When financial booms are followed by busts, there are usually distinct developments.
The other day, a stockbroker told me that, in the last month, it is as if ‘‘someone has pushed the accelerator button on the downturn’’. He was trying to sum up the feeling in the financial community as the economic data – which the ‘‘economic fundamentalists’’ who cheerleaded the boom were telling us was robust – turned out to be marshmallow soft.
Across the board, from tax revenue to unemployment and company insolvencies, the evidence of an accelerated slump is everywhere. Bank lending has dried up and house prices are in freefall, as confirmed by figures last Friday showing a sharp 1.1 per cent monthly drop in April.
There are no buyers. This negativity has been accompanied by the rumour mill of imminent bankruptcies. The same lad was at the Heineken Cup final in Cardiff last weekend and told me that the conversations among the attendant brokers and bankers centred on speculation about who was next.
The gossip, innuendo and tittle-tattle about which ‘big player’ is about to go under is only human nature. It is the mirror image of what was happening in the boom, when the gossip centred on who was making what, how ‘mega-deals’ were being put together and how such and such was ‘worth’ this or that amount.
Put simply, mass greed has been replaced by mass fear. Everyone is terrified of the financial equivalent of the KGB knocking on their door in the middle of the night. Meeting your bank, which only last year was an exercise in ego-massage and financial back-slapping, is now about as enticing as a chat with Josef Stalin.
Given the rapid change in sentiment, it is probably worth looking at other financial rollercoasters to assess what we are likely to face for the next few years. Looking at a number of experiences in other countries, we find financial booms that are followed by busts always lead to three distinct developments.
The first is financial scandals, where sharp practice in the boom gets exposed. Whether it is a couple’s life savings expropriated by some snake oil salesman or the high-level malfeasance of Enron, the details are usually the same. JP Morgan himself described the herd mania with the brilliant observation that ‘‘nothing undermines your financial judgment like your neighbour getting rich’’.
Typically, the blindness of the frenzy leads people to believe almost anything, so long as it promises to make them rich. Therefore we can expect a deluge of financial scandals to be exposed in Ireland over the coming years. If the people you gave your money to over the past few years are now refusing to return your calls, get on to your solicitor.
The only problem is that it is quite likely that your solicitor got you into the deal in the first place. Therefore, expect a number of high-profile – as well as numerous low-profile – cases of financial skulduggery, where cash has gone missing, investments have gone pear-shaped and promises have been broken. This is guaranteed.
As well as affecting the individuals involved, theses episodes will further undermine the credibility and integrity of the financial system.
The second development is that house and land prices will fall way below where they should. Asset prices have a tendency to both overshoot and undershoot. In good times, prices go way out of whack with any economic rationale, because the herd makes the fatal mistake of thinking that this time it’s different. People just get carried away on the promise of quick riches.
This occurred in Ireland in the past seven years, when house prices reached silly levels. Similarly, now that prices are falling, they will drop way below the level that is justified by economic logic or what is termed fair value. We have a long way to go.
A simple way of calculating the value of a house is to examine rent. The value of a house as an investment should be some multiple of the annual profit or rent you can generate from that asset. In the US, for example, the long-term value of the house has been 12 to 14 times rent. So if the rent were $10,000 per year, the house would be worth between $120,000 and $140,000.
At the peak of the housing boom, this multiple had risen to 22 times in certain expensive areas, so the house generating $10,000 rent was selling for $220,000. Let’s call this valuation method the rental value of a house, or RVH for short.
Granted, the Irish RVH could be higher than the American for historical reasons, so let’s call it 18 times – although this is more to make us feel better about our financial situation than any hard analysis.
To get a handle on how far Irish house price might fall, I asked the very helpful people at daft.ie to assemble a similar valuation for Ireland, taking in Dublin, the major cities and the countryside where thousands of people have bought holiday homes – many now trying to sell them.
The table gives the price of a house, the rent it is fetching at the moment and the multiple of that rent to the price of the house. So what is the Irish RVH telling us?
As you can see, even today after a 25 per cent fall in house prices, Irish property is madly overvalued and is likely to fall dramatically over the next few years.
For example, your average three-bedroom house in Donegal is trading on an RVH of 48 times. This implies that even if this property fell by 50 per cent from here, you’d still be better off renting. A three-bedroom house in Kildare trading at an RVH of 23 times is a much safer bet, albeit still significantly overvalued. Clearly houses in Connemara and west Cork make no sense at all.
As for Dublin, large houses are the most overvalued and, while apartment prices have fallen dramatically, the overall picture is that prices would have to fall by at least another 40 per cent to be fair value.
The problem in downturns is that prices undershoot fair value and will have to become very cheap before people realise there is a bargain and begin to snap up properties. Taking the experience of other countries and the RVH index into account, we are in for major downward movements in house prices for some time.
As a result, the third observed development of boom-bust cycle is ongoing banking problems, where the banks begin the downturn by hiding bad debts and only eventually confess – when they have to. This takes time and explains why Japan only had its first real banking crisis six years after the property market began to turn down.
The lessons from the rest of the world and from our own RVH is that, without a massive increase in rents, which are determined by wages – or immigration, which is determined by job opportunities – Ireland is in for a long, difficult transition.
How is going Ireland going to cope with a labor force increasing by 50,000 p.a and an economy in freefall?.Time to shut the door on Eastern Europeans and the Chinese.
David, unfortuately there is a long way to go down in property prices as your analysis highlights very well. 18 months ago at the top of the market, some considered selling their homes, ‘bagging’ some cash and renting. Since there seems to be a long way to go, this still sounds like a sensible option from a monetary point of view. But I suppose ‘greed’ stopped people before and fear will stop them now, The consequences unfortunately are many more will slip into negative equity or see the ‘theoritical’ gains over the past number of years disappear. Why is no… Read more »
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David, this analysis does not take on board the fact that certain houses in certain parts of the country are rented as holiday homes for part of the year only, they are not full time ‘homes’. sarah chalke, I agree. This also affects rents which in turn has an effect on the price of property. We have hundreds of thousands of immigrants here fueling demand. To hell with holiday homes, a lot lie empty most of the year anyway, we should be thinking about the masses of apartment blocks we build that are filled with foreigners paying this rent. Maybe… Read more »
Sarah: No need to shut any door. When the jobs dry up then economic migrants move. This makes fascinating reading. Another way of looking at it is multiples of the average industrial wage to determine what’s the right price for the average house. Why a bank would think an 8 times multiple is sensible is beyond me but I’ve seen examples. Another question is how much of the celtic tiger wealth is liquid and how much is invested in property schemes of one form or another? That will have a big impact on the economy’s ability to recover from the… Read more »
I disagree entirely that immigration should stop because we were stupid. Blaming the East Europeans and Chinese for our own greed is nonsense. It is obvious now that the Government couldn’t find their arse with both hands and a map and had as much ‘influence’ on the boom as they are having on the bust. We relied on selling houses to each other and on working for multinationals who were governed by and looked at other tea leaves and not operating in the best interests of Ireland. We need to snap out of this savious mentality. We need to stand… Read more »
David – This is a very interesting article, although I think the last sentence could do with further explanation. It is the by far most attention-grabbing line in the piece and it leaves me wanting to know more..maybe you could thrash it out a little further in your next post?
Shane Dempsey,
Do you live in Dublin? are you in PR?
Shane Dempsey, 86% or thereabouts of all Irish investment money over the past few years was ‘invested’ in property at home and abroad. Not exactly diverse is it? Also very risky as loans are leveraged against equity in half-payed off semi d’s in Dublin(devaluing now it seems) to buy apartments in Bulgaria etc.(devaluing now also it seems) where the natives are not part of the market and the average industrial wage is peanuts. If half of these stupid robo-paddies stayed at home and invested in businesses, the country might be better off. We need venture capital after all to create… Read more »
“Blaming the East Europeans and Chinese for our own greed is nonsense. ” I am a bit dubious about this “our” business. The capitalist class, and the hegemonic ideological new left were in one voice on immigration, not powerless little “us”. We werent really asked. Nobody is blaming immigrants, just the level of immigration and in fact many immigrants think themselves that the problems in Dublin are lifestyle problems caused by over-population, lack of services. It is not in the interests of workers – including past imigrants- that there be mass immigration in any one year. I say “mass” advisedly… Read more »
Can someone tell me what happens to all houses when a lot of immigrants leave?
Emigration will be far more likely than immigration, during this long difficult transition, if only for ‘historical reasons’.
John Q. Public: That’s an interesting figure. Which institution or organisation produced it? I’m particularly interested in the profile of the top 10%, those with the most notional wealth as their future investment in companies, if possible could help avert a meltdown. It’s possible there’s little or no cash, with almost every spare cent associated with property debt. This would be uncomfortable to say the least. Bob: Lived in Dublin for a short time. Been in Manchester and Cork also but spent most of my life in Waterford. Never been in PR. Why do you ask? Eugene: They’ll come here… Read more »
One interesting thought is that the higher the minimum wage, the less advantage ‘low cost immigrant labour’ has, so, one has to assume, the less there’d be.
Of course, it’d make things less competitive compared to those countries that have a lower minimum wage – looks like a political decision to me.
Shane Dempsey: I think David himself produced this figure recently(help us out there if you can David). I can quote from ‘the generation game’ that a ludicrous 59% of all residential building in Ireland today has been bought either for speculation or a holiday home with equity released from a first home. In the book David points out that these ‘investments’ are the ‘Achilles heel of the market’. Also 1 in 6 houses in Ireland are now empty. Our top 10% wealthiest people will not save the day as they do not employ enough people in the first place. They… Read more »
B – a moment of common sense in a sea of spectacular ignorance about the Irish “immigration” “system.” The Irish work visa system exists only for the benefit of Irish employers who wish to bring workers here. If you are from outside of Europe you cannot simply arrive here on your own bat and take up any job, you can only come here with a job offer for a particular job and right now your visa and work permit covers that job ONLY. If you don’t like it, tough. If your employer cheated you, tough. If the job is something… Read more »
Stephen Kenny – good point but part of our problem in Ireland is that the minimum wage needs to come to significantly above the basic rate of social welfare, which in Ireland right now, it does not. For anybody working on the minimum wage who is living in the private rented sector, even a 40 hour week is likely (even for single, childless adults) to come in only a few euros above what they will get in welfare and rent subsidies. Families are likely already to be significantly better off on welfare than in a low paid or even moderately… Read more »
Laura: I thought there was a 2005 statistic that said that only around 3.5% of workers were actually on the minimum wage. I agree with what you say about negative and ill-informed attitudes to immigrants. It’s 5 years before a third-country national can apply for residency here, unless they’re married to a European. There are a few other exceptions I think. The ironic thing is that if the statistics being discussed here are correct then the employers who have exploited some of these 3rd country nationals on working visas have piled their money into a shaky property market. A situation… Read more »
This is not an Irish problem. The economy is in meltdown everywhere. US is in tatters, France is a basket case, Iceland and NZ are going down the tubes, Japan has been in deep doo doo for a decade and so on. UK is also having its meltdown. Germany, the picture is mixed 2% growth to flat depending on who you talk to and maybe heading south as well. Granted, the Irish bit might be the over-investment in property – but I still think this is more ubitquitous. We are being treated to a triple whammy. Oil, Dodgy Financials and… Read more »
Why oh why do people connect immigration with low paid work? Immigrants do all kinds of jobs here. Some even have businesses. While we were off buying tacky cars and buying holiday homes in the Costas the real work was being done at home. By immigrants. I know because most of them are the only people worth hiring. If we let the illigitimate Spaniard DeValera be Taoiseach and President we must redefine what being Irish really is. If he can get it anyone can. I am well aquainted with the immigration “system” here. It is based on fresh air and… Read more »
“negative and ill-informed attitudes to immigrants” Hmm. These are just pc buzz words. I could write an essay here about the liabilities of mass unskilled immigration, produce copious economic arguments against it from a workers point of view ( ignoring cultural aspects) and yet it would be deemed “ill-informed” no matter how informed. Non-Eu immigrants need a working visa? A lot of the 100 looking for that londis job seemed to be non-European. How honest do we think Irish employers are – or, to put it another way – most immigration to Ireland EU and non-EU has taken place rapidly,… Read more »
As an Irish national living abroad it seems that everyone in Ireland wants to lay the blame on the “immigrants”. Plus ca change. Irish people never take any responsibility for their own mistakes. For the last 10 years all I have heard is bar room economists and 25 year old ‘property developers’ “explaining” to me the rationale behind their investments. What a load of crap. It was cobblers then and it’s cobblers now. Not only that but it was the blind leading the blind – everyone was an expert but in reality hardly any of them knew sh*t from shinola.… Read more »
David,
I like your idea of using rent as a means of valuation but you are using the US ratio (from last weeks NY Times?) and transferring it to Ireland. You are not allowing for high US property taxes and community charges which run into thousands of dollars a year. I think Ireland should have a somewhat higher ratio to reflect our lower cost of ownership. Granted houses are still way overvalued and have a long way to go before there is any kind of yield.
I like the comparaison between inflation and immigration. It gives a bit of perspective to better understand the potential of a trend that has kept Ireland running for the last couple of years. Another important question for the future of this country is: what kind of jobs will be created next? Low skills/low pay jobs which are often associated with immigration will not save Ireland from an economic “hard landing”. You can’t keep running with only the Tesco’s and the Abrakebabra. Where are those ultimate “high skill/high pay” jobs the government is dreaming about every night? And who’s gonna have… Read more »
your RVH calculations are based on the assumption that all rent prices and house prices posted on daft are accurate/realistic !! I think both landlords and sellers currently need to reavluate what they are asking for ……..
Hi David, Yes, the price of a home in relation to its rentability has always to be conisdered as its true underlying commercial value. Especially when unwarranted hotair doesnt value propertioes any longer. Of course, rents can and do go down in relation to supply and demand issues, and properties that were at one stage very rentable may find themselves less so in future circumstances, eg: in long distance commute ‘burbs. One measurement is the oft-quoted ‘Yield’, which is akin to your RVH, although in many cases the Yield values are not always calculated openly nor correctly. > your average… Read more »
I work in the recruitment business and receive 500 unsolicited cvs’ each week equally divided between Irish and non Irish people.At best we receive 50 new job vacancies each week hence the imbalance between the supply of and demand for labour.My firm refuses to deal with school leavers’ or graduates’ which shows how out of kilter immigration policy is with reality.Working in the bottom quartile of jobs (in terms of pay) is a nightmare but people who work in the public sector and earn an average of 1,250 p.week and set immigration policy do not have to compete in the… Read more »
Recruitment busines. hahahahahahahhahahahahahahahahahahaha. That “industry” is a total joke.
The fact that most companies hand off their recruitment to the leeches in the agencies means that they couldn’t care less who they get.
I am not fully agreed with David. Approach only with price-to-rent is describing market only from point of view of investors. First, in Ireland, I think, that prices are mostly based on supply-demand model. Number of houses, demographical situation and number of immigrants are well known and it is easy to see that first oversupply crisis happen in 2001, when supply exceeded demand from Irish people. In order to prevent falling of prices, government allowed to property speculants to buy excess of supply in hope that demand due immigration will be higher and they can sell houses/apartments for bigger prices… Read more »
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I think the issue of immigration is not that relevant. – I only worry we might loose talent to manage this place. Immigrants = new ideas and attitudes we desperately need. I am happy about the fact that competition for 3rd level may be hotter than expected this year. That means better people going into 3rd level. I am of course making some big assumptions on a stable arrangement for accomodating new cultures etc. The views on RVHs show that we are in for a major mega credit crunch – In a few years banks will want your soul as… Read more »
Whether Rental Yield is a useful tool or not is open for debate. What I can saw is that it is something that I use myself – and to me Ireland appears to be overpriced. I am also doubtful of the prospect of rents rising – for any number of reasons. Fewer immigrants – over supply (both inner-city lux exec. apartments and suburban semi-Ds) – high numbers of empty houses – demographic changes slowing down (people not marrying as young as predicted… I think what David was talking about was how the media has changed. From once ignoring the signs… Read more »
“My conclusion — if builders will lover supply and everything will be as before — we are closer to bottom of house price fall and it have a good chances to stabilize at the middle of next year and then start to grow closely with inflation.”
Sorry Alex. That won’t work. For builders to lower supply means cutting their workforce. Construction counts for a huge of GDP/GNP. It employed over quarter of a million people. Cutting activity means losing a lot of jobs and this will be the death blow to the housing bubble.
Gaius, I am understand your point, but I am not fully agree with you. First, I don’t think house building is very useful for GDP — for me it is actually borrowing of money from future incomes to create something now. The same result for GDP will be if government will borrow money to build an infrastructure. Only difference will be that in this case debt will be concentrated in one place, rather then spreaded over hundreds of thousands house owners. Second, losing a lot of jobs is not so dramatic for Ireland, because a lot of positions are occupied… Read more »
B said, on June 2nd, 2008 at 10:53 pm Why oh why do people connect immigration with low paid work? Immigrants do all kinds of jobs here. Some even have businesses. While we were off buying tacky cars and buying holiday homes in the Costas the real work was being done at home. By immigrants. I know because most of them are the only people worth hiring. “If we let the illigitimate Spaniard DeValera be Taoiseach and President we must redefine what being Irish really is. If he can get it anyone can.” “To finish I would like immigrants to… Read more »
So Obvserver. You are saying leave or we will kill you. Thats a bit like Poland in the thirties isn’t it? Imiigration is here to stay and I hope it does because before immigration we were in the shit house. I agree that the natural reaction here will be to attack the outsider rather than fixing our own problems. Much easier to blame the bogey man. West Brit my arse. I am as Irish as they come. I do have a problem with people of any nationality trying to reinvent the wheel or continue on with the attitude that what… Read more »
If you want to see exploitation look a the rich people and the Filipino slaves they have pushing their kids in prams. These are gentle sociable people for whom I have a lot of time for and have eaten in their homes, met their parents and their kids. Their only problem is they are too nice and employers take advantage of this. In Ireland it is perfectly acceptable to have slaves working in the home. the work permit is with the employer and the girl is their slave. I have first hand experience of seeing this happen over an over… Read more »
“Irish people are in general lazy and want to see the reddies before they make a half arsed commitment. There are exceptions but the norm seems to be going to and from holidays and eating all around you. And the overt and/or snide racisim that we get on a daily basis from supposed liberal Green party voters is incredible.”
clearly the only racist here is you. albeit an anti-Irish one. You hire non-Irish because you want cheap labour. We cant base a society on your ideology.
“In Ireland it is perfectly acceptable to have slaves working in the home. the work permit is with the employer and the girl is their slave. I have first hand experience of seeing this happen over an over and over again.”
that’s correct. There are working hour directives for all workers. The employees work 8 hours, in lieu of a creche, and then can go out for the night. restriction is actually slavery, or a form of illegal constraint.
Do you think in all fairness that an immigrant from a third world world country with her whole reason for being here tied to her employer going to say anything that in doing so will have her on the first flight home? The immigrant I hired is an accountant. She previously worked long hours serving drunk people chips. She averaged 90% in college and we gave her a shot. I do not regret the hire for a second. She gets paid well and gets paid study leave. I don’t see the point of low skilled immigration nor do I see… Read more »
“What I was saying before being accused of racism against myself”
ok, i take that back. i think you should be more moderate in use of language to describe Irish attributes. it bugs me a bit.
Getting back to the subject in hand… Davids article was not about immigration… I know that immigration is a component but… Anyway, I am an Irish Property Bear and have been for some time. I dont think it will be as bad as David is making it out to be. The example about rents and yields in Donegal is a good example, assuming you can get tenants I guess. My opinion is that propery prices will fall by another 20-30% and then stall. The stall may be a long one because as David says we need to get prices back… Read more »
Seeing as there are 500 million people in the eea any employer who is recruiting from outside of this pool of labour is a cowboy and deserves to have his application for a work permit binned.The U S A does not even have an open labour market with Canada and makes do with 1 million legal migrants’ per annum.Australia accepts 200,000 migrants per annum as does Canada implying a figure of 35,ooo for Ireland as perfectly adequate.
B, I suggested that Migrants who apparently fuelled this so called “boom” we had. Actually jumped onto a miraged bandwagon which had the wrong wheels and was only 5/10 of gas full. Don’t accuse me of National Socialism …….. that is slander and offensive. I am a Monoculturalist and firm believer in Irish Identity like every other National Culture/National Identity in the world deserves protection. It was Irish Enginnuity that attracted investment into this country; not all these foreigners who have contributed partly but only a minscule scale. Reports only within the last 3 months in the UK has proved… Read more »
Korea doesn’t have a past like ours. They were invaded by the Japanese on multiple occasions over hundreds of years and were the pawns in a proxy war between China and the US. The 38th parallell is a line drawn because the Americans pushed too far and woke up the Chinese. I was in Korea and North Koreans and South Koreans and the Chosungok are the same people. There is no ethnic or religious boundary. They can drink though so we are like them in that respect at least. I don’t even know what National Socialism is so I am… Read more »
Why does immigration unsettle people? I was sitting on the bus yesterday, listening to a couple of white South Africans complaining about what they clearly reckon is the start of an influx of Kosovans into little South Africa (the Southfields area of SW London). What’s wrong with that, after all, the South Africans have only been there a few years? But clearly something was wrong with that. They probably don’t even know any Kosovans. The phrase ‘common sense’ came to mind, and I had a thought. One reason people have a problem is because of ‘common sense’, or to be… Read more »