House price need to fall by 50%

Idbatterim

how is it that location has almost nothing to do with the rent here as has been mentioned, how can a double bedroom cost €500 whether your living in Dundrum, Ranelagh etc as Lucan or Tallaght!

MG

Money Shot wrote: »

I assume there are a few typos in there, three to be exact, and you mean 1996 for a lot of those figures and not 06 as the unemployment rate and av house price are just way off ???

Yes as noted on the previous page

Blackjack

MG wrote: »

Yes as noted on the previous page

Do you have the corrected figures to hand?

MG

Blackjack wrote: »

Do you have the corrected figures to hand?

To the best of my knowledge the figures are correct - only the years were wrong. I suppose I'm in denial that 1996 is 13 years ago :eek: Below is a correction:

Unemployment: Aug 96: 11.4% Aug 09: 12.4%

Av House Prices: Aug 96: 89k Jul 09: 239k

CPI: 1996: 6455 2008: 9702 (change 50%)

Aug 96 House price adjusted to 2008 CPI 133k (44% lower)

Stats from Status Ireland
(2009 CPI was not available from Status Ireland, hence the use of the 2008 CPI in the last sentance - I was doing it quickly. The CPI fell 5.9% in the year to Aug 09 so the 44% is more likely to be around 41% when updated.)

ZYX

MG wrote: »

Actually, what do you think the average yield should be?

Irish shares average a yield of about 2.5% or so over last 20 years. It is hard to see why property should be much above that. A return of 7% a year (ie rental income and capital gain) would also seem a good return from what is essentially a low risk investment. Ie unlike shares the chances of a significant loss are very small.

7% from rent and capital growth combined would mean property prices about 20 times rent. This refers to average levels. I am not talking about the amount I would like to earn from property, more a level that would be sustainable. Smarter investors, who bought well and ran their businesses well would of course earn much more. Joe Soap who just buys any property would expect to do worse.

The problem with saying 14 times rent is (as you agree) that it is unsustainable. At that level investors would rush into the market and renters would leave the market to buy. So the very fact that prices were 14 times rent would mean prices couldn't be 14 times rent.

MG

ZYX wrote: »

Irish shares average a yield of about 2.5% or so over last 20 years. It is hard to see why property should be much above that. A return of 7% a year (ie rental income and capital gain) would also seem a good return from what is essentially a low risk investment. Ie unlike shares the chances of a significant loss are very small.

7% from rent and capital growth combined would mean property prices about 20 times rent. This refers to average levels. I am not talking about the amount I would like to earn from property, more a level that would be sustainable. Smarter investors, who bought well and ran their businesses well would of course earn much more. Joe Soap who just buys any property would expect to do worse.

The problem with saying 14 times rent is (as you agree) that it is unsustainable. At that level investors would rush into the market and renters would leave the market to buy. So the very fact that prices were 14 times rent would mean prices couldn't be 14 times rent.

For the following let’s assume 2.5% average inflation (Figures from Status Ireland imply this since 1988 if you deduct 5-6% from the 08 CPI to allow for 2009 deflation)………. That would imply, under my methodology and McWilliams figures, a 4.5% gross return on above inflation (7%-2.5%). Taking off 1% as a net to gross, this bring me to approx 3.5%, perhaps a tad high, but given the ballpark nature of these numbers, is not too far from the 2.5%. Intuitively this makes sense as you would not expect different asset class returns to vary significantly.

Now under your assumptions that you would take the 2.5% inflation as a given return. Therefore to match the 2.5% share yield you could live with a yield of 0%. Again, I add 1% back as a net to gross brings me to 1% positive yield. Adding a further 1% to match my return above (2% above inflation gross) and you would expect a 2% yield or multiplier of 50.

As an example, that would mean that a house or apartment with a rent of 1000 Euro per month would be worth 600,000. Even at the height of the boom I never saw those levels.

ZYX

MG wrote: »

For the following let’s assume 2.5% average inflation (Figures from Status Ireland imply this since 1988 if you deduct 5-6% from the 08 CPI to allow for 2009 deflation)………. That would imply, under my methodology and McWilliams figures, a 4.5% gross return on above inflation (7%-2.5%). Taking off 1% as a net to gross, this bring me to approx 3.5%, perhaps a tad high, but given the ballpark nature of these numbers, is not too far from the 2.5%. Intuitively this makes sense as you would not expect different asset class returns to vary significantly



Now under your assumptions that you would take the 2.5% inflation as a given return. Therefore to match the 2.5% share yield you could live with a yield of 0%. Again, I add 1% back as a net to gross brings me to 1% positive yield. Adding a further 1% to match my return above (2% above inflation gross) and you would expect a 2% yield or multiplier of 50. .

MG, shares have a dividend and capital growth. To compare like with like you have to compare shares (dividend and capital) with property (rent less expenses and capital growth). Therefore to match shares I could not live with a yield of 0%. To match the share yield of 2.5% I would need a rental yield of 2.5%.

MG wrote: »

As an example, that would mean that a house or apartment with a rent of 1000 Euro per month would be worth 600,000. Even at the height of the boom I never saw those levels.

I think you are trying to confuse yourself and everyone else here. As I said
"7% from rent and capital growth combined would mean property prices about 20 times rent"

That means an apartment with a rent of 1000 Euro per month would be worth 240,000. (not the 600,000 you are saying)

So following this example someone investing €240,000 in property should on average get a rent of 12,000 per year giving about €8000 after expenses a year. Someone else investing the €240,000 in shares would expect €6,000 a year. The reason I think it is fair to earn 33% more from property is that the potential capital gains are not as high with property. That being said potential losses are also much lower with property.

ronbyrne2005

You need to look at the PE ratio of iseq and not dividend yield. Dividend yield is just a cash redistribution and not earnings. Property is also usually financed and financing costs makes a higher yield(than financing costs) neceassary

ZYX

ronbyrne2005 wrote: »

You need to look at the PE ratio of iseq and not dividend yield. Dividend yield is just a cash redistribution and not earnings. Property is also usually financed and financing costs makes a higher yield(than financing costs) neceassary

I take your point on the fact that dividend is not earnings but, with business you have to reinvest substantially more than you do with property.

The fact that more people borrow money to invest in property than shares doesn't really come into it. If shares had the same return and safety as David McWilliams is suggesting property should have then banks would be very willing to lend money to buy shares also.

I still come back to the same point again and again. If property prices were 14 times rent then financially it would make more sense for people to buy than rent. That means huge numbers would stop renting and buy. This pushes up prices and push down rents. With a potential rent income of 7% many more people would invest in property, thus again pushing prices up and rents down. Therefore property prices would no longer be 14 times rent. Again, the fact that prices are 14 times rent means prices could not be 14 times rent.

Can anyone explain how prices can be 14 times rent.

Blackjack

MG wrote: »

To the best of my knowledge the figures are correct - only the years were wrong. I suppose I'm in denial that 1996 is 13 years ago :eek: Below is a correction:

No need for the Paranoia - many posters highlighted the error - one indicated there were 3.

Thought you may appreciate the opportunity to put up the corrected information.

Amhran Nua

ZYX wrote: »

I still come back to the same point again and again. If property prices were 14 times rent then financially it would make more sense for people to buy than rent. That means huge numbers would stop renting and buy. This pushes up prices and push down rents. With a potential rent income of 7% many more people would invest in property, thus again pushing prices up and rents down. Therefore property prices would no longer be 14 times rent. Again, the fact that prices are 14 times rent means prices could not be 14 times rent.

Can anyone explain how prices can be 14 times rent.

The Netherlands has 6.63% rental returns, New Zealand over 7%. What caused the massive amounts of property speculation in the boom was very lax lending controls from the banks. Its unlikely that will be repeated for the next couple of decades at a minimum, which not only puts a crimp on BTL purchases but house purchases in general - also many people who rent have no other choice, students, migrants, and so on. In any case buy to let investors are buying to let, increasing the size of the rental market, thus driving rental prices down.

MG

ZYX wrote: »

I take your point on the fact that dividend is not earnings but, with business you have to reinvest substantially more than you do with property.

The fact that more people borrow money to invest in property than shares doesn't really come into it. If shares had the same return and safety as David McWilliams is suggesting property should have then banks would be very willing to lend money to buy shares also.

I still come back to the same point again and again. If property prices were 14 times rent then financially it would make more sense for people to buy than rent. That means huge numbers would stop renting and buy. This pushes up prices and push down rents. With a potential rent income of 7% many more people would invest in property, thus again pushing prices up and rents down. Therefore property prices would no longer be 14 times rent. Again, the fact that prices are 14 times rent means prices could not be 14 times rent.

Can anyone explain how prices can be 14 times rent.

Again you are confusing return and yield. McWilliams is explicitly using a PE ratio – effectively an inversion of yield and a multiplier of rent, not of yield plus capital gain. This makes sense from an investor viewpoint as gains are not guaranteed. Any investment market will look at the yield as an (almost) guaranteed return and the capital gain as a bonus but also as an indicator of potential capital gains.

Your example of a 1000 rental being worth 240,000 is within reason correct because you assume a rent of 12,000 and multiplier of 20 on the rent. However, this is based on your yield not on cap growth. The valuation of 600k comes from your assumption that capital gain will cover inflation and the rental yield need only be 2 or 3%., otherwise your exceptional returns would be squeezed out of the market by entrants. Your PE multiplier from these yields would therefore be between 33 and 50.

When you say "7% from rent and capital growth combined would mean property prices about 20 times rent" you either mean that yield is 5% and cap growth is 2% or you are approximating 20 as a multiplier for 7% ( it’s closer to 14% but as a rule of thumb it’s fine) and the cap gain is implicitly 0%. Either way, we need to talk about yield and not mix in Cap gains to PE ratios.

For some more reading on the PE ratio (or yield) valuation, here are some links


http://www.forbes.com/forbes/2006/0605/142sidebara.html
http://www.globalpropertyguide.com/real-estate-school/How-to-avoid-buying-into-a-bubble (this one explains your question on entry and exits impacting the yield cycle and how the approx 7% is an average around which the prperty cycle revolves)

Another supporter of this yield method is Morgan Kelly, except that he claims a equilibrium of 8%
http://www.irisheconomy.ie/Crisis/KellyCrisis.pdf


You might also like to see this link which shows the PE ratio at 13 for Dublin in 1996
http://www.davydirect.ie/other/pubarticles/econcr20060329.pdf