Thursday, February 12, 2009

Ignoring reality in the realty market

The property market in Ireland has ground to a standstill and seems likely to stay this way for some time. Today’s Irish Times has an article on how to help kick-start the market. It is from Conor Gallagher of estate agents Douglas Newman Good. Bluntly, it is not a very good piece. Judging by the title you’d think there was only one market that matters in the economy. Lets look at what’s been done so far to “kick-start” the market without government intervention.

Over the last 18 months or so those on the supply side of the market have been getting ever more desperate to try and get some sign of life from the demand side of the market.

For a long time there was an unwillingness to reduce prices so sellers looked to put extras in to encourage buyers. It started off with some small efforts to spark a bit of interest. Initially the sweeteners ranged from free foreign holidays to fitted kitchens. This continued and some developers offered the allure of a free car to try and attract buyers.

To this observer this seemed to simply be a reluctance to reduce the asking price. In fact during this period house price indices showed little change in house prices when in fact the real price was falling substantially.

The sweeteners didn’t have the desired effect so eventually sellers began to realise that falling prices were a reality that they couldn’t ignore. But again they tried to ignore reality.

The next “innovation” was “rent to buy” schemes. Here a buyer agreed to buy a house at the current price but only paid for it three years later - at which point the buyer could withdraw from the contract. The buyer paid rent for the three years which would be subtracted from the purchase price (plus interest!) if they bought the house. As before this had little effect as buyers clearly felt that prices would fall by more than any amount they would pay in “rent”.

Next the sellers turned to buyers’ gambling instinct and we had the “buy one and you can win one” schemes. In a scheme of 30 houses the developer would (try to) sell 29 of them and then raffle the last house among the buyers so that one lucky buyer would get too for the price of one. The tune is the same with this. In reality that was akin to a price reduction of a little more than 3% for the developer but of course the nominal “asking price” wasn’t reduced.

Again buyers were not turned on by this. Most people only want one house not two and would prefer a price reduction on their own rather than enter a lottery. Plus, the house would only be raffled when all 29 were sold. It might be a long wait! Inspired by this one man took the idea of a house raffle to extreme, see here.

The most recent attempt has been the introduction of Secure Step Mortgages. This time the developer pays a 15% “bond” to the mortgage provider. After five years the property is independently valued and if it has decreased in value the purchaser will be paid the money from the bond up to the value of 15%. If the price is the same or has risen the bond will be returned to the developer. This is supposed to provide “security” to buyers against falling prices. It was only launched yesterday but I can already guess what the buyer reaction will be.

Those on the supply side of the market are arguing that they have tried their best to “kick-start” the market and that now it is time for the government to intervene. Well, I have one piece of advice for Conor Gallagher, Douglas Newman Good and their ilk that is guaranteed to generate activity in the market - reduce prices. No sweeteners, no raffles, no gimmicks, just prices!

Anecdotal evidence suggests that mortgage brokers have “lots” of customers on their books who have mortgage approval but are waiting either for prices to fall further or the market to turn. As with all markets there is no shortage of buyers in the market and current low interest rates are likely to serve as a further stimulus.

However, buyers are well aware that current asking prices are still unrealistic and all the gimmicks in the world won’t change that. In the long run houses should be valued at 4 to 5 times average annual wages or 12 to 14 times average annual rents. Once prices get back to this level we’ll see a bit of action.

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