Property has been a one-way bet for investors over the past decade. But will 2004 change that, asks Cliff Taylor, Economics Editor

Economists, so the old saying goes, have predicted six of the past three recessions. Forecasting is a precarious exercise, as shown by the diversity of predictions on the housing market. At one end stand the bubble-is-about-to-burst brigade; at the other are those who believe the market can continue to climb.

Meanwhile, people are continuing to borrow more and more to get a foot on the property ladder, move up a rung or, as is increasingly common, buy a second property for investment or holidays. Mortgage lending growth last November was running an extraordinary 25 per cent ahead of the same month in 2002, according to figures published last week.

A recent report from Davy Stockbrokers estimated that up to a third of new houses are now going to satisfy demand for second homes. The behaviour of these investors will be a crucial factor in the market over the next couple of years.

Will it all end in tears? It will if you believe the predictions in the Economist magazine, which said that Irish houses are overvalued by 40 per cent and are likely to fall by 20 per cent over the next four years. Similarly gloomy warnings have come from no less august a body than the International Monetary Fund. Other research suggests that homes are not overvalued, however, given the strong rise in wealth in recent years, the demand for housing and supply factors, such as the cost of land.

You would need an advanced knowledge of mathematical equations - and an understanding of the assumptions underlying them - to judge between the mathematical models established to assess the state of the market. So what sense can we make of the predictions?

Whether or not there is a bubble in the housing market depends crucially on what factors have driven the market and how sustainable they are. Research by Dr Maurice Roche, an economist at NUI Maynooth, suggests there is no bubble. His work tries to take into account the main factors affecting the supply and demand of new houses. Demand has been pushed up by demographic trends, rising incomes and low interest rates; supply has been affected by rising land and building costs.

Taking all this into account, he believes that houses are around fair value or, at most, overvalued by 5 per cent. Work by the Central Bank of Ireland suggests a similar conclusion, with property overvalued by perhaps 10 per cent, according to its calculations.

Given that prices have increased threefold in the past decade, a 5-10 per cent overvaluation should not be a cause for huge concern in itself, although the level of prices is clearly causing huge difficulties for first-time buyers.

The overall market suggests that the increase in prices could ease from about 12 per cent a year to, say, 5 or 6 per cent this year - a remarkably soft landing after years of spectacular growth.

Is it all likely to work out this neatly? It could. More than 65,000 houses were built last year, meaning that supply has been catching up with demand. That should moderate the speed at which prices climb. So long as interest rates remain relatively low and employment levels hold, this moderation might not lead to a collapse in prices. In other words, house-price growth could slow for a couple of years.

But there are a few areas in which the market could be vulnerable. The first would be if the economic recovery were not sustained. The soft-landing theory relies on the gradual boost to confidence of an improvement in international and thus domestic economic conditions. There are encouraging signals that such a recovery is under way, but any upset caused by factors such as a collapsing dollar would hit confidence and so affect the property market.

What is certain is that the combination of very low interest rates and strong growth is coming to an end. A delayed recovery might put off higher interest rates and there is even a chance that the collapsing dollar may trigger one more European rate cut, before the cycle turns upwards. Even if the initial increases later this year are moderate, 2004 is likely to be the year that homebuyers are reminded that interest rates can rise as well as fall. Longer-term fixed rates for borrowers are already edging upwards.

Any hit to confidence could undermine demand, and with housing supply having ratcheted up so quickly this could quickly be reflected in falling prices. Davy Stockbrokers estimates that the demand for housing will fall to about 45,000 new homes a year over the next few years. As this is well below the current rate of building, this suggests a falloff in housing supply.

Davy concludes that "further rapid increases in housing prices are most unlikely", adding: "The risk of a price correction has increased." It points out particularly that any relaxation of planning restrictions for housing around Dublin "should see price pressures reduced sharply".

The market is therefore delicately balanced, with some concern that price rises have not tailed off enough and that mortgage borrowing is continuing to accelerate. Even if prices in general continue to rise slowly, of course, some areas of the property market may suffer. Massive supply increases in the wider suburbs of Dublin, for example, could push prices down in some areas if demand eases at all.

The huge presence of investors is another key factor. Davy estimates that as many as 40 per cent of new homes were "not needed to meet new household formation". An exact breakdown is not available, but most of the remainder appear to have been bought as investment or holiday properties.

Property has been a one-way bet for investors for a decade, but the demand they create introduces further volatility into the market. Average rents are falling, and anecdotal evidence suggests many investors are finding it difficult to find tenants.

Apartment complexes with a large proportion of investment purchasers are therefore another area of the market that could be vulnerable to falling prices. Any shock to the economy would increase this risk; a sustained economic recovery would make it less significant.

Conclusions must be tentative. A combination of factors means that the period of rapidly increasing house prices is fast ending, however. The question now is whether a gentle easing back in housing inflation will do the trick. For this to happen will require a steady economic recovery and a good helping of luck.