This article was originally published in the November 2004 issue of “The McWilliams Agenda” a subscription based newsletter. As the topic is just as relevant today, it has been published in place of David’s usual article while he is on sabbatical

Now that the housing market is showing serious signs of a slowdown, it is probably worth revisiting the wisdom of all the foreign apartments, houses, condos and the like that were bought by us Irish over the past five years.

Little did we know when we were kids playing in the school yard that coming “Paddy Last” could cost us our financial security. However, with the Paddies scouring the globe for property deals, the old adage “Don’t be Paddy Last” applies like never before. From Cape Town to Gateshead, Bulgaria, Budapest and Boston, Paddies are driving up property prices and driving down yields to dangerously low levels in the process. Almost everyone is at it. This weekend, in all the papers, properties from the four corners of the globe were still on display and investor appetite was still palpable. Where will it all end and how?

Let’s start in the air. This summer’s Malev (Hungarian Airlines) in-flight magazine had a full page on Budapest’s property market. The writer was ascribing the recent gains in prices in Budapest to a variety of factors: political stability, demographic factors, credit etc. Finally, the magazine highlighted what it called the “Irish effect”, not the “overseas buyer” effect or “international investor” effect, but simply the Irish effect. Anyone visiting Budapest this year will know exactly what the magazine was getting at. For example, last August there were more GAA shirts in the lobby of the swanky Marriott Hotel in Budapest than in the Burlo’. Paddy was there, cheque book open, ready to spend. The local estate agents say that in Budapest there are three prices — one for the locals, another for the foreigners and a third for the Irish. Although, yields have been pushed down to perilously low levels (that’s if the property can achieve decent occupancy), Paddy feels he has a bargain because relative to Dundrum, Budapest appears cheap.

The same story applies in Cape Town. Landing in the international airport is one of the least African experiences that you can experience in Africa. Everything is spotless, efficient and clean. The largely white, immigration staff are pleasant to a fault. Contrast this with landing, for example, in Abidjan in the Ivory Coast, where stoned, gun-totting soldiers hassle you for cash at the customs desk. South Africa is different. This, at least, is what the estate agents say to you and granted, Cape Town is a magnificent city. Tourist numbers are up, property prices are sky rocketing, yields are holding up reasonably well and the Paddies are swarming all over the market.

When seen from Table Mountain, Cape Town appears like a shining beacon of what South Africa and its “Rainbow Nation” could be like. Yet the drive in from the airport takes you round the back of Table Mountain, the part you do not see from the glamorous Waterfront.

There, shantytowns extend for miles, hidden away in the flood-prone plain called appropriately the Cape Flats. The only major question for the investor in bricks and mortar in Cape Town, is at what stage do the millions of shanty town dwellers say “Enough” and demand some of the action. In other words, is buying in South Africa today a bit like buying an idyllic Big House from an Anglo-Irish landlord in 1912? We all know what happened to Big House dwellers in the 1920’s in Ireland. They were burned out, driven out and even when they did reach a settlement with the new nationalist government, the compensation for their property was derisory.

My hunch is that South Africa’s ANC government and the emerging black middle class is loath to let anything cataclysmic occur and a type of Faustian pact has been arrived at between the power bases on both sides. This arrangement was best described over dinner in Jo’burg in 2002 by the most senior black industrialist to emerge since Mandela took power who, when I asked him how come there appeared to be so little recrimination on the black side towards whites, answered “they pretend it never happened and we pretend to forgive them”.

Two years ago, I was back in South Africa and in the car park of the Cape Town’s Newlands Stadium ahead of the Ireland-South Africa test match, one of the great rituals of modern Afrikaaner culture is taking place. The Springbok-mad Afrikaaners arrive from all over South Africa to pay homage to the national rugby team. Before the game, they wedge their pick-up trucks into a field, put on the “braai” and drink ferocious amounts beer — in a superannuated display of rugger-buggerdom. Yet even amongst these Afrikaaners there was a great love for Mandela and an equally great fear about “AM” — After Mandela. Even these intimidating farmers are concerned about “What will happen when he dies”? None had an answer.

But this does not matter to Paddy because (like Budapest) prices in Cape Town are cheap compared to Dundrum and as long as the Irish market is ridiculously expensive, the whole world looks like a bargain.

And this is where the “Dundrum Paradox” comes into play. Some of the world’s property markets are now being impacted by how much leverage Irish banks are willing to lend on the back of the Irish property boom.

Most small Irish investors are buying property abroad on the back of equity withdrawals on their Dundrum semi-d’s or something similar. The Irish banks, which are finding it hard to make the silly valuations and profits demanded by their shareholders, have to generate huge volumes of business to make money. They are thus facilitating practically every proposed equity withdrawal. The Irish property market is therefore being leveraged at least twice. If anyone believes that the banks are staying within the Central Bank’s multiple of income guidelines when it comes to lending, they need to have their heads examined. So the “Dundrum” equity withdrawal is a credit derivative that is driving up property prices in Budapest.

Forget that the locals couldn’t afford to buy at the prices the Paddies are paying. The locals do not matter in this hermetically sealed Irish ponzi-scheme. The Paddies are largely now buying from other Paddies and the exit strategy is to sell to another Paddy when you want out. As long as the ponzi-scheme keeps going, fuelled by equity withdrawals, abundant credit and low interest rates, Paddies can make money by playing “beggar my neighbour” with other Paddies. The name of the game is to avoid being Paddy Last when the deck of cards comes crashing down.
Finally, there are a few pitfalls to watch out for before the ponzi-scheme implodes. Beware a devaluation or a series of devaluations in eastern Europe, particularly Hungary.

Like Ireland in the early 1990s, a run on the currencies of all these countries including Poland, the Czech Republic and Slovakia, is likely. In Hungary, it is highly likely. The reason is simple. To be competitive, these countries need an undervalued currency.

At the moment, all the countries have overvalued currencies in an effort to keep up with the euro. This will become increasingly difficult as the euro strengthens against the dollar. So with low growth, high unemployment and current account imbalances, the more the euro strengthens, the higher the currency risk in these countries. Interest rates are likely therefore to rise. No country can endure higher interest rates for long when jobs are scarce, so expect either managed or messy devaluations. This will have the short-term effect of knocking value off your property, but in the longer term might it be positive for the property market as it was in Ireland. But again be warned. Whatever internal growth there might be will be insufficient to make any of your purchases affordable to the locals.

Don’t be Paddy Last!

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