This time last year, Minister for Finance Brian Lenihan announced, with the unveiling of NAMA, that all that was required for it to break even was for property prices to rise by 10% in 10 years. At the time, there were some – for example in the property industry – who thought this was “an easy ask”. And on the face of it, it sounds like an easy ask.
But there was a catch. It wasn’t that property prices would only have to rebound by 10% from wherever they bottom out. It was that property prices would have to be, by 2020, 10% above November 2009 prices. (November 2009 was subsequently set, for reasons best known to NAMA, as the final cut-off date, after which it would not be paying any attention to property prices.)
That is a very different proposition. It means that with each passing month of falling property prices since last November, it becomes more and more difficult for NAMA to achieve this “10% in 10 years”. Take residential property. Say asking prices peaked in early 2007 at an average of €350,000 across the country. By November 2009, the three main sources in the country – Dept of the Environment, PTSB and daft.ie – all showed an average fall of about 30% from the peak. This would mean that by NAMA’s cutoff date, it saw the average property as worth €245,000 and therefore that property’s long-term economic value as 10% above: €270,000.
What has happened since then? As we all know, property prices have continued to fall and, in all likelihood, will fall by about 15% between NAMA’s cutoff of last November and the final quarter of this year. This means that from a peak of €350,000, the average property value by late 2010 will be about €210,000. More important for NAMA than the comparison with the peak is the comparison with its break-even value: €210,000 is €60,000 below the break-even amount NAMA has set itself. So, instead of having 11 years to rise by 10%, we now have only 10 years to rise 30%. That’s an average annual rise required of 2.6%, and not the “easy ask” of 0.9%. Already, things are looking bad.
Unfortunately, simple mathematics means that this can get much worse. Suppose property prices fall by about 10% on average during 2011 (and there are surely few who would argue that the dynamics of supply, demand and interest rates will bring a significantly more optimistic outcome). The average home would be worth about €185,000 by then. We would now require a boom in property values of 45%, or 4% a year for nine years, for NAMA to break even.
Of course, all this is very easy with hindsight. How was NAMA to know that the long-term economic value was actually south of 2009 values and not north? Unfortunately for the taxpayer, any thorough analysis of residential property would have shown that this was the case. They wouldn’t have even needed to have paid any consultants. Any economist with access to the (free) Q3 2009 daft.ie rental report would have seen that the average yield for residential property across the country was 3.4%. NAMA itself set a target yield of 6%.
Suppose NAMA went a little bit easier on residential property and set an average yield of 5%, as not all purchasers of residential property, particularly in the family homes segment, are always watching the annual rental income. Then, it would have concluded that, if average prices were €245,000 in late 2009 when there was a 3.4% yield, then the long-term economic value of residential property was 32% below 2009 values, not 10% above. Again, this is not 20-20 hindsight, this is using the information available at the time. Many people, myself included and on more than one occasion, tried to make NAMA aware of this at the time.
The figures above are shown in the graph below. The blue line is what has actually happened prices. The red line is the NAMA long-term economic value, while the green line is long-term economic value according to the type of yield analysis which NAMA said it was using but doesn’t actually seem to have used. Figures for 2012 are also included, based on a scenario of a “final fall” that year of 10% (year-on-year), which would bring house prices back into line with a 5% yield.
I know that average property prices can be a bit abstract, so the light orange bars, which use the scale on the right-hand side, show the annual increase in property prices needed for NAMA to break even by 2020. One year on, 1% a year (the “10% in 10 years”) has already become 2.6% a year (or “30% in 10 years”). If house prices reach their true long-term economic value, NAMA may need a recovery of 6% a year to 2020 (or “60% in 8 years”) to break even. I wouldn’t want to bet on that.
PS. It should be pointed out that NAMA has not had things its own way on the calculation of long-term economic value. The European Commission has ruled, sensibly, that a euro in 2020 is not worth the same as a euro now. Through this stance on discounting, and through forcing NAMA to price better the effort spent taking over the bank loans, it has effectively wiped out the money that NAMA would have paid for its supposed long-term economic value upswing. That doesn’t, unfortunately, protect us from the downswing, though.