Advisors.ie

(this article is taken from Karl Deeter’s original article in the Sunday Business Post 4th September 2016)

Property prices are on an upward spiral, and no one, including the government, can stop them

An explanation is not an endorsement, so the cries of ‘unfair’ when I try to explain that there is a very high likelihood that property prices will spiral upwards are pointless.

I don’t agree with sky-high, unaffordable home prices, archaic development systems, red tape costs, third-party rights and many other things, but being powerless to change them means you have to make your value and judgment calls, accepting that these things exist.

Interest rates have been on a downward trend for a long time. It’s effectively a secular trend, and it’s happening across the globe.

Interests rates are zero in Europe and below zero in Japan, Sweden and Switzerland. Looking at other developed nations, we see that Britain is at 0.25 per cent and the US is 0.5 per cent, but with a yield curve that is flattening.

The yield curve, in particular, is telling. What it does is express (via a squiggle on a page), the forward expectations of interest rates. Currently it’s negative or zero 11 and half years into the future. This means that there is virtually no expectation of inflation in the near term and that trend has implications.

The first implication is that it benefits whoever holds assets. It’s no surprise that stock markets rise in this environment or that the S&P500 is all-time record high territory. The other implication is that investors seeking more of a fixed income return have to look to assets outside regular government bonds which are at record lows, at zero or below zero in every one of the G12 nations.

Right now, interest rates are at the lowest they have been on record. That comes with implications. Alternative assets (property being a popular one) will benefit from this environment.

This will play through into credit. Credit prices will come down (for mortgages and other loans), and this is inherently asset inflationary when mixed with property. Cheap credit makes leveraged investments viable and profitable, a sacred ark of sorts in a zero-yield world.

Add a shortfall of homes into that matrix and it effectively becomes a government-backed license to print money.

The sad fact is that not everybody will be able to avail of this because rising prices and rents don’t benefit ‘outsiders’ and it brings us back to a classical Irish obsession with treating outsiders and insiders differently.

Many TDs refer to insiders when they bemoan the firms that can buy property assets and pay little or no tax, or where they can buy a loan but the existing owner doesn’t get a shot at buying the same loan at a discount that the bulk buyer gets.

These entities are things like S110 companies, Real Estate Investment Trusts (Reits) and Qualified Investor Alternative Investment Funds (QIAIFS). Each has been treated in this column in the past.

Each is diametrically different to how we treat our homegrown investors and, again, whether this is right or wrong is secondary. What is of primary importance is that it forms another part of the upward price pressure we will experience.

One reason is that these entities can buy profitably at lower yields. This means ‘bidding up’ becomes more common. A retail investor (typically) needs about seven per cent to be safeguarded in the long term. A tax-free investor (due to being tax free) gets the same result at below four per cent.

Rising prices will act like an informal tax on renters and would-be buyers while bestowing ‘taxation powers’ on entities who are not the same as our national tax authority. What is perhaps most frustrating is that nobody, dare I say even the government itself, has the power to stop this from happening.

The reason is that any intervention will only be effective if you find a way to make outsiders the new insiders. That can only occur by creating transfers because the market as it stands won’t facilitate this.

Those transfers can be things like new first-time buyer grants, or building homes to rent where the state takes the debt but the occupant gets the cheap housing benefit (at a cost to our exchequer general) or some other way to bestow rights and privilege on whoever is lucky enough on the day to be at the top of the queue.

This is as wrong as the current system, so supporting it is simply a value call on who is more worthy. That’s not quantitative, it’s a social morality query.

When considering all of the forces at play in Ireland, from shortages, to higher costs, land prices, development land values as well as things like rising rents, mortgage rules and a flat yield curve, there is simply no cogent argument for property prices to do anything other than rise.

It is so much more ideal to avoid a boom than to cope with a bust but we are so firmly on a path towards rising prices that there can be no other outcome. For now, the tree that is the Irish property market is like a sapling nestled in a nice mulch of well-fertilised soil reaching for the sky. What that means is that prices are going to rise no matter what we do.