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Ronan Lyons (Oxford / TCD / Daft.ie)
Challenges Facing the Irish Economy
European Commission Conference, Galway,
March 24th, 2012
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By way of introduction Todays theme:
importance of internetand social media tomodern commentators(and academics?)
My own benefit ronanlyons.com
@ronanlyons on twitter
LinkedIn even got me a
job!
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Today is based around
four stylised facts
Real estate is a bad investment
The property market is imperfectAccommodation is a service
Governments can manage the property market
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Real estate is a bad investment
The property market is imperfectAccommodation is a service
Governments can manage the property market
Outline
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But surely
Buy land theyre notmaking it anymore!
Mark Twain
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This is Amsterdams Herengracht
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0
100
200300
400
500
600
700800
900
1000
1628
1642
1656
1670
1684
1698
1712
1726
1740
1754
1768
1782
1796
1810
1824
1838
1852
1866
1880
1894
1908
1922
1936
1950
1964
Herengracht house prices, 1628-1962
On the face of it, house prices do
seem to rise at least some of the time
1628 = 100 Source: Piet Eichholtz
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0
500
1000
1500
2000
2500
1628
1642
1656
1670
1684
1698
1712
1726
1740
1754
1768
1782
1796
1810
1824
1838
1852
1866
1880
1894
1908
1922
1936
1950
1964
Herengracht house prices, 1628-1972and rose dramatically 1950-1970
1628 = 100 Source: Piet Eichholtz
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50
100150
200
250
300
350
400
1628
1642
1656
1670
1684
1698
1712
1726
1740
1754
1768
1782
1796
1810
1824
1838
1852
1866
1880
1894
1908
1922
1936
1950
1964
Inflation-adjusted Herengracht house prices
Correcting for inflation, though,
substantially alters the picture
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Property stores value but little more Relative to the cost of living, prices in Central
Amsterdam were no higher in 1975 than in 1875 or 1640
Stylised fact (1): over time, house price increases onaverage match inflation but dont beat it
This can be investigated worldwide
The literature on long-run house prices around the
world is small but pretty clear on this point e.g. NewYork commercial real estate or Boston house prices
Bad investment in the sense of capital gains needto look at the dividend instead rents
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But surely Ireland is different?
0
50,000
100,000
150,000
200,000
250,000300,000
350,000
400,000
1975Q1
1977Q1
1979Q1
1981Q1
1983Q1
1985Q1
1987Q1
1989Q1
1991Q1
1993Q1
1995Q1
1997Q1
1999Q1
2001Q1
2003Q1
2005Q1
2007Q1
2009Q1
2011Q1
Average house prices in Ireland, 1975-2007
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The period to 1996 looks familiar!
0
50,000
100,000
150,000
200,000
250,000300,000
350,000
400,000
1975Q1
1977Q1
1979Q1
1981Q1
1983Q1
1985Q1
1987Q1
1989Q1
1991Q1
1993Q1
1995Q1
1997Q1
1999Q1
2001Q1
2003Q1
2005Q1
2007Q1
2009Q1
2011Q1
Inflation-adjusted house prices, 1975-1996
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Our expectations about the future
should reflect this
We should only expect house prices to increase
the same rate as inflation
This has big implications for those who bought duringthe bubble (or those who bailed out bubble-era
lending) They cant expect inflation to eat away their problem
they will have to wait until the principal is paid off to selltheir property
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It may be the 2050s before prices
reach levels seen at the peak
0
50,000100,000
150,000
200,000
250,000
300,000
350,000
400,000
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
Potential for house prices in Ireland, 1975-2060
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Outline
Real estate is a bad investment
The property market is imperfectAccommodation is a service
Governments can manage the property market
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How did prices reach 2007 highs? The short answer:
Ticking all the boxes
of a textbook bubble-and-crash...
...in a market withadaptiveexpectations, wheremomentum is key
"Bad advice given by so many resulted insome people making mistakes when theyshould have bought property last year.
Bertie Ahern, April 2006
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Economics likes assumptionsAssumptions are needed to come up with any sort of
model of the world
Assumptions typically either
1. Strip away unnecessary detail
2. Simplify a process we dont understand yet
The danger is when economists mistake a type (2)
assumption for a type (1) assumption
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Rational expectations is one
contested assumption Rational expectations means that consumers know
all information and can process it
An alternative is adaptive expectations
i.e. people do not process every last bit of information instead they look at the past and extrapolate into thefuture
This has very different implications for policy Property markets exhibit strong tendencies of
adaptive expectations
We can see this in Ireland over the last ten years
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Bubbles occur when a favourable
change is amplified by easy credit1. A bubble starts out with an initial change in conditions, often
a desirable one In Ireland, this was moving from 1980s stagnation to 1990s export-led
growth2. Boom becomes bubble when prices detach from fundamentals
this needs a generous supply of credit Entering the Eurozone gave Irish banks access to German savings to
lend a failing at EU level
3. For the bubble to suck in large numbers of people, generoussupply of the asset itself is needed
Tax breaks for both builders (Section 23) and borrowers (mortgageinterest relief) were domestic policy errors
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Despite all this, people did not see
the end of the bubble
Source: Analysis of ESRI-IIB Consumer Sentiment Surveys
Cognitivedissonance?People seeingwhat they want
to see
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People also find it hard to see the end
of the crash The typical respondent to a survey on the property
market in January 2012 expected house prices to fall afurther 10% this year
Just one in six sees house prices being higher in 2017than they are now
This is only slightly above the number who believe houseprices will fall by a further 35% or more during the sameperiod
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Outline
Real estate is a bad investment
The property market is imperfectAccommodation is a service
Governments can manage the property market
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Economics is not:
what goes up must come down
0
50,000
100,000
150,000
200,000
250,000300,000
350,000
400,000
1975Q1
1977Q1
1979Q1
1981Q1
1983Q1
1985Q1
1987Q1
1989Q1
1991Q1
1993Q1
1995Q1
1997Q1
1999Q1
2001Q1
2003Q1
2005Q1
2007Q1
2009Q1
2011Q1
2013Q1
2015Q1
Average house prices in Ireland 1975-2015
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Economics is about:
supply and demand Supply is largely fixed
Both generally: in housing markets (compared to othermarkets) supply moves slowly
And specifically: in Ireland at the moment, very littleconstruction activity happening
To understand where house prices will land, we needto understand demand
This is often thought of in short-hand as the ratiobetween incomes and house prices
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House prices relative to incomes Between 1988 and 1995, the average house price was
3.6 times household income
Household income in 1990 was 1.15 times average income(compared to 1.33 in 2005)
The ratio in 2005-2007 was over twice this (an average
of 7.4)
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What if house prices had reflected
household income?
0
50,000
100,000
150,000
200,000
250,000300,000
350,000
400,000
1975Q1
1976Q4
1978Q3
1980Q2
1982Q1
1983Q4
1985Q3
1987Q2
1989Q1
1990Q4
1992Q3
1994Q2
1996Q1
1997Q4
1999Q3
2001Q2
2003Q1
2004Q4
2006Q3
2008Q2
2010Q1
2011Q4
Inflation-adjusted house prices in Ireland
Actual
Income ratio
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But the income ratio is a symptom
not the cause Some of the increase
above the dashed linemay not be due to a
bubble It may be because
Ireland went from a highinterest rateenvironment to a lowone 0%
2%
4%
6%
8%
10%12%
14%
16%
18%
1975Q1
1979Q1
1983Q1
1987Q1
1991Q1
1995Q1
1999Q1
2003Q1
2007Q1
2011Q1
Interest rates
Pre-1995 averagePost-1995 average
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The ultimate value of real estate
comes from the service it offers Income multiples also tell us very little about why
house prices vary spatially
Rents matter even if you are not a renter or alandlord
One of the most important services in a developedeconomys GDPis imputed rent
What would an owner-occupier pay in the rental marketto enjoy their accommodation?
The ratio of rents to house prices is the fundamentalmeasure of health in a property market
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Rents and house prices reflect a huge
range of non-market services
Figures show the estimated effect of moving a property from 1km awayfrom a particular amenity to 100 metres away
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The ratio of rents to house prices is
like the return on housing Think like an investor: a property that rents for 800 a
month has an annual rental value of10,000
Knowing that this property has an annual dividendof10,000, what would you buy this property for?
If you had lots of cash, you would compare the return to,say, interest rates on savings accounts
If you were borrowing, you would compare the return tothe cost of borrowing
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The rent-to-price ratio is closely
related to interest rates
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
1978Q1
1980Q1
1982Q1
1984Q1
1986Q1
1988Q1
1990Q1
1992Q1
1994Q1
1996Q1
1998Q1
2000Q1
2002Q1
2004Q1
2006Q1
2008Q1
2010Q1
Yield
Interest rateRising house prices in 1996may have been justified bylower interest rates
Perhaps the real damagewas done when yields werepulled down by low ECB
rates post-2001
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What if house prices had reflected
rental yields?
0
50,000
100,000
150,000
200,000
250,000300,000
350,000
400,000
1975Q1
1976Q4
1978Q3
1980Q2
1982Q1
1983Q4
1985Q3
1987Q2
1989Q1
1990Q4
1992Q3
1994Q2
1996Q1
1997Q4
1999Q3
2001Q2
2003Q1
2004Q4
2006Q3
2008Q2
2010Q1
2011Q4
House prices in Ireland 1975-2011
Actual
Income ratio
Yields
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Crystal-ball gazingAsking prices fell by an average of 52% between 2007
and the end of 2011
If asking prices have fallen a further 5% since then andaccepted bids are typically 10% below the asking price,then prices are down 58%
The average transaction price now is in the region of155,000
This is in line with both income multiples and rentalmultiples
but prices wont actually stabilise until credit returns
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Government can put in place good
market foundations Caution: Intervention was part of the problem
As of 2006, the Irish property market the mostintervened in among developed economies
In addition to tax breaks for construction and mortgageinterest relief, also no annual property tax or capitalgains tax!
New intervention has to be aware of the stylised factsof property markets
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Three principles will go a long way Sensible land use
E.g. site value tax, which encourages socially beneficialuse of land and penalises land banks, derelict sites
Sensible lending
E.g. covered bonds: to lend over 30 years, banks mustborrow over 30 years effectively creates culture of fixedrates so Ireland would be less prone to ECB decisions
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Three principles will go a long way Sensible borrowing
E.g. improving theinformational
infrastructure publicly available houseprice register
Huge role for
information technologyand the internet
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Thank you
Comments and questions welcome
For more, see ronanlyons.com or get in touch onTwitter (@ronanlyons)
http://www.ronanlyons.com/http://www.ronanlyons.com/