Incomes will rise faster than house prices this year for the first time in more than a decade, making property more affordable, according to a new analysis from Bank of Ireland.

The affordability boost will, however, be short-lived, with higher mortgage costs to cancel it out before the end of the year.

Dr Dan McLaughlin, Bank of Ireland's chief economist, is expecting growth in house prices to slip from 8.6 per cent in 2004 to 5 per cent this year.

The drop will come as household incomes expand by 6 per cent, thus outpacing price growth in the property market. As long as euro-zone interest rates remain at their current historic low of 2 per cent, this would make housing more affordable.

The affordability measure used by Bank of Ireland is based on the relationship between an average employee's earnings and the average annual cost of a new mortgage.

Dr McLaughlin predicts, however, that rates will start to rise around the middle of this year. He has pencilled in a half-point rise in euro-zone rates for 2005, with the first of two quarter-point increases to come in June.

This would take the average variable mortgage rate to 4 per cent by the end of the year. When combined with an increase in the average value of a new mortgage, this will see home loan costs rising from 28.4 per cent to 31 per cent of average earnings, according to the study.

Dr McLaughlin points out that while this will only have a slight effect on the market, more rapidly increasing rates could eat into mortgage demand and, ultimately, house prices.

He believes that the housing market reached a "watershed" in 2004, when the pace of residential construction finally had the effect of slowing price inflation. Continued high levels of construction will help to "dampen" prices more this year, the study concludes.

"House prices in Ireland are finally responding to the scale of supply, and the era of double-digit house price inflation may well be over," Dr McLaughlin notes.

Last year was also the first year that the number of new mortgages exceeded the 100,000 mark, with the collective value of all home loans rising by 19 per cent on 2003 to €17 billion. Dr McLaughlin estimates that the value of mortgages will rise by another 11 per cent this year to pass the €19 billion mark.

He sees support for the residential market coming from increased earnings, high levels of migration and job creation.

Investors are not, however, expected to play a big role in house purchases, with commercial property to deliver more substantial returns.

Dr McLaughlin believes that commercial returns could reach 15 per cent this year, having come in at 11.5 per cent in 2004. He says the driver of the outperformance may shift from retail to the office sector, as vacancy rates in this area continue to decline and rents stabilise.

Returns in the industrial sector should also improve this year, according to the Bank of Ireland analysis.