Over the past few months, a number of people have asked me whether I think it’s a good time to buy their first home, sell their investment property, etc. Their worry is two-fold: on the one hand, they don’t want to try to catch a falling knife and buy a property at 25% below peak when, say, it turns out the market falls a further 15% from the peak. On the other hand, they don’t want to be sitting paying someone else’s mortgage when there’s perfectly good value out there on the market.
Their mistake is obviously asking an economist: economists are not only not qualified to give financial advice but in fact are almost perfectly qualified to give equivocal advice! That said, economists can bring perhaps a dose of the analytical to what is generally quite a gut-driven decision. So what kind of analysis would an economist use right now?
Why a potential owner-occupier should care about rents
I’ve mentioned yields quite a bit in relation to NAMA and in my opinion the single most important metric one can look at, in relation to the health of a property market, is its yield. A yield is nothing more than the rent expressed as a proportion of the price of the house. Why should that be important for someone looking to buy-to-live, not buy-to-invest? The main reason is that the yield is an incredibly useful statistic about the health of a property market. Very low yields suggest either rents are unhealthily low or – much more likely – house prices are unhealthily high. High yields say something about the attractiveness of a particular segment of the market.
In that way, the yield can be thought of as equivalent to the interest rate you get on a savings account. A risk-free savings account might get you 2%. Money you’ve put aside into investments in stocks and shares might get you 10% a year on average but also contains an element of risk. Your investment in your house is somewhere in between: a less risky asset than shares but certainly riskier than a savings account. Therefore, the yield you should expect in a healthy property market is probably between 5% and 6% on average.
What do current yields on property reveal?
The problem with Irish property between 2001 and 2007 was that house price rose rapidly while rents were – more or less over the whole period – static. Not surprisingly, the yield on property collapsed from 6% or more to about 3%. The problem since 2007 (from a yield perspective) is that while house prices have fallen back, so have rents. The net effect has been to leave yields more or less exactly as they were at the height of the boom.
The graph below shows the yield from 2007 to 2009 for four different types of property, each of which is a viable family home (i.e. suitable for a generation or so, depending on the size of your family):
- A two-up two-down terraced house in Stoneybatter/Phibsboro
- A three-bedroom terraced house in Crumlin
- A four-bed semi-d in Castleknock
- A four-bed detached house in Dublin 6 (Rathmines/Rathgar/Ranelagh area)
- A five-bedroom detached house in Blackrock.
A sixth line is also included. It’s 6.3%, which is the percentage of your house price you would pay every year, if you had a 90% mortgage over 25 years, where the average rate of interest is 5% (not an excessively high medium-term average). The gap between the line at the top and the other lines is the percentage of each house price you would save each year, by renting not buying.
First things first: the maths behind taking the plunge now compared to 2007 don’t look that much more convincing. Nonetheless, no-one would deny that whatever about the relative level of house prices (compared to rents), the absolute level is a lot more attractive now than three years ago. The 2-bed in Stoneybatter is over 40% cheaper, the 3-bed in Crumlin 12 is over 35% cheaper, while the larger family homes are about 25% cheaper, in terms of asking prices. A second argument is that it certainly may be a lot cheaper to rent, but at the end of the 25 years, you don’t own the house – whereas you do if you pay the premium and take out a mortgage.
What would a 25-year cashflow look like?
However, just how important is it to own your home in this day and age? For example, how many people would be happier to pay €1,700 a month to live in a five-bedroom detached house in Blackrock, instead of €7,000 for the same privilege, and squirrel away the €5,000 savings a month – €60,000 over one year – into a fully diversified savings and investment portfolio?
Even taking account of (relatively) fixed mortgage costs, compared to rents which will probably drift up 2-3% a year with inflation over a 25-year time horizon, the savings from renting not buying based on current prices are substantial: from €100,000 in the case of the Crumlin home to €1.3m in the case of the Blackrock home. Is that enough to compensate for not owning your home?
Let’s take the middle house of the five – the four-bedroom semi-detached house in Castleknock. Currently, it rents for €1,635 a month, whereas a mortgage based on current asking prices would be €3,665. In 25 years, if rates stayed at 5%, that mortgage repayment would still be €3,665 whereas say 2% inflation in rents (on average) would mean you’d be paying €2,630 in rents by the end of the period. Taking that sliding scale of monthly savings – from €2,000 at the start gradually down to €1,000 at the end – the total savings add up to €470,000, oddly enough close enough the current value of the home.
Of course, those savings aren’t lying idle – the first month’s savings will have had 25 years to increase in value, the second month’s savings one month less, etc. An investment strategy spread across shares, bonds and deposit accounts that averages 5% a year would have turned into €1m by the end of the period. A slightly less successful portfolio – returning an average of 4% a year rather than 5% – would be worth €850,000 in 25 years time. Higher returns (e.g. 6%), naturally, mean your nest-egg is worth much more (6% turns into €1.2m).
And what of the house itself? What will it be worth in 25 years time? Well, nobody knows of course. The least unlikely guess is that – just as house prices did from when the Government started measuring them until the mid-1990s – house prices will match inflation. An average of 2.5% inflation would mean the home is worth €925,000 in 25 years time – right between the 4% and 5% return portfolios presented above.
How does one make a judgement call? After that, it really comes down to a couple’s preferences. How much is knowing you own the home worth to you? How much do you value freedom from property taxes or freedom to move at short notice if employment circumstances change? How much do you value having diversified savings with as much liquidity as your circumstances dictate?
All in all, given the variety of reasons for renting not buying, perhaps we will see something a swing towards long-term renting in Ireland. Ultimately, very few people lose out as someone still ultimately own the property, hence that part of the Irish economy that depends on home ownership needn’t be too afraid.
A nation once again?
What’s the point of all this? Well, the reason that property has been such a popular investment in Ireland since independence is that it has been one of the best bets against inflation in the country. Only in the last fifteen years did it actually create wealth, as opposed to protect it. Once it did, it dominated Irish investments so much that Bank of Ireland estimated in 2006 that three quarters of all Irish wealth was in property.
Looking ahead to the next twenty-five years, though, it would be unrealistic to expect property to do anything more than protect against inflation again. If people expect this, and act accordingly, this frees up Irish money to save and invest in all manner of ways, including in Irish firms. Becoming a nation of renters once again might in fact be a key part of our future economic success.