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Monday, 11 May 2009

Exposing The Lie Of The Land...

Take a long look at the chart below. Digest it. Maybe look again if you have to. This happened in the most sophisticated economy in the world.

This is what happened to the price of development land in Japan. Prices roared upwards and then collapsed, ending up below where they started at the beginning at the boom. This is likely to happen here; development land is likely to settle back to 1996 prices. We haven’t seen the half of it yet. When we hear some property lads talking about green shoots, this chart should be enough to tell them to snap out of it.

But we can’t seem to snap out of it. We are still caught in the trap. We seem to believe that the price of houses and land will miraculously rise again some time soon. This will not happen. It can’t and shouldn’t. In fact, houses prices are likely to fall another 50 per cent from here before we see anything like the bottom.

International comparisons bear out these forecasts. Until now, many Irish people have clung to the myth of what I call ‘Dunnes Stores economics’. You know it: it is the school that suggests ‘‘the difference is we’re Irish’’. Well, the bad news is that being Irish makes no difference at all. It offers no protection. What happened to the Japanese will happen here and, in terms of the recovery, the sooner the better.

I came home last week having been making a documentary since late February in the US, China, Iceland and Australia. In all these countries, property prices have fallen, but in no country did they ever get as high as they did in Ireland.

In the US, I went on a repossession bus tour, where houses were being sold at between 50 per cent and 30 per cent of their peak value. In Iceland, we saw failed banks sell off their portfolios at even bigger discounts. The original loans in hard currency will never be paid back. Last Wednesday, I was in Perth in Western Australia, where property prices are falling.

Even taking into account the fall in Irish property prices in the past few months, property in Perth is still twice as cheap as it is in Dublin - and Australia is not even in a recession yet.

The paper on the plane home, specifically the Irish Times’ property section, made for depressing reading. Not because prices had fallen, but because they hadn’t fallen half enough. We are still fooling ourselves. Irish property prices are still criminally high. Can people not understand that it is over?

Irish property, like Japanese property in the 1980s and 1990s, will take decades to recover - and will only do so after years of consecutive falls. How much more evidence do we need to conclude that the spin we were sold of the immutable triumvirate of banks, credit and property was a sick joke?

The question of how low property will go is not just a matter for people who are selling or buying, of how much equity we have or how much we owe. Given the establishment of the National Asset Management Agency (Nama),the price of property affects everyone, even those who never got involved.

This is why, according to the Japanese example, if Nama is going to buy property assets, it needs to buy them at a 70 per cent discount from their peak market value, to make sure that it is not bailing out banks. Anything less than a 70 per cent discount and the taxpayer will be subsidising bank shareholders. This is hardly fair.

So how low are prices likely to go? The best way to answer this crucial question is to start with the premise that the age of property speculation is over. There can be no more ‘hope value’. There can be no more belief in the notion that there will be a big capital gain in buying a property, any more than there will be capital gain in buying a sofa.

The value of the asset will have some relation to the yield the asset returns. In houses, the yield is the rent. In the US, a house was traditionally valued at some multiple of the rent it generated. Typically, the value of a house was calculated at 12 to 14 times its annual rent. This relationship has held in the US for over 100 years. There is no reason to believe that this shouldn’t be the way to value Irish houses.

This is a normal price/earning ratio that we would use in the stock markets to assess value. What the US valuation model is saying is that, over time, property should trade on a price/earnings (P/E) ratio of 14 times.

So, let’s see where Irish houses will end up. Take a typical house in a commuter town. On daft.ie there are hundreds of them. For example, in Newbridge, Co Kildare, you can buy a new three-bed house for €335,000.This is a steal, according to the ad. A bank will finance this for €9 95 per month.

According to the same website, the average rent for a three-bed in Newbridge is between €950 and €1,000 a month. This house, if it can be rented, will yield €11,400 a year. This implies that, applying the US valuation to the asset, the house should be valued at €159,600.However, in Ireland, we are expecting the house to sell at €335,000.

The Irish house, at a ‘bargain’ price of €335,000, is still more than 53 per cent overvalued. It will have to fall by half again to make the sums ad up.

The real fair value means that, in a world where house price speculation is over, Irish house prices will have to fall on average by 50 per cent from where they are today to be worth buying. Madly, even after a year of house price contraction, the P/E for the average Irish house stands at over 29 times - twice the historical average for property.

So, let’s snap out of it. Why can’t we just mark down prices to where they should get to, take the bankruptcies and move on? Why should we be any different in coming to terms with the new reality?

Maybe Dunnes Stores was right all along. Maybe that’s the reason. Maybe ‘‘the difference is we’re Irish’’.



Report by David McWilliams - Sunday Business Post

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