Approach property deals with care
14 September 2008
By Kathleen Barrington
For any special offers in the housing market to be considered good value, prices will have to drop further.
The decision by some property developers to slash the price of new homes grabbed the headlines in recent weeks and may have lulled some prospective buyers into believing there is now good value to be had in the property market.
But buyers should scrutinise these special offers before signing on the dotted line. For the fact that a property developer cuts prices does not of itself mean that the property represents good value in the current economic and financial climate.
Take the case of property developer Ray Grehan for example. Grehan grabbed the media limelight when he announced earlier this month that he was now selling two-bedroom apartments at the Grange in Stillorgan, Co Dublin at 2005 prices of 525,000.
Grehan has shaved about 60,000 off the asking price, down from a high of about 585,000 at the height of the property boom according to Grehans auctioneers Savills. That is equivalent to a 10 per cent price cut.
In addition, Grehan also offered buyers an interest-free loan worth 15 per cent of the value of the property for up to seven years. The rest of the purchase price could be raised with a 5 per cent deposit from the buyer and a mortgage worth 80 per cent of the purchase price from a bank.
The special offer generated lots of free publicity for Grehan as journalists devoted loads of space and airtime to explaining the complexities of the deal. It also appears to have boosted viewings of apartments at the Grange, according to press reports.
The Insider is a great believer in transparent pricing and our initial instinct would be to run a mile from this deal on the basis that it is unduly complex.
But lets crunch the numbers and see. Assuming a buyer wants to buy one of Grehans apartments for 525,000, the buyer needs to produce a 5 per cent deposit of 26,250. The buyer can borrow 15 per cent of the purchase price, ie 78,750 interest-free from Grehan for seven years.
The buyer then needs to fund the remaining 80 per cent of the purchase price by raising a mortgage of 420,000.
The buyer would have to shoulder mortgage repayments of 2,814 a month if the mortgage was repaid over the traditional 20 years, though this could be reduced to 2,499 if paid over 25 years and 2,173 a month over 35 years. The figures assume a mortgage interest rate of 5.20 per cent.
The figures obtained from Simply Mortgages do not include the benefits to the borrower of mortgage interest relief (about 4,000 a year for a first-time buyer couple) or the costs to the borrower of house insurance, life assurance, property management fees and property maintenance (likely to amount to several thousand euro combined).
At the end of year seven, the buyer would still have to pay Grehan back his 78,750 either from savings, from remortgaging the property or from the proceeds of any sale. It is not clear what the cost of a mortgage might be in seven years time or even whether a mortgage will be available - just one of the things that make this deal hard to assess.
But one way of estimating the cost of repaying Grehan is to work out how much you would need to save each month to pay him back in seven years time.
Calculations supplied to us by a leading bank suggest you would need to save 769.70 a month to have 78,750 seven years from now. The figure assumes you save in a deposit account offering a 7 per cent interest rate.
All these saving and borrowing costs have to be weighed against the cost of renting the apartment for as little as 1,400 a month, according to figures supplied by property website Daft.ie which tracks rents in the property market.
Indeed, Naoise McNally of Daft calculated the yield on an investment in the Grange at just 2.9 per cent (the yield is calculated by taking 11months average rent and expressing it as a percentage of the purchase price). Even assuming a higher rental income of 1,600 a month, the yield works out at just 3.3 per cent.
Given that these yields are lower than the borrowing costs of 5.20 per cent, given that inflation is running at 4 per cent and given that many banks will pay 6 or 7 per cent for deposits, the idea of settling for a yield of just 2.9 or 3.3 per cent seems daft - all the more so when few observers consider capital appreciation to be likely in the next few years.
Based on rental assumptions in the 1,400 to 1,600 a month range, the Insider reckons property would need to be priced in the 250,000 to 300,000 range to deliver an even minimally acceptable yield of 6 per cent. That is a long way off the 525,000 at which the apartment is currently on offer.
Of course, the decision to buy a property is not exclusively about money, particularly for people who plan to live in it. And some may be prepared to pay over the odds for a good location on good public transport with all the facilities including a swimming pool on offer at the Grange.
Even so, the deal on offer at the Grange could hardly be described as compelling in the current economic and financial climate.
Like many other developers, Grehan appears to believe that by shaving the price of a home and offering prospective buyers gimmicks such as interest-free loans they will be able to shift unsold property off their books.
They have failed to understand that the economic and financial environment has changed utterly in the last 18 months or so and that buyers will no longer be as easily seduced.
For starters, prospective buyers are more cautious because they are worried that their jobs are less secure than they once were, particularly if they work in any sector that is dependent on construction. They know that they are likely to be hit with stealth taxes in coming months as the government seeks to plug the hole that has been blasted in the exchequer finances.
The world has also changed in that the cost of finance has soared, while the rates available to depositors are ahead of inflation. Many people piled into property a few years ago while deposit rates were below inflation and below the cost of borrowing.
But now deposit rates are far more attractive, leaving potential buyers the opportunity to rent cheaply and save the difference with the possibility that their money will go further in the property market in future years if property prices continue to fall or even if they remain static.
And finally the herd psychology has changed. Prospective buyers have smelled blood. They know they have finally got the property developers over a barrel and they are savouring every moment of it. My guess is they will be waiting for Grehan to slash his prices further before they even consider buying at the Grange.
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Originally Posted by Supermanpolitician