So with lower house prices you make big savings right?….erm…kind of…

something amiss in the irish marketThere has been much talk in the papers from many respected sources giving people the message that ‘now that prices have dropped its a good time to buy’. I think that the true nature of what purchasing a property boils down to needs to be examined before such a statement can be shown to be true or false.

Firstly you have to look at what you are actually getting and then you have to consider what it will cost you over the long term and do a like for like comparison for the same time last year, I think that not using 2007 as a control is one fundamental flaw that commentators are making because you can’t simply look at something and say that because its cheaper today it makes sense, if you do happen to believe that please call me immediately as I happen to have some cans of dog food that I was selling for €600 last year but you can have them at a steal for €300, but hurry, they’re going like hotcakes!

Anyway, moronic inklings aside, we will take a look at a property that was for sale in 2007 and then at what it would fetch today and you will see that just because the prices has come down it doesn’t mean it’s ”cheaper” because so much has changed in finance since then, our basic premise is that by looking only at property prices (which are just one part of the equation) you don’t get the full financial picture, it would be the same as thinking that a big SUV is cheaper in 2008, on the face of it they are but petrol is much dearer and you can’t have one without the other, this type of hand in hand relationship of cars and oil is as equally intertwined as property is to interest rates.

market clearing price in propertySo let us take a look at a comparison between a person who is buying a property today for €50k less than they did in 2006, the price we will use is €300k in 2006 and €250k today, in order to compare like for like I have to assume similar leverage on each as a percentage, in this case (to keep the equation and concept simple) we’ll say that each time the person borrowed the full 100% amount even though 100% mortgages are not available any more, really this is just to give comparative mathematics.

We’ll also assume 25 year terms in both examples, and to give a relevant comparison we’ll say that the rates quoted are for the full term of the loan (we all know that rates change but in order to compare them we need constants), so without further delay here is the breakdown.

A €300k mortgage in 2006 at a rate that would have been common back then (4.1%) would cost €1,449 per month. Today a loan for €250k at a rate of 6.2% would cost €1,531 per month, which is €82 more than the other loan. That might not seem like much month to month, but it adds up to €984 per year, and that figure is even more impressive when you look at the impact it has over the life of a loan, the difference in total payments – even though you are buying the place for less – is €29,368 more paid on the cheaper place! So it may cost more to buy a cheaper house!

Not something you will hear in the papers!

pain of adjustment in financial marketsNow let us look at another example, that of the ‘you can’t go wrong now that prices have dropped so far’ theory. In this case we’ll assume the same rate (6% but any rate would do because they are both going to use the same one) and same term, again 25 years. In one example Joe Bloggs holds out for another 6 months and buys a place for 5% cheaper. For the sake of the numbers we’ll say that today you could get a place for €280k and that in 6 months you could get the same property for €266k (5% less than €280k).

The total cost over time (capital and interest all added up) in the first example is €541,213, if you were to get a comparable property for 5% less (at €266k) then the total cost would be €514,152 which means you would be better off to the tune of €27,061. If you were renting all that time you would have spent (assuming you pay c. €1,000 per month-could be less if you are sharing) an additional €6,000. All said you would still be €21,061 better off if you held out for a few months.

Then of course there is that old nugget the investor market, we’ll assume that you can buy a property for €520,000 that earns €1,600 per month (just a random property and rent figure taken from daft in John Rogersons Quay) which is a 3.6% return. Official figures by Davy Stockbrokers put the average yield at 3.9% so this figure is not too far out of line with that. If you put your money on deposit instead of taking out a mortgage you could earn up to 5% (with postbank for a similar risk undertaking). That is before you factor in ‘opportunity costs’ such as stamp duty etc.

So whats the answer? It’s truly simple, prices must come down, they must come down to the market clearing level and the only way to do that is for people to accept the pain and move on with things, the market we are in is not abnormal, rather, it is the market that preceeded this one that was abnormal and now we are adjusting back to a sensible one. No bailouts are actually required, it is common sense that is required and until that permeates every facet of the market we will remain at an impasse.

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