The Perfect Storm

A storm is brewing in the Irish housing market. Most commentators would agree that the weather has worsened, but remain divided over how bad it will become. Bullish EAs forecast improving weather after the election, while bears warn of darkening clouds. Yet all hang back from offering firm forecasts, saying "well, we can't predict the future". While we can't predict the future with absolute certainty, we can look to the past as the best indicators of future performance. And history tells us that we are headed for the storm of the century.

The economic history of the world is strewn with asset bubbles. From the Dutch tulip mania, to the dot.com bubble, and countless real estate bubbles, history provides us with a great deal of data about speculation-driven asset bubbles. And from this data, we can learn a thing or two about our own home-grown asset bubble, the Irish housing market, and where it is headed.

Analysis of housing bubbles reveals an interesting fact, one that conflicts with the "common knowledge" offered by Irish EAs. House prices don't always go up in the long term, and they most certainly don't rise at 10%pa, outperforming all other asset classes. In fact, two very long term studies of the US and Amsterdam housing markets, over 150 years and 400 years respectively, both showed that house prices only increase at the same rate as inflation. So it seems that you can go wrong with bricks and mortar after all.

Armed with this knowledge, what can we infer about the Irish housing market? Well, quite a lot actually. Knowing that house prices only match inflation in the long run, if we can plot the rate of house price increases against the rate of general inflation, we can determine how far from the mean our market has become. So lets do that!... And what does this graph show us? It shows us that our rule of general inflation does apply to the Irish market, where house prices were flat in real terms (relative to rises in the cost of living) for 20 years from 1970 to 1990, and fell from 1980 to 1987. It was only since 1996 that house prices began to depart from historic norms, surging upwards every year, pausing only momentarily in 2001, before racing again to our current unprecedented high. According to this data, Irish housing is overpriced from 60% (for new builds in Cork) to 68% (for second hand houses in Dublin). (2006, 2007 data not included.)

If you accept that we have been in a housing bubble (and the above data proves that we have), then a house price crash is inevitable. All asset bubbles mean revert (as confirmed by a recent OECD study).