Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

Notes on NAMA: Haircuts and house prices when I retire

The bill outlining how NAMA will work has just been published. I’m not a financial expert, so I leave it to those who understand these things far better to argue about the finer points of detail. I am happy, though, to make a contribution on the whole topic of “haircuts” and property values, namely what value NAMA will put on the ‘impaired assets’ that the Irish taxpayer will own, in what Ruari Quinn describes as the world’s largest real estate company.

NAMA’s mechanism allows for two channels to inform the prices NAMA will pay for the assets it comes to own: current market value and long-term ‘economic value’, as outlined by Karl Whelan on the Irish Economy blog. Key to all of this will be the yield, or ratio of house prices to rents, that NAMA chooses as its benchmark.

Current market value

On current market value, the market is muddy and I don’t think those involved in compiling the PTSB/ESRI index would argue that their measure is currently capturing in a timely fashion the full extent of falls in house prices.

As evidence, one need only look at the relative year-on-year changes in asking and closing prices. The PTSB index has been stuck at in or around -10% year-on-year since the start of 2008. By that measure, the fall in house prices has been slow and steady over the past 18 months. At the same time, falls in asking prices have accelerated sharply, from about -10% in Q3 2008 to almost -20% in year on year terms by Q2 2009.

The paradoxical result is that, by established measures, closing prices seem to have fallen less from the peak than asking prices. This is despite the widespread perception that asking prices are still above closing prices, i.e. if someone posts a ad for a property asking for €300,000, they’re likely to get a good deal less than that. So, even regardless of the future trend in house prices, those working in or for NAMA should not just use those stats they’re comfortable with, they need to have a broader look at the market to work out current value.

Longer term economic value

On longer term economic value, NAMA needs to be cold and calculating. While owner-occupiers are naturally sentimental to some extent about the value of the house, NAMA will be an investor on behalf of the Irish taxpayer. A lot of the properties NAMA is taking over will be unoccupied or even unfinished. As NAMA is an investor, this takes us back to yields. Which takes us back to rents. Which are falling, due to more properties available to let at the moment than ever.

The chart below shows recommended “haircuts” that NAMA should offer based on two sets of figures. The first, along the horizontal axis, is the fall in rents from their 2008 peak (they’ve already fallen 17% so hence the axis starts at 20%). The second is the yield, or ongoing return, the market gives on property, and is closely related to the house price-rent ratio. It’s also closely related to the cost of borrowing, and the graph below gives five different scenarios, from a very low yield of 4% to a significantly higher yield of 6%, closer to a yield, as the NAMA legislation says, “consistent with reasonable expectations having regard to the long-term historical average”.

How much should NAMA discount property prices?
How much should NAMA discount property prices?

The smallest “haircut” NAMA should offer, in the optimistic scenario that rents only fall 20% from the peak and a 4% yield satisfies investors, is 37%. This is significantly more than the 20% often discussed in public debate, although Brian Lenihan’s comments this morning suggest that NAMA is perhaps already thinking of the necessary 40%+ cuts. If rents were to fall by as much again as they’ve fallen in the last 15 months, i.e. a fall of about 33%, even just a 4% yield would mean a haircut of 47.5%. Working off a yield of 6%, on the other hand, would mean a discount from peak prices of 65%.

As the graph shows, the further rents fall, the closer the shave. If NAMA expects rents to halve, certainly a possibility given the trebling of properties available to let since 2007, restoring a 6% yield – last seen in Ireland in 1998 and briefly in early 2002 – would mean NAMA should offer just 26% of the peak price.

House prices when I retire

NAMA may also have one eye half-cocked to future returns and far-flung property prices. For that reason, I decided to have a look at house prices around the time I retire. Now, I had thought I’d be retiring in 2045, although I’m prepared to push that back to 2050 at this point, as I don’t think the “whole work for 40 years, retire for 20” model is really that sustainable any more. But I digress…

The chart below shows a possible trajectory for house prices between 2014 and 2050, assuming NAMA acts as a some sort of trough price-setter, a reasonable assumption given its size in the market. The black line shows peak prices in 2007. The other lines are for each of the yield scenarios and show growth at 3% per annum, a figure chosen with deference to both the ECB 2% price stability goal and a steady-state 1% real growth in house prices.

Where will house prices be in 2050?
Where will house prices be in 2050?

It is immediately clear that the yield that NAMA chooses has a significant effect on the future trajectory of house prices, as it determines the start-point of any renewed growth in house prices and thus the annual increase in house prices. When would we see 2007 prices again? That depends on the yield. In this scenario, a 4% yield, a very risky choice for NAMA, would see peak prices return in 2035. A much safer choice for NAMA, a 6% yield, would see peak prices return in 2049.

That of course is hugely dependent on the steady-state growth rate in property prices. Suppose growth were to average 2.5% instead, on the face of it not a large difference in growth rate. In that case, a 6% yield scenario would mean that house prices would still be 13% lower than 2007 peak prices in 2050, as I settle down, “grandchildren on my knee” as Paul McCartney would say, to retire.

  • Shane ,

    Ronan – good article. I have one quick question – what was the average yield when property was at its peak?

    • Ronan Lyons ,

      Hi Shane, thanks for the visit and the question. The boom period was associated with house prices rising a lot faster than rents, so yields continued their long fall from the 1990s (as lower interest rates in preparation for ECB kicked in) right through the 5-7% one might have expected them to stabilise at. The yield troughed in 2007 at just above 3% (3.05% was the expected yield nationwide mid-2007) before rising slightly up to mid-2008 – currently, with rents and house prices in a race to the bottom, the yield has stabilised again, at about 3.5%.

      • Brian ,

        Excellent website. A comment on the projections for house prices – whilst appropriate in analysing an investment does it not ignore the fact that residential housing isn’t (in the main) an investment vehicle? As the Irish home ownership levels are unlikely to fundamentally change (it’s part of what we are and all that) houses are homes not investments – therefore prices will be influenced by supply/demand issues and changes in incomes. As the world recession eases one would expect employment and income levels to improve – couple that with the expected erosion of our massive stock overhang and I would expect that prices will go back up quicker than you are anticipating.

        • Ronan Lyons ,

          Hi Brian,
          Thanks for the visit and the comment. You make a fair point, but it should be noted that Ireland’s sales and lettings markets are better integrated now than they were 20 years ago. (What I mean there is that if you think of a property type, there are now significant sales and lettings cohorts, be it a detached dwelling in Ballsbridge or a one-bedroom apartment in Cork city or a commuter belt 3-bed semi.) This level of integration means that yields will be every bit as important as investors will be trading with owner-occupiers, meaning that they will not be on separate price planes.
          I agree, though, that changes in the unemployment rate will be significant for the trends in house prices (in fact I posted a correlation between the two over the past 25 years on this site recently).
          One final point would be to note that pre-2000 growth in nominal house prices should be viewed through the lens of inflation. Real house prices don’t necessarily go up over time, they were just good hedges against inflation in the past. 3% annual growth in house prices over a 40-year period would be relatively high.


          • Brian ,

            On the calculation of the “haircut” are you allowing for the difference between the haircut now to be taken and the reduction in value in the properties? You are primarily looking at completed residential property above (in that you are using rental yields etc in your calcs) so presumably you have allowed for the fact that the LTV on the debt was initially set at (on average which is all we can look at across the market) c75%. So a 25% reduction in property prices would result in zero haircut being required (as the debt value would equal the property value). Then (presumably) you have also allowed for the writedowns already taken by the bank of c10%/15% – meaning that if property prices fall by up to 35% the additional haircut is still zero. So a 30% haircut now implies a fall in property values of over 55%.

            • karl deeter ,

              Hi Ronan,

              if you bought property (for instance) for €100m and had a mortgage of €70m and the market drops by 40% (new mrkt val: €60m) then a 20% haircut from €70 – it’s based on the loans not the valuations at time of purchase- then the price paid for the loan would be €56m.

              obviously not every property was bought at peak prices so using peak to trough isn’t exactly a fair demonstration either.

              I think people will be shocked when the pricing comes through, because (and I said it from the beginning) i suspect that the only way to resolve this is to overpay on some level otherwise banks won’t sell the loans.

              • Ronan Lyons ,

                Brian and Karl, you’re both right. I used the wrong concept of haircut, hopefully the true meaning (peak-to-trough) comes out clear enough from the blog post itself.
                Incidentally, does anyone know where one might find LTVs for developer loans? What’s a typical LTV, 70%?

                • Brian ,

                  I had a look at the AIB results (HY2009) presentation and on slide 15 they indicate that the original LTV on their “Land & Development loans” was 75%. After their own write down they are saying that the current loan o/s is c65% of the original values. So on that basis if we assume a 20% haircut from those levels you would be implying a fall in the value of the land of c48%. I personally think that the majority of media commentators are missing this point – a 20% haircut implies approx 50% fall in property values. They are reading “haircut” as being equivalent to the assumed fall in property values and are (correctly when operating off this false premise) concerned/angered that developers/banks are only being hit by a 20% reduction.

                  • Stephen D ,

                    See Alan Ahearne 4 a much much rosier scenario uhm is it another wa of arriving at a similar prediction: ‘…Between 1991 and 2004, real estate prices in Japan dropped 60 per cent. House prices in Tokyo plummeted 90 per cent. To put things in perspective, if house prices here were to follow a similar pattern, the average price for a house in Dublin in 2022 would be about €42,000!…’


                    Where does another metric nameli longterm ratio of average domestic properti price: average wage get us I wonder?

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