A Bad Idea, or ‘How to turn NAMA into a developer bail-out also’

Recently, there have been some suggestions coming from various interested parties that NAMA should not only take over management of the loans underpinning the €88bn in property deals, but also the properties themselves. Richard Curran, in last Sunday’s Business Post wrote about one example of this.

In Curran’s article, he describes the somewhat odd circumstances surrounding “legal-eagle-turned-property-developer” Noel Smyth making a suggestion about how NAMA should do its business, apparently at the behest of a senior Government Minister.

This, incidentally, isn’t an off-the-cuff remark from one developer. This is a response to a Minister’s request for suggestions in the form of a business proposal with background research from Indecon economic consultants. And the punchline isn’t good for taxpayers. Smyth suggests that NAMA should take several thousand apartments itself and rent them out.

This is an unqualified Bad Idea (that’s right, folks, capital B and capital I). Why? Well, it’s one thing for the taxpayer to say, “OK, we need a functioning financial system and we’re prepared to take all these property loans off the books of the banks – and possibly pay up to €20bn over the odds too – because our financial system means that much”. This may be craziness, but that’s what we’re committed to doing, so we are where we are.

However, it’s quite another to say: “Do you know what? I know we said we were going to take over the loans and pursue the debtors (i.e. the developers) to the ‘Gates of Hell’ to make sure they pay back. Now, though, instead we’re going to buy the properties off these developers, let them off about their business, and manage the properties ourselves.”

This is when a Bank Bailout becomes a Developer Bailout. What could they possibly be thinking, I hear you ask? Well, from what I can see, the line of reasoning is as follows: why should NAMA sell all these vacant properties, flooding the sales market and getting a lower price as a consequence, when they could be rented out instead? By renting them out on the market for, say 5-10 years, the properties could then be sold for a tidy profit at the end of the period. Surely, this is somewhere between harmless and genius, right?

Well, leaving aside who is doing what for a moment, I don’t think anyone would disagree with the principle that some sort of income should be coming from these properties to pay off the loans. After that, though, this is neither harmless nor genius. Here the top five things wrong with this idea, in no particular order:

1. Developers would be paid over the odds for the apartments. If banks are going to be paid above current market value for loans on these properties because it is assumed that the properties will increase in value over the next 10 years, presumably the developers would also benefit from a similar scheme. We would be doubling up on the gamble of Long-Term Economic Value.
2. It just reallocates the flooding problem. The approximately €8.4bn in Irish residential projects covered by NAMA translates into about 34,000 residential units, taking €250,000 as an average sales price. This is about half the total stock of properties for sale sitting on the market at the moment, at least measured by the listings on daft.ie. It translates into roughly a year’s demand for new properties, which is certainly a lot. Taking one third of these, say 10,000 units, and putting them on the lettings market creates a problem of an entirely different scale, however. The rental market typically has only 5,000 units available to let at any one time. The increase in that figure to almost 25,000 units over the past two years is the primary reason that rents have fallen so fast. Dumping a further 10,000 units on to the lettings market will drive rents even further down. Which means looking at the average rent you could achieve now (€900 or so per month) is looking at the wrong figures. But also…
3. Driving rents down drives house prices down. It often seems the case that people believe house prices to be independent of rents. They certainly don’t follow a one-to-one rule in the short term, but in the medium term, the relationship between the two – the yield – will be a key metric. By flooding the rental market, thus driving rents down, the yield on residential property will fall. (A quick reminder: NAMA is assuming that yields in Ireland high relative to their 6% historical average. Yields are actually about 3.3% on average for residential property.) Any investor looking to buy property from NAMA will look at the rent they could obtain and multiply up. A property giving a rent of €800 a month would probably get a buyer for €150,000, but not much higher.
4. It requires an optimistic recovery path. But it’s all going to be OK in the long-run, right? Ten years from now, we’ll look back at how cheap property was and laugh… right? Let’s see if this holds out. Rents peaked at €1,000 on average in early 2008. It now looks as though they’ll fall 33% from peak to trough. Assuming the average rent in 2010 is €667, when might rents reach 2008 levels again? At a very optimistic 5% growth every single year, 2019. At a still optimistic 4% average, it would take until 2021, while an average growth rate in rents of 3% – probably the most realistic of the three figures – would mean a return to 2008-esque rents of €1,000 in 2024. This is important precisely because of point (3) above: with rents like that in 2020, at a 6% yield, any normal investor would pay something in the region of €180,000 on average… not €280,000 or even €380,000 as some might think.
5. Ultimately, it’s all about who should be taking the risk. Bank shareholders invested in banks knowing that there was a nonzero probability the worth their shares would go to zero. Nonetheless, they are being bailed out and, for better or for worse, taxpayers will just have to accept that it is for the sake of a functioning financial system. Property developers are in the same boat, but they don’t have the same hold over the taxpayer because they don’t hold our savings. They took risks, knowing that there was a chance the whole thing would come crashing down. Why on earth should we as taxpayers take over that risk too?

For me, if we’re stuck with NAMA, we should try and keep NAMA as closely as possible to its core function: banker to the pre-2009 property sector. Let those who are experts – and prepared to take risk – deal with who rents what or who sells what, and let’s not double up our banking gamble with a developers’ gamble too.