Only stoke property demand if you can fulfil it

Many statistics can be identified to demonstrate the remarkable collapse that occurred in the economy since 2007, but the property and construction sector provide the most vivid and frightening examples.
Only stoke property demand if you can fulfil it

In the midst of absolute carnage in the sector, three statistics stand out. In the second quarter of 2007, 276,200 were employed in the construction sector on a seasonally adjusted basis; by the first quarter of 2013, this had fallen to just 96,900.

In 2006, the financial sector extended total mortgage loans of €39.9bn; this had fallen to €2.5bn by 2013. In 2006 the construction industry delivered 93,419 housing completions; in 2013, this had fallen to just 8,301.

I could go on, but the message is very clear — the Irish property and construction sector suffered a calamitous collapse after 2007 and is only now starting to show signs of stabilisation and a little bit of growth.

We will need to build a lot more houses to accommodate demand from both owner-occupiers and renters; we will need to build and upgrade schools, roads, hospitals and other public buildings, and vitally we will need to ensure that there is an abundant supply of commercial and industrial property to meet the requirements of the new businesses that are developing and more especially the foreign direct investment that the IDA is still successfully bringing in to the country.

To satisfy these requirements, it will be necessary to rebuild a sector that has been decimated and stripped of a vital skills base. In this context the publication of Construction 2020 last week should be given a guarded welcome.

The report contains 75 action points for the sector; some are quite vague and aspirational, others are short term and very political in their slant, but many of them make perfect sense if one really does believe that we should rebuild the sector and that it can make a very strong contribution to growth in the future.

The measures in relation to the housing market are of considerable interest. I was out of the country when the report was published, but I picked up some pretty negative vibes about the measures suggested.

There is a commitment to work with the Central Bank to ensure transparency around mortgage lending, including loan to value and disposable income ratios and the mortgage process. I am not sure what this means in reality, but it sounds good in practice, particularly if one is trying to curry political favour. More substantive suggestions were made in relation to mortgage insurance. This is a key feature of markets such as Canada and the US, and it works well.

Mortgage lenders are under significant pressure to rebuild profitability, reduce the size of the balance sheet and hold adequate levels of prudential capital.

High loan-to-value mortgages are much more expensive from a bank’s perspective, because they are more risky and consequently the banks are forced to hold higher levels of expensive capital. Hence there is no incentive for lenders to engage in high loan-to-value lending, but such lending may be warranted for worthy borrowers, particularly those who have strong earnings capacity, but cannot get a sufficient deposit together.

The creation of a universal mortgage insurance model would impose a mandatory requirement for all lenders providing high loan-to-value mortgages and enable those financial institutions insure the portion of the high loan-to-value mortgage above a certain level, such as 75%. This would mean that the financial institution would not have to hold expensive capital and thereby would be in a position to offer lower interest rates to borrowers.

Under such a model, the insurer would have an external role in assessing the mortgage credit, thereby creating better oversight; higher lending standards would be enforced through the higher level of oversight; the solvency of the financial system would be helped through greater risk diversification; and first-time buyers would be helped onto the housing ladder, which is important from a social cohesion perspective.

It is a product worthy of consideration. However, it is essential that if demand is helped, there is sufficient supply to meet it. If not, any demand-side measures would lead to disaster.

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