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.