Housing Bubble Bursting

SkepticOne

Kipperhell wrote: »

I would like to point out nobody has even managed to come up with a counter simply example to prove how wrong it is.

Kipperhell, here's the calculations.

We start with your 1,000 rental income you used in your example. If yield is 4% then the property is valued at 300,000.

How is this investment financed?

Assume an 80% mortgage. This means a deposit of 60,000 and a principle of 240,000. At 5.5% (EBS buy to let LTV>75%) our payments are 1651 per month. If the rental income is 1000 then the investor is left with the shortfall of 651.

So for putting down 60,000 and paying 651 a month we end up with the property valued at 300,000 in today's money.

Alternatively,

Putting down 60,000 and saving 651 a month in an investment account returning 5% pa gives us 430,000 over the same 20 years.

And remember the 5% savings is a lot safer than the mortgage approach. We should really be looking at a much higher yielding but riskier investment to compare with the property investment which can have you bankrupted if you get it wrong.

niall2j

SkepticOne wrote: »

Kipperhell, here's the calculations.

We start with your 1,000 rental income you used in your example. If yield is 4% then the property is valued at 300,000.

How is this investment financed?

Assume an 80% mortgage. This means a deposit of 60,000 and a principle of 240,000. At 5.5% (EBS buy to let LTV>75%) our payments are 1651 per month. If the rental income is 1000 then the investor is left with the shortfall of 651.

So for putting down 60,000 and paying 651 a month we end up with the property valued at 300,000 in today's money.

Alternatively,

Putting down 60,000 and saving 651 a month in an investment account returning 5% pa gives us 430,000 over the same 20 years.

And remember the 5% savings is a lot safer than the mortgage approach. We should really be looking at a much higher yielding but riskier investment to compare with the property investment which can have you bankrupted if you get it wrong.

Sorry to dive in across the two of you here, but it's an interesting point.

Based on those calculations, in order to match that nominal €430k the €300k property would have to rise by 1.8 % per annum in nominal terms over 20 years. Some costs on both sides of the argument are ignored here but your assumptions are fair to both.

In the example above, the decision, at it's basest level, would come down to whether the person believes the property would appreciate by 1.8 % p.a. over the next 20 years before inflation. Even given today's housing climate, I'm not sure that's unrealistic.

SimpleSam06

niall2j wrote: »

In the example above, the decision, at it's basest level, would come down to whether the person believes the property would appreciate by 1.8 % p.a. over the next 20 years before inflation. Even given today's housing climate, I'm not sure that's unrealistic.

Also theres the fact that as you reduce your capital in the mortgage, your interest payment reduce, while the rent is bringing in income, and presumably increasing. You aren't just left with a property, you are left with a going concern, a business, which might be a damn good business, depending on the location.

Its a tricky one!

My feelings on it however are that with the oncoming changes in the economy and demographics, unless you can get a great location for renting, don't bother.

nesf

SkepticOne wrote: »

Assume an 80% mortgage. This means a deposit of 60,000 and a principle of 240,000. At 5.5% (EBS buy to let LTV>75%) our payments are 1651 per month. If the rental income is 1000 then the investor is left with the shortfall of 651.

So for putting down 60,000 and paying 651 a month we end up with the property valued at 300,000 in today's money.

Alternatively,

Putting down 60,000 and saving 651 a month in an investment account returning 5% pa gives us 430,000 over the same 20 years.

And remember the 5% savings is a lot safer than the mortgage approach. We should really be looking at a much higher yielding but riskier investment to compare with the property investment which can have you bankrupted if you get it wrong.

You're assuming no inflation in prices or rental rates. The investor might make a loss over the first 5-10 years and then be turning a largish nominal profit for the last 20 or so.

The problem for investors in the present market is that a) they'll make a loss to begin with and b) they can't exit without taking a loss (assuming house prices continue to fall).

There is a lot going on if you are looking at this over the lifetime of a mortgage.

SkepticOne

nesf wrote: »

You're assumi ng no inflation in prices or rental rates.

Yes, a number of factors both for and against property incvestors are left out. Speculation about house price movements one way or the other has been deliberately left out. What I've also left out is speculation about the future of interest rates, for example, is a 4% base rates rate realistic going forward. And so on.

Kipperhell

As I said rental yield does not need to be above interest rates. Property in not fundamentally bad or good it just needs to be observed correctly. It does however point out hat many current investors are not in a dire situation especially considering comparatively they way have combined outgoings on property less than a neighbour living beside them due to when they entered the market. Right now may not be the best time to go into the market but it doesn't mean every body is going run away from the market. If I inheritated a house I wouldn't sell it right now and take the rental income. It would make a lot of financial sense to invest money into it for tax reasons in fact.

SkepticOne

I think the next couple of years will be a great period of learning about risk. That's really the core of what happens when a bubble bursts. During the boom we become blind to downside risks and this blindness further inflates the bubble and the risk increases. The fact that people can't see risk in committing to servicing massive loans over long periods means to me that the bust is only just getting underway and the falls will be greater than previously expected.

nesf

SkepticOne wrote: »

Yes, a number of factors both for and against property incvestors are left out. Speculation about house price movements one way or the other has been deliberately left out. What I've also left out is speculation about the future of interest rates, for example, is a 4% base rates rate realistic going forward. And so on.

True, but leaving out rental rate inflation is a much bigger source of error than assuming a base 4% interest rate over 20 years in you example tbh. The issues for short term investors and long term investors are massively different. If I'm locking myself into an investment in property for 20 years the factors I need to take into account are massively different to someone looking to make some easy money in a short time frame. Most of the investors in the present market fall into the latter category though, I imagine.

Maxwell

Just to add what I have just been told.

2 housing developments in Nenagh, Co.Tipp have been "cancelled" due to there being "NO" interest in any of the houses in the first phase of a development in the town. This came from the developer in the past 2 days.

Jobs will be lost as there is no way the developer can continue building phases of houses as the houses already built can't be sold.

Gurgle

Maxwell wrote: »

2 housing developments in Nenagh, Co.Tipp have been "cancelled" due to there being "NO" interest in any of the houses in the first phase of a development in the town. This came from the developer in the past 2 days.

Jobs will be lost as there is no way the developer can continue building phases of houses as the houses already built can't be sold.

Houses are built, not manufactured.
Whats the difference?
The margin.

In manufacturing of a mature product, the margin between costs and price are 5% to 10%.

Have a look at the cost of an average new ~€300k house in a development:
Serviced site: ~€40k
Building materials: ~€60k
Labour: ~ €60k

Thats ~€160k to build each house.

If you have one batch that are slow to sell, you can either drop the price and wait or stop building.

Dropping the price would be a terrible decision. How much would you have to drop it to get 20 houses sold?
10%? - €30k per house on a small development of 20 houses would be €600k.
20%? - €1.2 million

What overheads does a developer have when building stops?
You can let most of your unskilled/semi-skilled labour go with a week's notice. Most of the skilled labour are on contract, so you have no commitments to them.
You're just left with a few salaried staff to pay, and the cost of your headquarters (a few hundred square feet of office space, if even that) while you're waiting it out.

On the scale of those margins, you can wait a couple of years to sell 20 houses rather than reduce the price.

MrVostro

And you could hire part of the labour back in a few months at a much cheaper rate and keep the units more or less the same and let them trickle out slowly.

ionapaul

Gurgle wrote: »

What overheads does a developer have when building stops?
You can let most of your unskilled/semi-skilled labour go with a week's notice. Most of the skilled labour are on contract, so you have no commitments to them.
You're just left with a few salaried staff to pay, and the cost of your headquarters (a few hundred square feet of office space, if even that) while you're waiting it out.

On the scale of those margins, you can wait a couple of years to sell 20 houses rather than reduce the price.

Surely the main overhead is the money they borrowed from the banks to build the houses in the 1st place! The banks have to be paid somehow...it must be better to slash the prices on new builds (we've already seen this starting) and get them sold rather than holding on to depreciating houses while having to repay the bank at the same time...

Gurgle

ionapaul wrote: »

Surely the main overhead is the money they borrowed from the banks to build the houses in the 1st place! The banks have to be paid somehow...

The interest on borrowed money is an overhead, the capital is not.
Even if they borrowed 100% of the cost to build each house, the annual interest will be a tiny amount compared to the loss if they reduce prices.

Tom123

Gurgle wrote: »

The interest on borrowed money is an overhead, the capital is not.
Even if they borrowed 100% of the cost to build each house, the annual interest will be a tiny amount compared to the loss if they reduce prices.

Whats to say that the banks will be willing to wait for them to be sold though?

SkepticOne

nesf wrote: »

True, but leaving out rental rate inflation is a much bigger source of error than assuming a base 4% interest rate over 20 years in you example tbh.

One percent higher interest rate roughly cancels out one percent higher inflation.

If I'm locking myself into an investment in property for 20 years the factors I need to take into account are massively different to someone looking to make some easy money in a short time frame.

As pointed out the big thing that people seem to not account for over a long period is risk particularly if it is a leveraged investment. Any attempt to justify current prices in terms of intrinsic value has to leave out risk completely. If you try to account for it you are left with a loss.

Most of the investors in the present market fall into the latter category though, I imagine.

I agree and the market will fall for this reason, but the lack of intrinsic value in the market will mean prices won't bounce back.

Kipperhell

SkepticOne wrote: »

I agree and the market will fall for this reason, but the lack of intrinsic value in the market will mean prices won't bounce back.

How do they lack "intrinsic" value? You can live in them! There are restrictions on the supply and location has value too.

You can say you think what ever but it is this over stretching that is ridiculous. Your going beyond opinion and stating things that just aren't true. Commute times go up the value of property can go up in one area and down in another. All house prices are local.

SkepticOne

Kipperhell wrote: »

How do they lack "intrinsic" value? You can live in them! There are restrictions on the supply and location has value too.

You can say you think what ever but it is this over stretching that is ridiculous. Your going beyond opinion and stating things that just aren't true. Commute times go up the value of property can go up in one area and down in another. All house prices are local.

I meant lacking relative to the to their price. Obviously you can live in them (well most of them ).

Cantab.

Kipperhell wrote: »

How do they lack "intrinsic" value? You can live in them! There are restrictions on the supply and location has value too.

Yeah, but an investor can only live in one house (his PPR). He requires people to live in his house to earn a dividend. Similarly, a company shareholder requires people to run the company he owns in order to get a dividend.

nesf

SkepticOne wrote: »

I agree and the market will fall for this reason, but the lack of intrinsic value in the market will mean prices won't bounce back.

I'm never comfortable when people talk about intrinsic value wrt the property market. It's location, location, location etc.

Kipperhell

Cantab. wrote: »

Yeah, but an investor can only live in one house (his PPR). He requires people to live in his house to earn a dividend. Similarly, a company shareholder requires people to run the company he owns in order to get a dividend.

So how does that make property have no value by its very nature? You are confusing how property can make money and whether it has ANY actual value.

I think this comes down to people not understanding the difference between fact and what their actual opinion is. I think I blame the media for this as news used to be about facts but it has turned into opinion. This has left some people without the ability to understand the difference.

Do-more

From today's Irish Times.

Housing slump 'could lead to zero growth'
House building could slump to the point where just 33,000 new homes will be completed in the Republic next year, a new industry survey says. Barry O'Halloran reports.

SimpleSam06

Kipperhell wrote: »

So how does that make property have no value by its very nature? You are confusing how property can make money and whether it has ANY actual value.

Value:n.
1. An amount, as of goods, services, or money, considered to be a fair and suitable equivalent for something else; a fair price or return.

Which is what SkepticOne said, lest anyone get confused about definitions. A lack of value is an incorrect (too high) amount of money being requested for a house.

On an unrelated note, has anyone been keeping a weather eye on Daftwatch? Properties advertised for sale have levelled out somewhat, and properties for rent have begun a massive spike upwards, just as predicted on this thread. How high will it go I wonder?

Edit: Actually looking at that, properties for sale in Dublin have in fact dropped significantly.

Kipperhell

SimpleSam06 wrote: »

Value:n.
1. An amount, as of goods, services, or money, considered to be a fair and suitable equivalent for something else; a fair price or return.

Which is what SkepticOne said, lest anyone get confused about definitions. A lack of value is an incorrect (too high) amount of money being requested for a house.

He said it had a lack of "intrinsic" value. Which means by it's very nature the property market has a lack of value. That is to say no matter what the price property is a bad idea. People should not confuse the current market with the nature of the property market.

http://www.thefreedictionary.com/intrinsic

in·trin·sic (n-trnzk, -sk)
adj.
1. Of or relating to the essential nature of a thing; inherent.
2. Anatomy Situated within or belonging solely to the organ or body part on which it acts. Used of certain nerves and muscles.

SkepticOne

Kipperhell wrote: »

He said it had a lack of "intrinsic" value. Which means by it's very nature the property market has a lack of value. That is to say no matter what the price property is a bad idea. People should not confuse the current market with the nature of the property market.

No, not what I'm saying. "Lack of" does not mean zero, it means insufficient and I mean value in terms of investment.

SimpleSam06

Kipperhell wrote: »

He said it had a lack of "intrinsic" value. Which means by it's very nature the property market has a lack of value. That is to say no matter what the price property is a bad idea. People should not confuse the current market with the nature of the property market.

Nobody is or was saying property has no value. It was very clear what he meant to all and sundry (the fundamentals, the value at the moment is not good value), so stop wasting time and cluttering the thread with grammatically dubious trolls, like a good man.

Kipperhell

SkepticOne wrote: »

No, not what I'm saying. "Lack of" does not mean zero, it means insufficient and I mean value in terms of investment.

Yes but intrinsic means by it's very nature. So you said by its very nature the property market has insufficient value regardless of time. You may feel you were talking about the current market but that is not what you said. I just pointed it out. So you were imply property is never a good investment which isn't true.

SkepticOne

Kipperhell wrote: »

Yes but intrinsic means by it's very nature. So you said by its very nature the property market has insufficient value regardless of time. You may feel you were talking about the current market but that is not what you said. I just pointed it out. So you were imply property is never a good investment which isn't true.

Sorry if you thought that is what I meant. I don't believe property is always a bad investment. I think it is overvalued at present based on fundamentals and that it will revert to fair value and possibly undershoot a bit. There are many who believe it will bounce back fairly quickly. I don't because of insufficient ("lack of") value at present. By value I don't mean market value but value based on future revenue streams to the owner. Hence intrinsic. Hope this is a little clearer.

Cantab.

Kipperhell wrote: »

So how does that make property have no value by its very nature? You are confusing how property can make money and whether it has ANY actual value.

I think this comes down to people not understanding the difference between fact and what their actual opinion is. I think I blame the media for this as news used to be about facts but it has turned into opinion. This has left some people without the ability to understand the difference.

No, you buy a property for x, you earn dividends y. You buy shares for p, you earn dividends q.

Someone made a point "but you can live in a house" -- my point is, that you can't live in a house you are renting out -- in this sense there is no "utility value" in rental property. But if you leave your investment property empty and use it every now and then (like those gentlemen with the "investment" flat in Rathmines), it's only a half investment property then isn't it? It's akin to being a shareholder in a company where the workers only work half days. Just like the price of shares can be wiped out in a short space of time, so can a property's value and its rental income.

SkepticOne

SimpleSam06 wrote: »

On an unrelated note, has anyone been keeping a weather eye on Daftwatch? Properties advertised for sale have levelled out somewhat, and properties for rent have begun a massive spike upwards, just as predicted on this thread. How high will it go I wonder?

Edit: Actually looking at that, properties for sale in Dublin have in fact dropped significantly.

It is an interesting development. Via Green Bear on the PropertyPin, according to this
http://www.sbpost.ie/post/pages/p/story.aspx-qqqt=THE+MARKET-qqqs=themarket-qqqid=28289-qqqx=1.asp developers, unable to sell their properties, are taking on debt to become buy-to-let landlords.

AIB has boosted its mortgage lending figures by allowing property developers with multiple unsold housing units to reclassify themselves as buy-to-let investors.
The bank told The Sunday Business Post that it was granting buy-to-let mortgages to property developers in cases where they could not sell completed houses at the prices they wanted. The developers were instead attempting to rent out the properties to generate cash while they waited for the market to rebound.
They would then hope to sell them for a higher price than is currently on offer.
The bank is understood to have lent to individual developers who had decided to rent out up to 50 properties in the absence of a sale.

indiewindy

Thats total desperationon the part of those builders, letting them out first will mean that anyone apart from a first time buyer will have to pay stamp duty when purchasing them, turning away a number of potential buyers