# Fundamental values of Irish housing

When you ask the question “how much will prices drop” you get people plucking all sorts of figures off the top of their head with no justification “20%, 30%, 5% because of our rising population etc”.

If we look at prices fundamentally what should the price of housing be?

I look at it this way. Equities are often compared using their p/e ratio, the price to earnings ratio. You can express lots of other investments in the same way.

E.g. a bank account paying 5% interest has a P/E of 20 (every 100 euros earns â‚¬5).

A so called “risk free asset” such as a gilt would have a p/e of maybe 30 (c.â‚¬3 return on every 100)

A big bank like AIB has a P/E of around 13/14, to reflect the increased risk of holding such an asset. (for every 100 you invest, you expect to get 7.x back)

A fast growing Internet company would have a P/E possibly in the high single digits e.g. Google is 44 (for every 100 you invest, you expect to only get â‚¬2 in a return, but you are hoping for high growth rates)

The E in Irish property is Rent. P = Price. Rents are running at about 2/3% yield, meaning the P/E on Irish property is about equivalent to a dot com/high growth share, at about 40.

A P/E of 40 on property is unsustainable, as you can get 3 times the return by putting your money into an AIB share. So what would it take to return property to a P/E of say, 12 (equivalent to a large bluechip company with some growth prospects)

12 would mean an 8.3% yield, which is consistent with the yields investors were getting before the boom. This tells me that a P/E of 12 on property is in the right ballpark.

A property worth 500k with a yield of 3% (a P/E of 33), is generating about 15,000 in profit per annum, which again looks in the ballpark, if a little high even. To get that property back to a P/E if 12 would mean either the rent has to increase to 41,500 or the price would fall to â‚¬181000.

That calculation implies that Irish property is exactly ( ) 63.8% overvalued.

puts on opposite hat

Sure, you can prove anything with numbers, but in Ireland we like to feeeel the value of the property and how it emotes us.

and may I add, “No you shut up”

Takes off opposite hat

There is one fairly interesting counterpoint to this and that is a bank won’t lend you money to buy AIB shares, so maybe the fact that someone else it stumping up the money should mean the yields would be slightly different?

I’m not saying prices are not overvalued but I have heard this argument before and I’d be interested in the counter view?

It’s all about the relative risk though.

• Rising interest rates could increase the cost of having somebody else stump up the cash, leading to cashflow problems.
• Security provided on the investment mortgage (family home?) is at risk.
• Your personal credit history is at risk, potentially leading to ongoing financial problems for many years to come.
• In the UK or the US you could file for personal bankruptcy if you were to find yourself in negative equity and cash-poor, not an option here in Ireland.
• the asset is very illiquid, so there can be a serious problem with limiting losses.
• lack of diversification.

All of the above have been sidelined by the massive capital appreciation and sellers market of the last 10 years, but in a stagnant market they can come home to roost, never mind a falling market.

In fairness, as I became more interested in the property market over the last couple of years, I did initially wonder why a decent yield wasn’t discounted against the fact that you didn’t need to personally stump up the full purchase price. But I guess the conventional wisdon of the 8% yield figure is something that has evolved over time, good times and bad times.

Credit was never so widely available, BTL loans of 100% interest only would have been laughed at. I don’t believe we are in a new paradigm, I think this cycle of easy credit will come to an end.

A rising property market cures all ills but the figures I’ve seen show that property has actually underperformed inflation over long runs (50 years+). If you’re borrowed up to the hilt that is very bad news.

Who remembers that before the central banks opened the floodgates a single person had to beg to get 2.5 times their salary and needed 10% down. It wasn’t so long ago, I think it’ll happen again.

Bring it on…

I dislike price/earnings (yield) as a means of calculating fundamental house prices, because in a housing market the two are not independent of each other, as they are in a stock market.
In a rising housing market, speculators will buy up property for capital gain, often leaving it empty (1). This reduces the amount of rental accommodation available, driving up rents.
In a falling market, investors unable to sell their properties will make them available for rent, to help their cashflow (2). This will increase the amount of rental accommodation available, driving rents down.
This is unlike a stock market, where a company’s output is largely independent of fluctuations in its stock price.
Thus, calculating a price from rental earnings during a boom is likely to overestimate the fundamental price, as rents will be lower at the end of the boom/bust cycle.

I prefer general inflation as an indicator of fundamental/mean house prices. The longest term studies have shown that house prices rise in line with inflation (3, 4). So knowing house prices and inflation at the start of the boom, we can calculate how far they have deviated from the mean at any point in the boom, and thus how far they have to fall.

A third indicator of fundamental values is house prices as a factor of average industrial wages. According to an international study (5), in an affordable market, the average house price should be 3 times the average wage. Some investigation shows that in pre-bubble Ireland the average house price was 4 times the average wage (so houses weren’t particularly affordable even then). By calculating how far they have diverged from these pre-bubble norms, we can work out the fundamental housing value.

According to these indicators, house prices are overvalued by between 60-68% (inflation) or 55-73% (wages), depending on what part of the country you live in.

I’d agree with those as measures, which begs the question as to how the CB and OECD arrive at their figures for 15% (or so) overvaluation - what’s the metric? Blindjustice I’m sure could supply some clarity.

I’m inclined to think the bank have thrown in an element of “it’s different this time” in their calculations which reduces the overvaluation percentage. When I see those words used, I run for the exit.

Before anyone else mentions it, yes the above does not apply if there is a shortage of houses - that will of course drive up the figures. I don’t think anyone could realistically argue that we have a shortage of properties on the market?

Sure, theres no shortage of supply but many bears on this site are underestimating the demand thats still out there.
I believe the buyers are still out there, they just have less money to spend since the interest rates went up. Ive seen properties sell really fast recently, within a week of being put on the market, because they were priced less than similar properties nearby.

If sellers understood that we’re in a new interest rate environment and all cut their prices by 15%, the backlog of properties would be cleared, and demand and supply would be back in balance.

I agree to an extent bargainhunter but then I think you overstate the case, there is a natural demand sure, it’s waiting in the wings fair enough.

I don’t see supply and demand being back in balance for probably 10 years!

If there’s only one buyer and one seller out of four cuts his price by 15% to get the deal, that doesn’t mean that there are 3 other buyers waiting in the wings.

Besides which, if everyone cut their price by 15% simultaneously, the psychological effect on the market of falling prices would cause buyers to wait and see, further dampening demand. That’s why busts tend to overshoot on the way down.

I believe that that latent demand will quickly evaporate as potential buyers realise that prices have further to fall.
I don’t believe that properties have stopped selling because buyers can’t afford them anymore. In fact, house prices are slightly more affordable now than 6 months ago because of the recent dip. independent.ie/national-news … 86941.html
The reason they’ve stopped buying is because they can see there is no potential for further capital growth. Why buy an asset now when it will be cheaper next year? This is as true for FTBs as it is for investors.
I think the people you see buying now at discounted prices are those who are either ignorant of the crash, or who believe that -15% is the bottom. Everyone else will stay away until they can see that capital appreciation/stability has returned to the market. And that could be years away!

Exactly! We are not in danger of “talking” ourselves into a crash oh no, what the VI fear is that we will all “wait” ourselves into a crash Its a lose-lose scenario no matter what happens.

I don’t agree, there will always be people who buy for utility value and are happy enough taking the jump fully aware of the risks… Because let’s face it, we got the timing wrong for so many years, how on earth can anyone accurately predict the actual bottom.

Certainly, there will always be some buyers; Those either forced to buy or willing to take the risk to have the house they want. No market is ever going to completely cease trading. But I think that most/enough will be scared away by the falling prices, and that in a couple of years, the idea of buying a house will be as unpopular as it has been popular these last number of years.

Agreed.That’s the end game in every bubble.
We are seeing it already what with investment managers starting to advise their clients to diversify away from property.

Timing was right, just 9/11 came and screwed things up!

Bar another 9/11 where IR’s were cut super low to help economies, the timing can be right(ish) this time.

So I agree with you and you agree with me and we agree with each other???

Anyway, do people still buy property in Japan or what???

I don’t think the ECB will go down the same route again if there were another 9/11. It was a panic reaction from many central banks to a shock event - if it were to happen again it would need to be 10 times more devastating to send the same psychological tremors around the globe.