What a difference a few months can make.
In June, EY predicted continued price growth for the UK property market through 2024. Now lenders are withdrawing mortgage products, homeowners fear skyrocketing monthly repayments and there is talk of a possible property sell-off United Kingdom. mortgage rates are at 5-6%, and are expected to rise further, so much so that analysts suggest UK property prices could fall by up to 20%.
And it’s not just the UK. Capital Economics predicts prices will fall by 20% in New Zealand and 15% in neighboring Australia, while in Canada prices are expected to fall by a quarter.
The common denominator behind the forecasts? Rise in interest rates.
Although other factors explain the changing outlook – the cost of living crisis, energy fears and recession expectations are all fueling shaky real estate markets around the world – interest rate hikes are nonetheless causing a brutal shock.
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So far the Irish market has been sheltered as major lenders have been slow to change interest rates, but common sense suggests it is only a matter of time. After all, the European Central Bank has already raised rates by 1.25% since July, and further hikes are likely.
So what impact could this have on the Irish property market over the next few months?
Real estate will become more expensive
When looking at a home, people often tend to look at the list price, that is, the price at which you buy it, rather than the “cost of ownership”, or the price after the cost funds are taken into account. However, it is the latter that reflects the final cost of a house, and the higher the interest rate, the more expensive the house will ultimately be.
Consider a house on the market for $350,000. It is purchased with a deposit of €50,000, resulting in a mortgage of €300,000. First, let’s assume an average interest rate of 2.2% over the term of the mortgage of 30 years. Considering the purchase price (€350,000), plus the cost of financing over these 30 years (€110,076), the actual price paid for this house is approximately €460,000.
But what if the average interest rate over the life of the loan is 4%? Then the total cost of the house climbs to around €565,000 – around a fifth more expensive.
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So unless you’re a cash buyer, rising interest rates will make buying a home more expensive.
Buyers will be able to borrow less
Higher rates also mean that some people will be able to borrow less, putting pressure on price growth.
“Borrowing capacity will be affected, I’m sure,” says Michael Dowling of Dowling Financial.
The Bank of Ireland has already indicated it will tighten its affordability criteria, while ICS has capped the amount homebuyers can borrow at 2.5 times income and introduced 20% deposit requirements for the first buyers and 30% for the second. buyers.
As part of the mortgage process, lenders consider borrowers’ ability to repay by applying a stress test, i.e. a higher interest rate.
“The important point is that the stress test is 2% higher than a standard variable rate,” Dowling explains. This means that, based on current rates, lenders such as Avant will stress test at a rate of around 4.7%, while Bank of Ireland (which has a high floating rate) will stress test at a higher rate of between 5.9 and 6.5%.
To put that into numbers, Dowling gives the example of a couple on $85,700 borrowing $300,000 over 30 years. To pass the Bank of Ireland stress test, for example, they will need to prove they are saving and/or paying rent of €1,779 per month, or €1,566 in Avant’s case.
And those rates haven’t gone up yet, but it’s surely only a matter of time before they do, which means tougher tests to pass to borrow the same amount of money.
“A 1% increase in stress test rates will add between €175 and €200 per month to the stress reimbursement required to prove,” says Dowling. “Obviously it impacts lower income people more than high income people.”
Rate hikes can also make people think twice about overshooting; a 30-year mortgage of €300,000 will cost €1,139 per month at an interest rate of 2.2%, but €1,432 with an interest rate of 4%, which is 25% more.
Already, mortgage approvals are stagnating; figures from the Irish Banking and Payments Federation show the number of mortgage approvals for first-time buyers rose just 1% in the year to August, while second-time buyers and the following fell 5%.
Bank of Mum and Dad could reduce its loans
With interest rates beginning to rise, this may provide parents with alternative investment opportunities that are less risky than those they faced during the low interest rate years.
This may mean that parents withdraw funding for their children.
In South Dublin, for example, Brian Dempsey of DNG’s Stillorgan office estimates that around 50% of deals in the area are financed with up to half the purchase price in cash.
Part of that comes from downsizing that pays for a property in cash, “but mom and dad’s bank is also a huge source,” he says, pointing to the prevalence of negative rates for so long.
But will this continue? Also, in the face of rising costs and fear of power shortages etc., parents may be less inclined to donate the money they themselves might need one day.
Price growth will slow
So what does all of this mean for pricing?
As the early signs from the UK illustrate, interest rates can have a big impact on the direction of a housing market. Indeed, as a recent note from Fitch indicates, Ireland’s boom in the run-up to 2007-2008 was fueled in part by “the decline in mortgage interest rates with the entry of Ireland in the European Monetary Union”.
So a moderation in price growth at least would not be unexpected in an era of rising interest rates, with Fitch forecasting Irish house prices to “cool” and grow in the 0-2 range. % in 2023.
This view is shared by Marian Finnegan, general manager of Sherry FitzGerald Residential.
“We don’t expect this level of price increases to continue,” she said, pointing to recent double-digit increases, adding that interest rate hikes “will contain price growth.”
“We wouldn’t expect house prices to continue to grow the way they have,” said Rodrigo Conde Puentes, senior analyst at Moody’s.
However, he notes that Ireland is at a different starting point than it was during the financial crisis, pointing to more robust price-to-income and price-to-rent ratios.
“In this regard, we don’t see any other red flags,” he says, adding that it may take a larger demand-side shock, such as soaring unemployment, to do so. lower real estate prices.
Indeed, a downside scenario analysis from Moody’s, which assumes high single-digit inflation through 2023 in all markets, and a more aggressive rise in interest rates, suggests that the proportion of distressed borrowers in Ireland would increase to only 2%. And that would not necessarily translate, even among troubled borrowers, into arrears and defaults. This compares to a much higher distress rate in the UK of around 13% due to a higher proportion of non-conforming loans.
Finnegan agrees that it would probably take something more than an interest rate hike for a price crash.
“For prices to come down significantly, you would need a very large drop in demand,” says Finnegan, adding that this could come from high unemployment/net migration.
Part of the reason why the mortgage shock – if and when it happens – may not be as large in Ireland as in the UK is that the market is undoubtedly better structured to withstand a shock than it was before the financial crisis.
In 2006, for example, about 20 percent of new loans were granted at loan-to-value (LTV) ratios above 95 percent, meaning that one in five new homeowners had a net worth of just 5 percent. percent in his home – so when prices fell by, say, 6%, they immediately fell into negative equity.
Similarly, 60% of loan-to-income ratios were above 3.5 times at the time. These days, Central Bank mortgage rules mean borrowers are in a much better position to weather shocks.
Also, generally speaking, the higher the proportion of variable rate mortgages in a country, the more homeowners are exposed to rising interest rates, and therefore the more likely prices are to fall. But in Ireland, rates have moved sharply towards fixed rates, with banks offering the best deals to those willing to lock themselves in.
Decline in sentiment
But apart from the fundamentals, the biggest negative impact could come from the drop in confidence.
“There’s a sense that there will be a reassessment of people’s needs,” Finnegan says, adding that this will impact sentiment.
Dowling agrees.
“Once interest rates start to rise, the sentiment changes,” Dowling says, adding that this can impact people’s decision on whether or not to consider buying a property.
Already, the numbers suggest that the sale has slowed; there were 4,742 properties for sale in Dublin in September 2022 compared to 3,586 at the end of September 2021, according to figures from myhome.ie. This represents an increase of around 32%, and the highest figure since the pre-pandemic era, in October 2019, when the market would have slowed down.
But while supply may increase, falling sentiment may put pressure on the development of new homes.
“New homes haven’t been delivered,” Finnegan says, adding that the level of inventory delivered in recent years isn’t as high as expected.
Now, with interest rates rising, that long-awaited offering could be further delayed as developers price sales amid falling affordability and rising input and construction costs.
For reasons like this, Finnegan would like to see the Central Bank’s lending rules changed, particularly regarding the 3.5 times income rule.
“There would be some debate as to whether or not it suits the current environment,” she says, adding that the rules have worked well in times of low interest rates, but may not be appropriate in times of downturn. higher rates.
For now, the housing market seems able to weather the storm of rising interest rates. But, given the pace at which the UK market has changed, a winter of discontent could still be on the cards.
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