The South Dublin Property Bubble - A Storm in a Teacup

Much has been made of the recent rise in property prices in South Dublin, which is already being hailed as a 'property bubble', a phrase that would instil fear in any Irishman's heart. I have a particular bee in my bonnet on this topic, and the unrelenting press coverage isn't helping anything.*

First, let me explain what a bubble is. A bubble is a situation where a group of people think that the price of an asset will continue to rise ad nauseam**, hence they lose all inhibitions and try and buy into that asset (sometimes multiple times) in order to take advantage of the price rise; get into the asset while they can still afford it***; or both. This state of irrational exuberance continues until an event occurs**** which makes people re-evaluate their purchase(s), and/or until enough people question why the asset is priced in such a way (which in essence creates the aforementioned event). Ireland was gripped in the throws of an enormous property bubble in the latter years of the Celtic Tiger (up to 2007/08), the likes of which has arguably never been seen before. The painful readjustment following on from the crash (in which house prices dropped 50%) has made many Irish people***** wary of bubbles and over stretching themselves ever again.

I have no doubt that the Irish bubble will be cited by economists and studied by students, for years to come, but we are not alone in getting excited about such assets******. Spain and the UK also had property crashes, as did the US but the scale of the Irish case is definitely unique in the modern era.

Anyway to the here and now.

Ireland's property prices are 50% lower than their peak and in most areas are still falling. However, while all the boats rose evenly on the tide in the boom years, all boats have not fallen at the same rate in the recession. Dublin prices fell far more than the rest of Ireland (circa 53%) with apartments falling approx 59% from the peak. The rest of Ireland faired somewhat better dropping circa 47%.

Dublin as the capital, was always going to be the first to rebound from the crisis, and we have seen big gains in employment in Dublin, which is yet to be matched by the rest of the country. Coupled with this (or maybe as a result of this) the prices of houses have stabilised and started increasing. A 12% rise in a single year is most certainly the stuff of bubbles, yet given the circumstances I think calling it a bubble is irrational (with a hint of exuberance).....

In a market, irrational exuberance is often followed by irrational panic. As people realise their bet is going sour, they sell like mad to try and limit the losses. The people that lent them the money (the banks) also start to sit up (start off by singing songs) and then probably curse a lot. After this they get serious and demand their money back, forcing more people to sell as most of their wealth has been invested in the asset......the one that was only ever going to increase in value.

So prices generally tend to undershoot their true market value. This is, I believe a part of what we are seeing in Dublin. Prices have gone too low; people with cash have taken note; and there has been a flood of buyers coming in to snap up these deals (of the century). There is another point to note here however. When we were back in the crazy days, building all these houses we built many of them in Monaghan, Northern Donegal, the land of Tir Na nOg etc. We also built a lot of apartments in Dublin (stack em high, sell them extremely expensive) but we did not build any where near enough family homes, for a growing population in a booming city. Construction has been no existent over the last 5 years and, as a result the amount of available and suitable family housing (3/4 beds) is quite low. Additionally there is the problem that all the people who's domiciles are in negative equity are unwilling and unable to sell, exacerbating the problem. This is causing a constraint in supply and basic economics tells you, that high demand and low supply forces up prices. In a properly functioning market, builders would react to these price signals and would start building. However, given most of Ireland's developers went bust during the crisis there may not be the demand side reaction that is needed. This might necessitate foreign companies entering the market, to fill the gap which is perfectly fine.

So why is this not a bubble?

1. In my opinion it's a correction for now and nothing more.

2. Most of these purchases are being made with cash which means the banks are not taking any risks, unlike in the previous bubble. This also means the taxpayer is not at risk.

3. The amount of housing transactions in the height of the boom was 90,000 per year. It is now around 10,000 per year. The level of transactions during a bubble tend to be very high.

4. It is confined to South Dublin, the rest of the country is in fact still falling.

5. Even with the recent price rises Dublin is still only catching up with the rest of Ireland in terms of % fall. Both are now heading towards 50% of their peak levels.

6. There is plenty of land that can be developed in Dublin, the glass bottle site is a notable example.

7. Nama have a lot of property that they can release onto the market to meet demand.


In conclusion, I think that all in all we can say that this is not a property bubble. However, if prices were to continue to rise at these levels over a sustained period the situation may change. I feel that this is a storm in a tea cup and that sensationalism is being used by the media to sell papers. As is their right.

We are a long way from the madness of the boom years, and maybe, just maybe, this is the beginning of the end of the recession.



*Which makes me wonder why I am adding to it with this blog

**Thats called irony

***Especially true with property

****In Ireland's case it was the subprime crisis in the US, which was itself a bubble

*****Leave to go and take advantage of other bubbles (London, Canada, OZ)

******See tulip-mania and the South Sea Bubble for historical examples.

Ireland, FDI and the Free Lunch (Irish Soda Bread with Edam Cheese Sandwich)

In Economics any academic will tell you, that there was no such thing as a free lunch. The theory goes that while the lunch may be free in the present, it has to be paid for – often with interest – in the future. Ireland's corporate tax rate (CTR) could be viewed as being a free lunch. Before it was lowered Foreign Direct Investment (FDI) in Ireland was very low, since the lower rate was introduced it has boomed. As there was very little FDI before the reduction, the low levels of CT it accrues does not matter. What does matter is the vast amount of employment (over 100,000 directly employed) it creates. But is this free lunch being paid for by other countries and will Ireland have to pick up the tab?

In last week's budget which I previewed here, Michael Noonan announced that Ireland would put an end to the ability for Irish companies to be stateless. This section of the finance bill is aimed at preventing large multinational companies (MNCs), like Apple from setting up an Irish registered company, that is in fact incorporated nowhere, in a bid to reduce their tax bill. Noonan did not do this out of a sense of social responsibilty, rather he did it because there is growing pressure on MNCs to pay their fair share of tax in the country where they sell their goods. Let me explain and in doing so, I will explain the name of the post.

A number of large American MNCs (Apple and Google being 2 of the more infamous) have big operations in Ireland - they route their sales from other countries through these Irish offices. As the sales are made in Ireland the tax bill falls due there. Ireland, as I am sure you will know has a 12.5% CTR, one of the lowest in the world. So you would think these companies, would therefore pay the tax on 12.5% in Ireland, rather than paying the rates in other European countries that are in the 20-40% range, right? In reality they don't pay anywhere near 12.5%.

What they do is they shift the taxes to a Dutch entity (a letterbox essentially) and from there they charge a royalty payment - which is tax deductible - from an Irish registered company that is incorporated in Bermuda, where CT is 0 (or in Apple's case nowhere*). CT is paid not on revenues but on profits and given that the profit generated can be substantially reduced by the royalty payment, the amount due to be paid at 12.5% also falls significantly - to approximately 2% of profits. This is where the Double Irish Dutch Sandwich name comes from, or as I refer to above the Irish Soda Bread with Edam Cheese Sandwich.

There is a sizeable loophole in Irish and American company law that lets these companies get away with this. An Irish company that is managed from the US is considered to be non resident for tax purposes in Ireland, while a US managed company that is not based in the US does not have to pay its taxes in the US - until such time as it repatriates the profit. Apple, Gooogle and others have aggressively targeted this strategy for many years, saving billions of dollars in taxes. This is by no means a new phenomenon. Apple has been operating in Ireland since the 80's, with Google coming to town in 2003. The financial crisis and the subsequent austerity imposed by Western Governments, has brought this practice to the fore in recent months and people are not pleased with the way these firms are doing business.

An important question in all of this, is are the companies doing anything illegal? The answer is most definitely no. They are more than entitled to and some would say obliged to minimise their tax bill. A public company is mandated to maximise its profits for its shareholders. The problem here is more of an ethical one. The question is are these companies doing something that is morally wrong? Evidently people think the answer to this question is yes. I however am a believer in free markets, if you don't like how a company operates, then don't buy it's products. The fallout from this does not seem to have affected Apple and Google to any great extent as profits are booming at both companies and Google's share price recently passed the $1,000 dollar mark .

Interestingly though, governments like the Tories - who are meant to be free marketeers - want to put an end to this practice using legislation - admittedly this comes on the back of public anger. An angry public who are still buying the latest Ipad it would seem!

So.... what does all of this mean for little old Ireland?

Well any multilateral move to pass legislation to stop this practice could mean that companies may have to pay the full 12.5% due in Ireland. Or, it may be taken one step further and CT would have to be paid in the country where the revenue is generated. Britain, France and the US are leading the pack on this - which is ironic given that Bermuda and the Channel Islands are UK crown dependancies - and are trying to bring in legislation to close the loophole. 

In an attempt to appease these larger nations, Noonan has announced that he will put a stop to Apple's stateless subsidiary but this is not going to change the status quo. Apple may simply choose to move it's stateless "Irish" company to Bermuda, which would put it in the same boat as Google. So in essence Noonan's gesture is a step in the right direction but a very small one.

Now if it no longer behoves a company to have a presence in Ireland for tax purposes, will they leave? This is in fact the million dollar question. I will try to answer it but in essence no one really knows.

First of all the gesture, Noonan says he has spoken to executives at these big MNCs about the change. He claims that they support the legislation, as they do not wish for their reputations to be harmed. Tim Cook made a similar suggestion at a Senate Committee hearing which means that Noonan's claim may be plausible. Another positive is that the Irish government have taken note and have acted first - albeit in a small way - and this may ease the pressure on the debate somewhat. 

Will a company stay in Ireland if a big change is made to worldwide legislation? 

Reasons that they would

• Google and Apple alone employ 7,000 people in Ireland, this is not a requirement for the low CT rate and is an endorsement of the skills of Irish employees and our flexible labour laws.

• Ireland has become somewhat of a tech hub and, as has been seen in Silicon Valley success breeds success and tech companies like to locate themselves amongst their peers.

• Ireland, like the UK, has a common law system which makes for a stable legal environment.

• Scotland is due to have a referendum on independence next year which could have far reaching consequence for the UK if a yes vote is passed.

• Ireland uses the Euro, thus there is no foreign exchange risk with other Euro countries.

• Ireland is pro Europe and there is no uncertainty about it's membership of the EU and the single European Market, unlike the UK which may have a referendum on EU membershion in 2017.

• The workforce is well educated and any skill shortages can easily be filled by other EU residents where required.

• English is the first language and we have a lot in common with the American's in terms of culture and heritage.

• Even after the furore began re the CT debate, Google announced it was opening a new innovation centre in Dublin and has invested heavily in data centres here.

• Ireland is a believer in free trade and is pursuing - along with the EU - a free trade agreement with the US, which would be worth billions to the Irish economy.

• Stability, Ireland has not budged from the 12.5% rate even in the face of pressure. MNCs will take note of this.

•  Companies may not want to damage their reputation further by moving operations just because Ireland is no longer 'tax efficient'.

•  If Labour are voted in at the next UK election, they will reverse the rate reductions made by the current UK government

Reasons why they would not

• Ireland's income tax is very high making it more expensive to attract the best talent from Europe.

• It is a small country and do not necessarily have the resources to fill all the open positions. There are 4,500 tech jobs open in Ireland at the moment.

• There is currently a brain drain due to the economic problems facing the country and the punitive tax rates

• Other countries are reducing their CT rates to become more competitive, the UK being a notable example.

• Venture capital is still a budding enterprise in Ireland when compared to bigger countries, this affects start ups more so than the big players but is still important.

• Ireland is a relatively rich country and wages here are much higher than in other countries like Spain, Portugal and the Eastern European block 

In summary there is a long way to go in this debate and only time will tell whether politicians will have the will to keep fighting. In the US, the debt ceiling debate could over-shadow the CT debate and it may fade to nothing. In the UK the increasingly left leaning Labour party are most definitely anti big business and would send shivers down any CEO's spine**. Any change will also have to be global, as a country that moves unilaterally will put itself at a disadvantage. It also appears that the Irish government knows that all its job creating eggs are in one basket and one would hope to see a change in strategy, towards making indigenous firms more prosperous. In my opinion Noonan has done well thus far with the limited resources he has available, the next step needs to be to reduce income tax however and level the playing field...... just in case.

Who will end up paying for the sandwich remains to be seen, for now though its business as (un)usual. 

*CT doesn't exist in nowhere, but if it did it would probably be 0 as well!

**See the UK energy price freeze debate

The eve of the Budget

It's been a while since my last post but with a massively important budget on the horizon I felt it was time to dust off the type writer and say a few words, using as few commas as humanely possible! I am picking out some of the more important points in the debate and understand that there will be gaps in the blog. Not everyone will feel the same way so please feel free to comment and make your own suggestions.

Tomorrow's budget is being hailed by Fine Gael and most loudly by Michael Noonan as the final austerity budget..... or nearly the final one anyway. They plan to take 2.5 billion out of the economy using a mixture of tax rises and spending cuts, but also have signalled that this will be a budget aiming to get people back to work. Now anyone with the slightest knowledge of economics knows that these two don't go hand in hand, an austerity budget should mean less jobs right?

Not necessarily, if Noonan takes the stage tomorrow and makes the right announcements, we could in fact see the rate of jobs growth pick up. We have been drip fed bits and pieces of his plan, a cut in VAT for the construction sector - which has worked wonders for the restaurant and pub sector - a cut in capital gains tax for start ups, which should encourage risk taking and an increase in DIRT tax on savings which should encourage spending. However, some people may be sitting here scratching their heads.... Aren't we trying to decrease the deficit? How does cutting taxes help us?

The reduced taxes should increase activity (and again this has been shown to work in restaurant trade), spending and employment and thereby increase income taxes, VAT, etc. These increases conversely pay for the loss in revenue from the lower tax rates. One would hope that this increased activity actually leads to more tax coming in, than is lost by the tax reductions. At the very least it should be tax neutral, but we still get the benefit of having less people on the dole, less rent relief, fewer medical cards etc. All of which saves the state money. Britain has been doing this in it's budgets (lower income taxes, lower CGT and lower corporation tax) and the early signs are positive.

Why have we not been doing this all along? I hear you say. Well the theory would tell you that in  recession you should lower taxes to stimulate employment and spending. This is rarely is the case however, as during booms (especially the one we had pre 2008) governments tend to become a bit lax on their spending (remember Santa Cowen) and can be fooled* into thinking that having one huge source of income is sufficient. In Ireland's case this was income from construction and in Britain's case it was construction and banking. When the bubble burst and this source of income dried up the Irish government had to move fast to shore up the finances. Do I chastise Noonan for the cuts he's made and the tax increases? The overall answer is no, we were on the verge of catastrophe and something drastic had to be done. The bond markets had already shut nay slammed the door in our faces** and we were staring down the barrel of a gun. Noonan had to get the deficit down any way he could. While I'm not a firm supporter of every decision he made, the job has largely been done and the deficit is now coming under control, so much so that we can start to introduce the growth policies outlined above. Britain has been able to do this much sooner because they have their own currency and can essentially print money for as long as they wish, in an effort to avoid a default. Their overall debt is also much more sustainable and this has allowed them more flexibility.

Anyway enough rambling, the budget. In my humble opinion Noonan can not afford to raise income tax (any tax really) by any amount whatsoever. If I had it my way I would actually decrease the top rate which weighs in at 53%. If people are to be motivated to work and if employers are to be competitive (remember employees are highly mobile) they need to be able to pay a salary that is attractive while staying in line with their competitors from the rest of the world. An Irish person who earns 100k in Ireland comes home with circa 47k after tax, in the UK they'd come home with circa 55k. This means the Irish employer would need to pay 115k*** to send their worker home with the same amount. That is 15k in extra cost and 15k less profit per worker. While a company may be willing to take the hit now they will not be willing to fork out any more.

VAT is another one that needs to be left alone. The top rate is already a whopping 23% and if we don't want to see a return to cross border shopping this absolutely can not increase and should in fact decrease. Increasing sin taxes on cigarettes and alcohol is also futile as the black market will simply step in and undercut the retailers (it has already done this to a frightening degree with cigarettes). Pubs can not take any more cost increases but a rise in off licence duty might help restore the balance.

I am vehemently against increasing the 9% rate for the tourism trade and raising that will help no one.

So back to the original question.. how can we take money out of the economy? Well it is my belief that the above tax cuts would start the process as employment and spending should increase with all of the positive spin offs associated with that. But unfortunately it ain't gonna bring us to the holy grail of 2.5 billion. For this we need spending cuts.

No one wants their income reduced but given the state of play it's unavoidable. And when I say unavoidable I mean we need to get out the machetes and start slashing. There has been a lot of talk recently about welfare traps. So called because it's not worth someone's while to give up the dole (and the associated benefits) to take a job that pays the same amount, in fact the job needs to pay considerably more to make it worth while. This is abhorrent and must be stamped out immediately. The dole should be a necessity not a choice. Anyone who has the ability to find work must be encouraged to do so at all costs. I am painfully aware that many people can not find jobs, but if employers have to pay above the odds just to entice a person to come off benefits there is something seriously wrong. The UK is going about this in a big way, far more drastic than I think Noonan would ever go for. Again there are people out there who are struggling and my sympathies go out to them but given that the economy seems to be starting its turn around these issues (welfare traps) need to be addressed.

On that note the dole for people under the age of 25 is set to be cut by 44 euros a week. This will make employers at the marginal level (i.e. paying a wage close to the old dole rate) more attractive and will force more young people to look for work. Again the work may not be there but at least some of them may decide to move back in with their parents and save the state money on that end.

International aid should be cut for a period of 5 years. Again this is a painful one but if we can't look after ourselves then how can we justify sending money to other countries. The EU would be up in arms about this but I think we could get away with it (possibly if we promised to make up for it down the line). Its easy for me to say these things rather than to do them, but tough choices have to be made and we need to look after our own people first.

Medical cards should be given to those who truly need them no questions asked, there have been many reports of late of people who have disabilities, cancer and other debilitating diseases having their welfare cut and this is not right.

Pensioners should also take a hit, most certainly those that can afford it, they have been the least affected by recession. They did not have large mortgages, they had been saving during the boom and thus have large pensions. The problem is that pensioners vote in large numbers**** and thus are protected from the worst of the cuts. Again I don't expect old ladies to be starved or forced to ration their gas and electricity but those who can afford to get less should get less.

Child benefit should be means tested (again see Britain) as the richest people in the country do not need this. Those on low incomes certainly do however and thus it should be left as is for them.

Finally in my budget I would not worry too much about the 2.5 billion target, if we can start getting growth going again and increase jobs the bond markets will give us more time. The yields on 10 year bonds are sitting at about 3.5% at the moment so we have time on our side. A good dose of growth would be welcomed far more than the deficit reduction.

The problem with my budget is in the name, its my budget and not Noonan's. He is going to increase some form of tax and cut less than he should, he like everyone else has to play the political game. I can't fault him but sometimes I wish politicians would take a stand for what is right.

There is one theme that overrides all of this debate. The corporation tax rate, if one thing is for sure that will not budge. Ireland has managed to shield itself from even more pain by managing to keep foreign Direct Investment flowing into the economy during the recession. This sector accounts for 100,000 direct jobs and probably the same again in indirect jobs. If the likes of Germany, the US and the UK get their way and they force this rate to go up or if they force multinationals to pay their fair share - rather than routing profits through Ireland - then our little island could suddenly become a lot less attractive. If you think the budget is tough now just imagine what it would be like with another 200,000 people on the dole.

In some ways this is a scary time to be Irish, we are on the verge of getting back on our feet and securing our future. However a bump in the FDI road could set us on a downward spiral once more. All Noonan can do for now is keep pushing on with the work he has done. You have to wonder about their job creation strategy however, given that it seems to be mostly reliant on foreign MNC's.

For more on the corporation tax

An optimistic outlook by Seamus Coffey http://economic-incentives.blogspot.ie/2013/10/12-billion-in-ct-revenue.html

A more pessimistic outlook http://www.davidmcwilliams.ie/2013/10/14/lets-talk-about-tax


*Some may wish to use the word bribed here

**Santa got hit pretty hard which explains the mushed up facial features

***I am ignoring tax free allowances and lower rates for ease of calculation

**** If Irish people took more of an interest in voting (39% turnout for latest referenda) this would not be a factor.