Don’t be tricked into believing that property is a one-way bet
HOUSE princes can fall as well as rise. That is worth repeating: property is not a oneway bet. The national conversation this week has had more echoes of the 2002-07 period than any other time since bubble-era property prices stopped rising just over a decade ago.
This was triggered by a prediction that prices could rise by a fifth over the next three years.
They could. And they could well rise by more than that. But they could also fall. Three-year predictions aren’t worth much in a highly uncertain world.
The body that made the call – the Economic and Social Research Institute (ESRI) – has had its fair share of bad predictions, mostly notably in the summer of 2008. Then, as the economy was already crashing, it predicted another five years of boom.
As the dogs in the street know, a depression was experienced in the following half-decade. Property prices halved over that period. Huge suffering ensued.
The truth is that all economic forecasting comes with a health warning. It is a pity that Tuesday’s ESRI study did little to highlight this. The absence of warnings inevitably led to the prediction morphing into a fact in headlines. This can only add fuel to the fire of excessive house price inflation.
Before looking at the many things that could result in a smaller price increase, or even a price fall, it is important to consider the psychology of inflation.
Economists have long recognised that managing inflation expectations is important. When Mario Draghi speaks from his European Central Bank perch in Frankfurt, he will often talk about the importance of keeping people’s expectation of future inflation “anchored”. If expectations become “unanchored”, and people come to believe that prices will go only one way, they can then rise more quickly, as people bring forward their purchases, thereby adding to current demand.
It is true that when central bankers talk of anchoring prices they almost always talk about goods and services. But the dangers of unanchored inflation expectations are even greater for the price of assets, such as homes, than they are for onions and haircuts.
If people expect house prices to be higher in the future, they are more likely to seek to get on the ladder now rather than waiting. In effect, this means that the expectation of future inflation can end up as a self-fulfilling prophecy. That, in turn, has the effect of amplifying the already built-in tendency for market economies to move in boom-bust cycles.
Rollercoasters are fun in a theme park. They are less fun economically. Individuals, families and businesses suffer fewer ill-effects when economies are stable than when they swing from boom to bust. Avoiding recessions and depressions, it hardly needs saying, is not only good economically, it is better in every way – from reducing people’s personal stress levels to maintaining wider societal cohesion.
Thankfully, Ireland has not returned to bubble territory yet, a point Tuesday’s ESRI paper makes well. Nationally, home prices remain one-quarter below their peaks of a decade ago. That is also true in the capital, where the gap between supply and demand is widest.
More importantly, private-sector debt levels are falling, not rising, something that never happens when bubbles are inflating. Indeed, rapidly rising prices accompanied by a rapid accumulation of debt is almost the definition of a bubble.
But this does not mean that prices won’t fall in the future. Property price developments will follow the wider economy. A halting of economic growth would stop prices in their tracks. And there is no shortage of risks to the economy over the coming years. Anyone thinking that property is a one-way bet should consider these risks carefully.
The first is domestic. The current period of growth in the Irish economy dates from 2012. Six consecutive years of growth is at the longer end of the average expansion in a developed economy.
While most indicators – in Ireland and in our main trading partners – point to strong economic momentum, a cyclical slowdown in Ireland in 2018 would not be odd or unusual.
Then there is Brexit. It is due to happen in March 2019. The ill-effects for Ireland have been limited so far and many possible outcomes remain conceivable.
But if new barriers to crossborder commerce are erected in 2019, there will be a hit on the economy. A hard Brexit could be enough to trigger an outright recession in Ireland.
Then there is interest rate risk. The European Central Bank has been signalling that interest rate increases are coming back on the agenda and that 2019 – the year of Brexit – is the most likely year for a rate rise.
Although it does not appear probable at this juncture that interest rates would rise by much in a short period, higher debtservicing costs would have a bigger impact in Ireland than most other euro area countries. That is because debt levels are higher here and a much larger share of household debt is on variable rates.
If rate rises coincided with a Brexit shock, the economy would be hit by a double whammy.
THE biggest unknowable of all is what is going to happen in the international financial system. Prices of almost every kind of asset – property, stocks, government bonds and corporate bonds – have been soaring in recent years. Increasingly, financial markets are showing bubble-like characteristics. Some commentators are even talking of a super bubble.
The 2008 financial crash and the manner in which it affected global economic activity was predicted by no one. Among other things, that proves how poorly understood the financial system is. That has not changed in any significant way.
As such, another international financial crisis cannot be ruled out. If that happens, prices of all assets will fall. Irish property is unlikely to be an exception. Let buyers beware.
There is no shortage of risks to the economy... a hard Brexit could trigger a recession