Wednesday, October 29, 2008

House prices should be equal to between 12 and 14 times earnings

In the US, analysts claim that, in the long run, house prices should be equal to between 12 and 14 times earnings. This means that if a house is generating a rent of $10,000 a year, it must be worth between $120,000 and $140,000 a year.

Apply this test to Ireland. A quick search of Daft.ie will reveal, for example, that a three-bedroom house in Co Wicklow - advertised as an investment property - is on sale for €289,000.

The same website tells us that the average rent for a three-bed in Arklow is €850. So let us say that, in the best possible case, this place is rented for 11 profitable months a year - the final month’s rent goes on various costs. The implication from the American model is that the house is worth about €122,000.

The implication from this, compared to the advertised price of €289,000, is that the house is still wildly overvalued. The Irish calculation means that the house is trading at 31 times its annual yield. This clearly needs to fall dramatically by close to 60 per cent for it to make any financial sense to buy.

So one of the factors impinging on Ireland’s recovery is that we have to see house prices fall dramatically for any investor in their right mind to get back into the market. As long as estate agents, banks and builders are in denial about where prices need to go, we will not have a platform for any recovery.

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