Irish Mortgage Brokers Blog

When a bank creates a loan that becomes an asset, the property it is secured upon is the collateral (sorry my teaming millions, I know I repeat this eternally). So if NAMA decide to become a brand of lender this October as we saw from an article in today’s Independent; then how does it work? Where does the money come from?

Take a property that they are putting up for sale (1st picture: pic not related). We’ll say for the sake of this example that it is worth €200,000.

The NAMA position may be that they paid more or less for this particular property but it doesn’t really matter; what does matter is that for the sake of them selling it the property may as well be unencumbered, there is no lien above that held by the NAMA.

This means they can give a title deed to the buyer when they sell it - but don’t forget, when a person takes out a mortgage there are two sales/purchases, the individual buys from the vendor (1st sale/purchase) then they sell it to the bank in exchange for the money [we call the 'mortgage] to complete the transaction (2nd sale/purchase) and the bank then take the ‘1st lien’ or ‘right’ on the property.

Prior to this they put in their deposit (10% or €20,000) which becomes their own, this is their ‘equity’, which is why ‘negative equity’ is described not as value versus the market (that’s called ‘price’), rather value versus the mortgage secured on the property.

What NAMA have indicated is that they will provide a kind of ‘bridging finance’ for buyers, so a certain portion will be made up of Bank borrowing, just a regular mortgage (we’ll speculate that it will be 60%).

This has a key advantage for the bank who will have 1st lien (because NAMA have said that there is some loss sharing mechanism which would indicate that at best they hope for 2nd lien). First of all they have a low loan to value (LTV) mortgage - considered lower risk because before the property gets into negative equity from the banks perspective (60% of 200k is €120,000) the price would have to fall a further €80,000. Secondly it means that they can lend a little more freely because their risk in this instance is reduced, it doesn’t mean ‘lax standards’ but it shouldn’t be as stringent as the lunacy that prevails now where it is so difficult to obtain credit.

So working through the example: The buyer puts in €20,000 (10%), the bank forward €120,000 (60%) leaving €60,000 (30%) to cover.

Thus we have the NAMA input; but where does this money come from?

Quite simply it comes from nowhere.

How? Because the property is unencumbered so what NAMA do is draw up a loan agreement (that then becomes an asset) and they give you the keys, along with an agreement that (speculating) might say that if prices fall then after 5 years there is some kind of loss sharing mechanism.

This means that they go from a situation of having an empty apartment generating nothing into the following:

Buyers input: €20,000
Mortgage: €120,000
Loan written: €60,000

The first two give a cash input of €140,000 which can then be invested (we’ll assume they get 5% p.a.) and they also have a loan of €60,000 which is a future claim on earnings of the buyer (again, we’ll assume 5% interest rate).

If there is ‘loss sharing’ don’t forget, the buyers equity gets wiped out first so it is not a case that if values fall that NAMA are onto a loser, rather it is if they fall greater than 10% over the next 5 years, and that may well be likely but don’t forget, they have money in hand today which will generate profit elsewhere.

That 140k over 5yrs at 5% will give them €178,679 (compound interest being [M=P(1+i)n]), the 60k loan will bring in €16,567 in cash meaning that they have €60,000 at risk but €55,246 in cash-flow, and let us not forget that if prices did fall and fall that the €120,000 bank loan has no loss sharing and would put NAMA in a better position than if they held out and sold at a later date - but I see that as an Armageddon scenario.

If prices fell a further 20% (which could happen and was hinted at in the Central Bank paper ‘Scenarios for Irish House Prices‘) then NAMA only have €20,000 to worry about and depending on the loss sharing scheme put forward all they do is write down the value of their loan on that basis giving the following:

€120,000 underlying bank loan
€20,000 deposit (now wiped out as buyers equity goes first)
€200,000 - 20% = €160,000 so the €60k loan they advanced becomes a €40k loan from that day forward.

Not a bad deal (for them) all said.

We were pleased to feature in studio with Sharon Ni Bheolain of Six One news on the topic of the CSO Property Price index.

I’d pass by this bridge and see architecture and engineering, Fred sees a greater social ill that needs to be addressed, his idea of ‘infrastructure gifting’ is compelling and well worth hearing.

We were featured on TV3’s ‘The Morning Show with Sybil & Martin’ in a piece they did on the recent Allsops auction. Angela Keegan of MyHome.ie and Karl Deeter of our own company took part.

The general view we have is that if you mark down prices enough then people are willing to buy what they see as value, that means that either prices remain too high or sentiment is such that appetite is not there at the current price level (we suspect the former weighs heavier than the latter!).

We were delighted to feature again on TV’s ‘The Morning Show with Sybil and Martin’ (although Brian was sitting in for Martin) on their monthly property slot.

This week we spoke about the necessity of price drops to get a property sold, it is likely the single most important factor, it is also overlooked that there is often a carry cost or opportunity cost loss if sellers don’t drop prices.

Next month we are likely to cover ‘empties’, that will be a fascinating show worth tuning in for!

Of the main changes we could consider in the near future from a national taxation perspective, none holds the potential for positive outcomes to the same extent as Land Value Tax (LVT) or Site Value Tax (SVT). Below are several points looking at why this is the case:

1. It is widely agreed that we need to spread the tax base to reduce taxes on employment to be replaced by taxes on assets, and to create a less volatile tax base. This can be achieved with Site Value Tax. In terms of ‘fairness’, it is important to remember that only 50% of properties in the country have a mortgage on them, and for that reason there is also taxable capacity in the market for this, in conjunction with a reduction in income taxes.

2. The Site Value Tax currently included in the Four Year Financial Recovery Programme, is such a tax. It applies only to land zoned for development, or already developed.

3. Land is a fixed asset. A high proportion of its value is dependent on its area, its location and its proximity to related infrastructure. Infrastructure which is created via public expenditure but rarely ever re-captured for the value it adds to surrounding areas.

4. Site Value Tax should therefore be a substitute for less sustainable forms of property tax, such as stamp duty income tax or other taxes on employment.

5. The provision of new infrastructure generally increases its value, and a site value tax yields increased revenue, which pays for the infrastructure over time rather than development levies at construction stage.

6. All land owners who benefit from the new infrastructure contribute to its cost, not just the owners of development land as at present – now not necessary after changes to previous point

7. For these reasons a land value tax should be used as the main tax source for Local Government, whose main brief is the provision and management of infrastructure.

8. It would eventually also replace Commercial Rates and Central Government contributions.

9.It could also be used to fund other Agencies providing national infrastructure, both environmental and social.

10.It will generate a higher tax return from wealthier citizens and a lower return from the poorest.

TV3 The Morning Show with Sybil and Martin from Irish Mortgage Brokers on Vimeo.

We were delighted to feature on TV3’s ‘Morning Show with Sybil and Martin’ on their monthly property slot alongside Angela Keegan from MyHome.ie

In the piece we discussed the property market as well as the financial side of it and how changes to both interest rates and taxation changes could affect buyers in the future.

At the moment in Ireland there is a conundrum for first time buyers: should you buy now and potentially over-pay on purpose?

It’s an unusual one and it partly related to property prices, it is a combination of taxation changes that will occur from the start of 2012 and expectations of interest rate changes from both banks and the ECB.

The argument of ‘rent or buy‘ is well established, we produced report on it with Peter Stafford (now of the IAVI/SCS) and Frank Quinn of Senior College Dun Laoghaire, but this is different - buy now or buy later isn’t taking the default of renting as an assumed continuous option, rather it is a case of delaying for the sake of market timing.

The changes in tax are on the tax expenditure side, namely TRS (tax relief at source).

Currently it is applicable to a maximum of €10,000 p.a. and the rates applicable are 25% in year 1 and 2, then 22.5% in year 3, 4 and 5 then 20% in years 6 and 7. That is set to change from 2012 whereby the maximum applicable amount of interest will go down by 70% to €3,000 per buyer p.a. with a rate of 15% being applied.

The second issue is about rates, today the papers carried a story stating that PTsb would hike their variable rates by a full 1% and our Mortgage Market Trend Outlook 2011 predicted a 1% increase in variable rates with rates to rest at or north of 5% by 2012.

Then you have the ECB who may well enter the scene as well, they tackle headline inflation as opposed to core inflation and the issue with that is when you have things like rising oil or other commodity prices (currently a large part of the reason Egyptians are overthrowing their government) it causes inflation which they then must address with their single mandate. The Federal Reserve looks at core inflation (then strips out even more to make everything appear rosy!) and has a general economic and now a price target remit.

So with all of these things factored in you might find the following scenario.

Buy today and your mortgage is €200,000 (which will get you a 3 bed semi in any city now)
with a fixed rate of or wait until 2012 for a 10% price drop and do the same thing a year later using a mortgage
of €180,000.

Both terms are going to be calculated over 25 years we’ll take a 5 year fixed in both examples so for the 2011 mortgage we’ll go with 4.39% and the 2012 one will be 5.7% which factors in about a 1% from the Irish banks and 25bps from the ECB.

Gross Costs: 2011             2012
Mortgage        200,000        180,000
Rate                4.39              5.7
Term               25                 25

Monthly         1099              1126

That is already a compelling comparison from a cost perspective but then look at the Net figure when you factor in TRS

2011 mortgage: 200,000 x 4.39% = 8780 x 25% = 2195 pa which is 183 monthly
2012 mortgage: 180,000 x 5.7% = 10,260 but the cut off is 6,000 so it’s 6,000 x 15% = 900 pa or 75 monthly.

The bigger the mortgage the bigger that difference becomes, and inversely the smaller it is the smaller the divergence, but compare net figures now

Net Costs: 2011             2012
Mortgage       200,000        180,000
Rate               4.39              5.7
Term              25                 25

Monthly         1099             1126
TRS                183               75

Net Cost    €916pm        €1,051pm

That’s 135 per month! And that will continue because when we called revenue to research this they confirmed that the person starting on TRS in 2011 will be on the old system (25% yr 1,2 etc) and the person from 2012 will be on the new one for the duration of TRS - which will end in 2017 entirely. The buyer from 2013 gets ZERO!

So it is vital to consider this if you are thinking of buying and not sure whether to buy now or hold off. Do the sums, it may be best to wait, it may be best to move now but you have to know so it is well worth a few minutes with your consultant here to work this out!

We have seen a growing trend in our brokerage of people getting mortgage approvals (mainly first time buyers) and not drawing down, this might indicate some pent up demand in housing - which if it comes will be regular houses as opposed to apartments - or it indicates fear of buying in general.

The thing that is pervasive is the ‘price’ of housing, and the idea is to wait until we reach the bottom. That is a perfectly rational concept, and when you are not purchasing over a long term then the price now (we’ll take from financial market vernacular and call it the ’spot price’ of housing) is the main thing to focus on.

However, that is only one part of the ‘price’ because the majority of new buyers are not buying for cash. The other price is the price of money, the financing costs. We indicated in our annual outlook that banks would, in 2011 alone, increase rates by a further 100bps or 1%, that any bank which isn’t government owned will have variable rates in the region of 5% come the end of the year.

So what does that mean? If you believe in another 10% price drop then do the calculations, or whatever percentage drop you want to use, the proxy is really down to your own belief of where the bottom is or may be. We’ll take a look at a further 10% in a Dublin market (for no reason other than that we are familiar with that market).

A house that is costing €250,000 today falls - in line with the assumption - by 10%, to €225,000 and the person instead (by waiting until 2012 to buy) takes out a mortgage of the same term as a person who buys today.

Our belief that fixed rates will be temporarily removed from the market would lead us to believe that in 2012 a long term fixed rate won’t be available, so the figures will be based on the following:

2011 loan: 90% of €250,000 using a 4.39% rate over 25 years
2012 loan: 90% of €225,000 using a rate that will be c. 5.2% (no fix in line with our projections) over 25 years

Cost of the 2011 loan: 1st 5 years: €82,500
Cost of the 2012 loan: 1st 5 years €80,460

so the net difference - and don’t forget that the person buying in 2012 gets no TRS in 2011 wheras the person in 2011 does, we are not factoring in the rent paid during the year of waiting for a price drop, nor are we considering that rates may go up even more if the ECB move higher.

Equally, don’t forget that the balance in year 5 is vital: for the 2011 loan it’ll be €219,000 for the one done in 2012 it will be €200,000 and in that respect you are onto a winner.

But long term capital differences of that amount (remember that this is skewed on the front end of the loan because we haven’t factored in ‘rent’ nor on the back side because there will be a year when the renter is paying a mortgage during which the buyer is mortgage free) don’t seem to make that much of a difference when you look at it over a 20yr+ term. And of course, several pro-buyer factors have not been included.

The real argument is therefore: should you buy at all or rent? The long term financing costs versus the long term renting costs are below, we factor in a 1.5% increase every year in a rent that starts at €1,000 p.m.

2011 buyer total cost of credit over 25yrs: €376,000+€82,500 = €458,500
2012 buyer total cost of credit over 25yrs: €344,000+€80,500+€12,000* = €436,500
Renter total cost of rent over 25yrs: 331,000
*(we add on €12,000 for rent paid in year 1)

(in this calculation we took the balance at year 6 and applied a 6% rate for both mortgages from that point on in order to make the calculations the same)

So it is clear that buying makes no sense from a ‘cost’ perspective. And that waiting to buy is also a winning strategy even if you get hit with a higher funding cost in one year, but don’t forget the assumptions!

1. TRS is not factored in in 2011 in our figures - and the person buying in 2012 will miss out on two years of TRS at the end of it (2017).
2. The ECB could push up rates and the idea of them settling at 5.2% over the 5yr period for the 2012 buyer could turn out to be fairly conservative.
3. Our example is based on a house in Dublin which has already had significant price drops, if you don’t get your 10% price drop then the calculations here don’t work out.
4. Rent prices may go up by more than 1.5% p.a. We accept that they are heading down now but there is evidence of a floor forming (in cities) and this is likely a secondary rather than secular trend.
5. The renter still has to live somewhere! The buyer will be rent free in 25 years, if the buyer was 30 at the outset then from age 55 to 80 (taking an average life expectancy - which will probably be higher in the future) then you have to add on another 25 years of full rent costs at the end. Even if they saved the difference every month (€600 p.m. and never spent a penny of it) they would have only €300,000 in year 25 and it is unlikely that you can buy a house in full for cash for that price given today’s valuations.

So rent or buy? It’s actually not very cut and dry, we would suggest that you weigh up the odds and make a decision based upon what you want in your life and the cost that is incurred depending on your perspective - the main lesson is that price and cost are two different things they are not the same and you can’t compare ‘value’ on the basis of a headline price alone.

found out that the PRTB was going to increase the price it charged to a landlord to register a tenancy and decided to email them asking for a justification for it (it’s going from €70 per tenancy to €90 per tenancy). Given that a tenant also benefits from the PRTB I thought it would have made sense to have them pay whatever the increase was over the landlords existing bill but first I wanted to ask why it was happening, my email is below

From: Karl Deeter
Sent: 22 December 2010 14:30
To: Registrations
Subject: re: change in pricing

Dear Sirs,

Can you write back and let me know what additional service is being offered in return for the additional fee or is it merely a price increase because you have the ability to do so?
Sincerely,
karl
–
Karl Deeter QFA, (LIAM)dip
Operations Manager

The reply I got is below…..

——– Original Message ——–
Subject:     FW: change in pricing
Date:     Fri, 14 Jan 2011 08:29:12 +0000
From:     Registrations
To:     karl deeter

Dear Sir,

I refer to your e-mail below. This is the first increase in the registration fee since the PRTB was set-up in 2004.

The PRTB is self-financing and is dependent on registration fees for income as we no longer receive an Exchequer grant.

The PRTB receives in the region of €6 million in registration fees each year whereas the operating costs exceed €7 million and it cannot continue to operate at a loss.

The PRTB has taken a number of steps to reduce its operating costs:
·         The staff of the PRTB have had two pay cuts in the past year.
·         All major contracts have been re-tendered publicly.
·         All Adjudicators and Tribunal members are doing additional hearings for the same daily fee.

Yours Sincerely,

Robert Allen
Private Residential Tenancies Board
—————————————————-

‘Costing’ €7 million per annum has nothing to do with a landlord, that is an internal budgeting issue, but unlike a regular business where you could just decide ‘I won’t deal with them because I don’t like their price’, you can’t do that with the PRTB because apart from being mandatory, there are no substitutions.

This doesn’t resolve well with me because if we ran a business that cost more than it brought in then we’d cease operations or have to do whatever it took to bring the service in line with the costs, the PRTB doesn’t have that issue.

The real rub here is that they haven’t even bothered to look at their existence and who their two clients are versus who pays the bill. The two clients are tenants and landlords, but only the landlord has to stump up the cost - the tenant who pays nothing stands to benefit only. In fact, the landlord who doesn’t pay is crippled because in any dispute the PRTB will represent the tenant for free and won’t engage with the landlord due to their failure to pay the bill.

Let us suspend reality briefly to enter into this world of cost being an arbitrary concept. The ‘cost’ of the PRTB is €7m+ p.a. but they only take in €6m so that is a deficit of about 14%, alternatively you could say that they need about 16.66% more in order to break even (€6m+ 16.66% = €6.99m).

So why has the price increased by 28.5%? That will bring them from €6m to €7.7m - and this at a time when they have apparently cut costs, the €7m+ figure is historic and for that reason the benefit of a full years cost reduction will only come through in 2011. It just doesn’t stack up, it doesn’t make sense and the maths behind it are wrong.

This one sidedness is disappointing and only made worse by the fact that a toll has been erected on only one side of the bridge (always whichever side the landlord is on). This is how a tax is introduced then driven up - and in time I expect they will rise their price again because of their ‘costs’, if only state agencies could come and work in the real world where an inability to cut your coat according to your cloth actually means something.