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White says that a line frequently trotted out by estate agents is that “buy-to-let investors are not worried about rental yield; they are in it for the long haul of capital appreciation”. That is fundamentally unsound investment advice. In the long run, the value of any asset is dependent on the income it provides. In the property market, capital appreciation is theoretically a function of rental return. What is buying a house in any case? It is the opportunity cost of not renting. An owner-occupier/investor is buying a discounted stream of rents for as long as he/she wishes to hold on to the asset. And vice-versa: a renter pays a monthly sum to a landlord rather than interest to a bank. The opportunity cost of not owning a home is forsaking the potential for a return on that investment. But if rents are relatively static, not only is the potential for capital appreciation reduced, it is also more attractive in cash-flow terms to pay rent rather than interest. White uses an example of a recent house on the market to illustrate that arithmetic is now prohibitive for a novice buy-to-let investor. A four-bedroom townhouse in Ballsbridge, Dublin 4, with an AMV of €1.9m, close to the site bought from former ISEQ-listed Jurys Doyle for €54m per acre last year, on a traditional (capital and interest) 90% mortgage over 25 years, would have a cash flow shortfall that would reach almost €83,000 annually. He says that an investor is down 10% immediately because of stamp duty and costs.
The Davy report says that the evidence summarised in Table 1 refutes the theory that supply shortages are leading to rocketing prices in “desirable areas”. If that was the case, residential rents would be rising rapidly, but they are not. On a countrywide basis, private rents increased just 4% year-on-year in the latest quarter and were unchanged over a five-year period. Since April 2001, house prices are up 52% on average nationwide but rents are down 2%! The average P/E in Ireland on second-hand houses using net yields—11/12ths of annual gross rent—from official Central Statistics Office figures is now 40x, up from 26x five years ago and 13x ten years ago. The report also says that the proposition that scarcity of land close to the city-centre makes residential property a low-risk investment is not supported by evidence from other countries. The same argument was made in Japan in the late 1980s, as property soared in value. Residential land prices in Tokyo are down almost 60% since March 1990; there has been a year-on-year decline in every year since. Moreover, property is a risky asset, like equities, corporate bonds and commodities. Net yields of 1.5%, which are commonplace in Dublin, look ridiculous compared with a risk-free rate of 3.5% on ten-year gilts. It is better to compare residential property to a similar risky asset like the ISEQ index, which has an earnings yield of 7%. Not only that, but Irish listed companies’ profits are growing three times as quickly as rents in Dublin. Rossa White concludes that investors must be extremely bullish about rental growth in order to justify the sort of record valuations ascribed to residential property in central Dublin. He says that this looks like boundless optimism. Supply in Dublin is set to remain plentiful for the next couple of years as we continue to build houses at a rate four times quicker than the European average. Meanwhile, interest rates will rise by at least one percentage point over the next year, pushing investors’ break-even point lower and lower. The amount of cash sloshing around due to SSIAs and tax cuts, and the current buoyancy of the housing market, suggest that valuations will become even more stretched over the next 18 months. But the fundamentals suggest that it will be an adjustment in prices, rather than rents, that will eventually bring valuations down to more realistic levels. Download report.
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