On what basis is Irish residential property 26% undervalued?

The special report published this morning by the Central Bank of Ireland may well have perked up your spirits if you’re a homeowner inIreland. The Bank has calculated that residential property inIreland is between 12-26% undervalued – in other words you might think your home is worth €148,000 but the Bank thinks it should be worth up to €200,000. The Bank has even produced a graph – shown above – which shows the degree of undervaluation based on four different models.

But on what basis does the Bank arrive at its conclusions? Despite studying the 13-page report, I’m afraid the best you’re going to get, is the Bank has used four models to examine actual prices versus expected prices. The expected prices are derived from observations of property prices over the long-term and their relationship to various factors such as average income, population, housing stock and the availability of credit. It seems that on an “affordability” basis, the biggest undervaluation of 26% occurs.

How did they get to 26%? I have not a clue. You can’t tell what actual prices have been used. The CSO’s index is probably the most reliable in recent times but it only goes back to the mid 2000s but as noted in the Bank’s paper there is a range in actual house prices of between 43-70% recorded at Myhome, DAFT, the CSO and the Allsop Space auctions. So which actual house price has been used?

And how are the models constructed? Again, not a clue is offered by the paper, though there shouldn’t be any reason to doubt that the Bank staff have diligently carried out their calculations. On the other hand it’s worth noting that The Economist reported in November 2011 “despite their collapse, Irish home prices are still slightly above “fair” value—partly because they were incredibly overvalued at their peak, and partly because incomes and rents have fallen sharply.” – The Economist was using rents and income to come to its conclusions – you’d expect income used by The Economist and affordability as used by the Bank to throw up similar results though.

The Bank is being asked for its calculations as it is noted that the report states “Detailed econometric results are available, upon request, from the authors”

There will be cynics who will suspect any projections issued by the Central Bank of Ireland on property prices. There are some who will claim that the Bank made itself a hostage to fortune in March 2011 when it used baseline and adverse scenarios for future property prices to assist with estimating the capital requirements of banks. And cynics might suggest it is in the Bank’s own interest to undershoot the adverse estimate in order to avoid additional calls on taxpayers’ funds to prop up the banks.

Speaking of cynicism towards house prices forecasts, yesterday the Sunday Independent – “Ireland’s most profitable newspaper group” according to the Independent but a group which made a loss of €41m in 2011, is balance sheet-insolvent and has seen its share price dive by 66% in the past year according to everyone else – claimed that house prices in Dublin had “finally hit the floor” based on the monthly release of the CSO’s index during the week. If that is true, then Dublin house prices have “finally hit the floor” seven times since prices started declining from peak in 2007, and on each occasion after a rise, prices subsequently fell. For a media company starved of property advertising revenue, with negotiations with banks over €400m of debt looming and with circulation falling, you’d wonder if IN&M is reporting fact or merely composing a prayer.