisions.  So that’s where I’ll leave it because we’ve used up all our hour but I’m happy to deal with questions as well but I know some people may have to get back to work.

Participant 11:  Just one question, it’s not mentioned in any of your slides, but do you not think our problems really began in 1977 when rates were abolished?  Local councils had no money, they did build houses.

Yeah.

Participant 11: Now I know there’s a lot of people saying they couldn’t get a house but if we had continued the way we were going they wouldn’t have been forced onto a market so inflating the price of houses.  I know I worked in the bank and I was told before I left, thanks be to God, I thought that the way they were managing the thing was wrong and I was told politely from my boss if you don’t want to do it Teresa there’s 1,500 out there who will and I was telling them that it’s wrong to add that into somebody’s ... they tried to bring them up to the mortgage rate, they were bringing in their bonus and overtime and every little ha’penny they could get, and I fundamentally disagreed and I was told very politely if you don’t want to do it somebody else will.  Well I was leaving so it didn’t matter but to me I think back in 1977 was when we made the first mistake because then they took no taxes on any house even.

Yeah.

Participant 11:  We’d no rates.  The local economy had none and now we’re complaining about 100 euro tax on houses or the thing, which is minimal.  And it’s just to keep our roads clean, the grass cut in our parks and keeping libraries open and I’m quite sure the 100 won’t cover it.

Yeah I completely agree and it comes back to the second last slide there about intervention and one of the interventions, one of the worst interventions was removing any form of taxation.

Participant 11: Yeah.

Because then it became a vote winner.  You could get elected by saying ‘I’ll abolish whatever last tax there is in the property market’ we saw that right through to 2007.  If you go back to the ... there was the table with all the different amenities, other research has shown that if you’re close to a park your property price is higher.  But if you have a tax, like a site value tax, that reflects the value of your land you’ve got a direct way of funding local authorities to maintain parks, to build new homes, to do whatever it might be to maintain the amenities that they have.  Yeah?

Participant 12: Ronan, an excellent presentation.  Thank you very much, I really enjoyed it and learned a lot from it.

Thank you very much.

Participant 12: I agree with you generally but I don’t think you should be making a bald statement in its own silo investing in property is a bad investment, I think you have to say property compares to cash bonds and equities as follows.

Yeah.  No that’s fair enough yeah.

Participant 12: I think you have to look at the two of them.  I mean you said for example that cash has kept up with inflation but you didn’t apparently but in the rent of property so if I had 20,000 which I think was the average price of a house in 1975, in a house, today it’s worth 150,000, if I had 20,000 of a deposit it’s still worth 20,000 in nominal terms so ...

Yeah, no that’s a fair comment.

Participant 12: ... I think and, you know, I defer to you but I think property has outperformed cash over the last 30 or 40 years and I would say historically it has outperformed cash as well.  I don’t know what a few Dutch Guilders were worth in 1640, you know, but I would imagine it’s the same over there.  I would imagine whatever price you could buy a house on the Herrenstrasse or whatever it would be a lot higher now.

Yeah, no that’s ... I mean that’s a fair comment and really the point I was making was it was trying to bring some contrast to the sort of stylised idea that people have.  As you say it is true that if you bought a property in 1970 and it was whatever it might have been, 20,000, and now it’s 150,000 or 200,000, you know, that is true but I am ... I guess the point of my slides was that don’t expect that to happen again.  It might happen if inflation does it so they were real ... well they weren’t even real values but let’s say you go to real values and you say you’ve got an increase in the real value of housing that mightn’t ... we shouldn’t be expecting that to happen again but I complete take it, I’m going to ... if I give this I’m going to be adjusting and in fact I wanted to include a point about equities but I had a data source but I didn’t have the time to crunch the numbers.

Facilitator: Folks maybe we’ll finish up there.  So thanks very much to Ronan for coming along.  (clapping) 
 

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