Don't bet your house on end of price falls
Lenihan says we can buy in confidence now prices are realistic -- not according to some valuation models, writes Roisin Burke
Published 11/04/2010 | 05:00
THE speed of the housing market crash is slowing, the Daft.ie house price report has suggested. It may be losing pace -- but contrary to Brian Lenihan's upbeat take on it, few people think that the market has bottomed out yet.
"The residential property market will now be stabilised at a realistic level," Mr Lenihan said after the 47 per cent Nama discount was announced. "You can now buy in confidence that the price is realistic."
The wider view is that prices could get a whole lot more realistic before they completely floor.
Is there much worse to come? By some calculations house-price values could have far further to fall. One internationally recognised valuation model reveals potential overvaluation in the Irish market of up to 60 per cent -- even after the massive price drops that have already occurred.
Dublin asking prices have dropped by up to 35 per cent from the 2007 peak, according to Daft, and nationally the drop has been 25 per cent.
Economists and others think the total tumble will stop at 50 per cent down from peak, but could it be more than that?
Very little is selling right now and more is piling on to the market. If not much is selling, then how the heck do you gauge realistic long- term value?
To try to get a handle on what housing might be worth now, we've looked at the different ways of pinning a value on this moving target.
Open market value
(What someone's willing to pay)
Bubble-era prices were dictated by what the market would bear, sheer supply and demand push. Post-property price crash, open market valuation has proved to have zero connection with long-term worth.
(What's next door worth?)
Another stalwart method pre-bubble. Not a scientific calculation, it's an educated guestimate based on comparing similar types of houses in the same area to get a price.
You're putting a three-bed semi in south Dublin on the market, you look at what the one down the road went for. it had a brand-new kitchen and bathroom so you dock €20,000 to factor in that, and so on, to arrive at a price.
In the new reality this rule-of-thumb method is more problematic.
A new model for new market realitIES?
(Price-to-rental income ratio)
The Economist magazine applied a version of this method in its major survey of prices in markets including Ireland's towards the end of last year.
It's based on the price-to-earnings (p/e) ratios used by stock market analysts to value companies. Just as shares are judged as expensive when their price-to-equity ratio is above its long-run average, house prices could be judged over-valued when the price-to-rents ratio runs high.
By The Economist's reckoning, the Irish market was still overvalued by at least 30 per cent in December.
A house price-to-income ratio value calculation used by chartered surveyors is to take the rental income potential of the property for one year, multiplied by a 15-year investment life span: 12 x months rental income x 15 years = property value.
Adjust for taxes, potential vacancy periods, repairs and rent fluctuations. The model stands up as a way of estimating value beyond the buy-to-let market.
Our application of this model (see panel) shows some property prices are still overvalued by up to 60 per cent.
Closely related to the model above, rental-yield income calculation was arguably one of the biggest red flags that property has been over-valued here. It looks at the return on investment from the rental yield a property would give, based on its current price.
For a property on the market with asking price of €200,000 and a rental income of €600 per month: (€600 x 12 gives €7,200 a year), this represents a yield of 3.6 per cent.
Though rent yields plummeted to unprecedented levels in the boom, buyers didn't care. Property prices were soaring ever higher and investors were confident of scoring big rewards from capital appreciation in the long run, which was madness, as any economist will tell you. And so it turned out to be.
"Rental yields across the economy are up but they're still well short of where you'd like to see it, at 5.5 to 6 per cent," said Davy economist Rossa White. They have risen from 3 per cent to around 4 per cent.
White was applying this approach in a report when he saw a problem in the market at the height of the boom. "Something does not feel right," he observed in a report in March 2006, where he noted that some Dublin house prices were heading for 100 times the rent earned.
House price affordability indices
Several respected indices gauge property values in terms of national household income.
The Demographia International Housing Affordability Survey covers 272 markets including the Irish one. House price is divided by gross annual median household income. Property prices are rated on a scale from 'affordable' to 'severely unaffordable'.
Its January study calculated that Ireland's market was still 'severely unaffordable'.
The EBS/DKM Housing Affordability Index measures the proportion of after-tax income a first-time buyer couple (FTBs) on an average income need to meet first-year mortgage repayments.
By its reckoning, affordability value is historically good for FTBs -- if they could actually get finance for a mortgage, that is.
The average working couple paid around 17 per cent of their net income to service a mortgage on the average house price in Q4, 1985, according to this index; while in Q1 1995 it was around 15 per cent. It's 13 per cent of income today, down from a high of 26 per cent at the peak in December 2006.
Used for property development and redevelopment purposes, it calculates whether a profit can be achieved on a development project.
The value of completed project, less total development costs, gives value of the property in its present condition.
A rough example: if the estimated sales price for a newly built property is €250,000 and the building costs amount to €150,000, the residual value of the site would be €100,000.
Other factors to be added to the mix included potential price appreciation or depreciation, taxes, interest and developer's profit margin.
If applied to several famous major developments built at the tail-end of the boom, this model showed certain projects were on seriously shaky ground from the very outset.
The cost approach
Based on estimating the replacement value of a property, value is calculated by adding the market price (compared to similar properties) of the land to the reconstruction cost of the building, less depreciation.
For example: €100,000 (land value) + €500,000 (replacement cost of building) - €75,000 (depreciation) = €525,000.
The obvious flaw is that the calculation takes you back to market comparison to get a market price, and it ignores the income-generating potential of the property.