Property affordability the highest in at least 10 years, so why are mortgages for First Time Buyers at a record low?

By reference to mortgage repayments as a % of take-home salary, Irish property has not been as affordable as today since at least 2006 according to EBS/DKM Consultants. Below is an exclusive chart of mortgage repayments as a % of average gross salary since 2000.

Notes:

Average National House Price is taken from the Permanent TSB/ERSI.

The ECB central bank overnight rate is taken from the ECB. The mortgage was assumed to be 92% LTV, 25 years, interest rate of ECB + 2%, 25% mortgage interest relief, repayment mortgage.

The average wage is sourced from the CSO who have published average weekly wages since Q1, 2008. The last report for the CSO is for Q3, 2009 and I have assumed the average wage has stayed at that level to the present. Because average wages were not produced except by sector before 2008, I took the Q1, 2008 average wage and adjusted it to reflect movements in the average civil service wage between 2000-2008. Eg average wage in Q1, 2008 was €704.28. The average civil service wage in 2008 was €916.06. The average civil service wages for previous years were €877.76 (2007), €838.35 (2006), €795.87 (2005), €744.24 (2004), €681.03 (2003), €656.19 (2002), €633.10 (2001), €573.57 (2000). In 2007 I took €877.26 divided by €916.06 and multiplied by €704.28.

No account is taken of income tax or other deductions for the years shown.

The decade started out with the % just below 35% and rose to 45% in 2001 and fell back to 40% until 2006 when it began to rise strongly to over 50% in 2008 before steeply falling back in late 2008 and 2009. We end the decade considerably below the start of the decade or any point since. There can be little doubt that mortgages are more affordable today than for a very long time.

And yet statistics on mortgage draw downs indicate that demand for housing via mortgages is at the lowest level by volume since records began in 2005. Curious, but why?

The simple answer would appear to be the perception that property has still some way to drop, 10-50% from current levels according to a range of current estimates (S&P, Moody’s, DKM, Brian Lucey, David McWilliams, Morgan Kelly) which prompts fears of negative equity, being stuck with a liability in an illiquid market and the loss of wealth. Although property dropped by “only” an average of 1.6% nationwide for the first three months of 2010 according to Permanent TSB/ESRI, that’s still a monthly drop of over €3,000 equivalent on an average property and is almost 1.5 times average month take-home pay. The other financial reason is that on average it would appear to make better financial sense to rent than to buy.  In such circumstances it is surprising that there is any activity at all though in the markets there are always bargains, priced below the average, and buyers may place significant value in non-economic factors (eg the loss of control with long-term renting).

However there is also a perception that wages will drop, non-income taxes will rise, the income tax burden will rise on the lower paid and that interest rates will rise. The table below examines the impact on an average wage earner (average wages taken from the CSO in Q3 of 2009, the latest available). The scenarios outlined are all probable to some extent and it is indeed possible that all four scenarios may come to pass which would cut by more than half the disposable income available to the average wager earner and would push mortgage repayments back to 40% of gross salary, much the same as the rate for most of the noughties.

Scenario 1 – The Patrick Honohan scenario – a 20% reduction in gross wages to bolster competitiveness. Calls for wage reductions have been called for, from many quarters though academic research has sought to show that current wage levels are not a drag on competitiveness.

Scenario 2 – The Fiscal tightening scenario – property tax, water taxes, VAT on local authority services. The average Greek property tax is €300 per annum. John Gormley has talked about water rates costing €1,000 per annum. Richard Bruton has estimated that the cost of applying VAT to local authority services eg bin collection, adds €200 per annum to the tax-take per individual.

Scenario 3 – The Constantin Gordgiev scenario – a flat 20% tax rate. Whilst I understand that the intention of a 20% flat rate tax was to attract high salary jobs and candidates, I have assumed a removal of tax credits (effectively a tax free allowance of €9,150 annually) which chimes with noises from the government that the tax net should be expanded and everyone should make a contribution. This scenario benefits those earning over €41,000 – that’s the tipping point when the 2% income levy + 20% of €36,400 + 41% of excess over €36,400 minus tax credit of €1,830 > 20% of the gross.

Scenario 4 – The end of historically low euro interest rates – interest rates rise from 3% today to 6%

Scenario 5 combines all the worst elements of the first four scenarios.

So for the average person, a 20% reduction in nominal wages would have the greatest impact (reducing “disposable wages” by 27.7%) followed by a doubling in interest rates which would reduce “disposable wages” by 13.1%. If all four scenarios were to come about then the average disposable wage would drop by 55.9% and would leave the worker with €667 per month.

Lastly whilst there are no reliable statistics available on mortgage applications versus approvals, anecdotally availability of credit has dropped, partly because of banks having difficulty access funding and partly out of concern that property may drop further in value and that the bank will incur a loss on a negative equity loan.

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Maybourne Hotel Group – in or out of NAMA?

Although identified as potentially NAMA-bound, it was reported over the weekend in London’s Daily Mail and Times that the Maybourne Hotel Group (backed by Derek Quinlan, Paddy McKillen and others) is working to refinance a reported €500m of Anglo and Bank of Ireland loans ahead of a December 2010 deadline. Deutsche Bank has been identified as one of possibly up to ten banks being talked to about finance.

The Maybourne owns Claridges, the Connaught and Berkeley hotels in London. Although the hotels are not in themselves development properties they have been described as associated assets financed by NAMA banks of developers who are expected to transfer to NAMA (Derek Quinlan and Paddy McKillen are claimed to have been amongst the top 10 developers transferred in tranche 1). If the hotel group secures refinancing from non-NAMA banks then its assets will fall outside the scheme unless they have been used as security/personal guarantee for NAMA eligible loans.

UPDATE: 18th June, 2010. Simon Carswell at the Irish Times reports uniformly positive noises from Maybourne and “Coroin, the firm which trades as the group” whose spokesperson says that talks are at an advanced stage for refinancing loans held by Maybourne with NAMA banks. “Imminent” with due diligence under way, said the spokesperson for Maybourne in relation to the financing adding in respect of the existing loans “They are fully performing and no covenant has ever been breached. The Irish banks will be repaid in full once the refinancing is complete and we expect this to be significantly ahead of the December deadline”. The clock is ticking in respect of the second tranche of loans and given that these loans were supposed to have been transferred several months ago (though thanks to the EU, NAMA and the banks – not the developers, there were delays), some curiosity in this transaction might be justified.

UPDATE: 2nd August, 2010. Whilst it seems that there is a frenzy of activity at Maybourne to secure external funding, most recently from Westbrook Partners and another unnamed, though identified by the Telegraph as a US property trust, party there is some confusion over NAMA’s involvement in Maybourne with the Irish Independent today claiming that NAMA is a shareholder in the Maybourne group alongside litigating Paddy McKillen, Derek Quinlan and others. How NAMA could have become a shareholder is unclear.

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