Dublin buy-to-let market showing signs of value

The sharp fall in Dublin house prices compared with the country, and rental rates that have remained relatively stable, mean Dublin yields have overtaken those elsewhere

Thu, Sep 5, 2013, 00:00

After five-and-a-half years of uninterrupted gloom the housing market is showing signs of recovery with prices up 2.3 per cent in the past 12 months. Welcome as this is, closer scrutiny shows that the recovery has largely been confined to Dublin where prices, according to the latest Central Statistics Office figures, rose by 3.3 per cent in July alone.

Given that nearly three quarters of Irish homes are located outside the capital, this is a major caveat and many commentators are now speculating that a two-speed market is emerging with Dublin, and prime areas of Cork and Galway, permanently decoupling from the broader national market.

In all of this debate, however, the fact that the Irish housing market has been quietly dividing along an entirely different axis has largely gone unnoticed. In recent years there has been a pronounced shift from the traditional model of owner occupation towards renting.

This trend may provide the best indication of how regional house prices are likely to evolve in the future.

Between 2006 and 2011 the number of households in rented accommodation rose 47 per cent. This can partly be explained by demographics – during the same period there was a 30 per cent increase in residents from overseas. And given that newly arrived migrants are unlikely to immediately buy property, one consequence has been increased rental demand.

Strategic choice has also been important. In recent years some households have opted to rent rather than risk capital losses by buying in a falling market. Finally, and most regrettably, a third reason for the swing towards renting is that some households are being driven out of home ownership by financial distress.

Taken together, these factors have underpinned the demand for rented property, and this is reflected in rents. As shown in Figure 1, although residential rents fell during the crisis, they declined by only about 20 per cent in Dublin and provincial locations.

Moreover, rents have been stable across the country since 2011. In contrast house prices have declined much more sharply and continued falling long after rents had stabilised.

This divergence reflects fundamental differences between the rented and owner occupied markets. Whereas renters are largely indifferent to changes in the value of the properties they inhabit, owner occupiers are highly sensitive to capital appreciation. Clearly, negative price expectations contributed to a deflationary spiral that helped propel house prices lower during the crisis. A second fundamental difference is that owner occupiers, unlike renters, require considerable capital to get started.

As household balance sheets weakened and credit tightened, financing the purchase of a home became increasingly difficult, particularly in Dublin where prices are higher. This also contributed to prices falling more steeply than rents, and to prices falling more steeply in Dublin than elsewhere.

Gross yields
With prices having declined more rapidly than rents, gross yields (the rent that a property could hypothetically generate, expressed as a percentage of its capital value) have risen sharply. This is what we would expect – yields on most assets drift upwards in a weak economy as buyers build greater provision for risk into their pricing.

What we would not expect, however, is for Dublin yields to be higher than those pertaining elsewhere in the country. Yet, based on these regional averages, that is exactly what we now find. Because rents fell by a similar amount everywhere, but house prices fell more sharply in the capital, Dublin yields have overtaken those in the rest of Ireland.

In essence, this means that residential property in Dublin is trading at a discount to that in the rest of the country. This contradicts the theory that strong underlying demand for more centrally located properties will ultimately drive up prices and push down yields. It also jars with the empirical observation that yields in Dublin have traditionally been lower than those elsewhere in the country.

In the medium term, therefore, market forces can be expected to restore the natural order. All else being equal, property prices would need to rise by more than 12 per cent in Dublin to drive yields back below those in provincial locations. Indeed, if rents in Dublin start edging up as suggested by recent data from Daft.ie, a bigger price increase would be required.

Alternatively, the natural order could be restored by a 10.7 per cent reduction in provincial house prices. Given current trends, however, the most plausible scenario is that the adjustment will come from both sides. That is, irrespective of the potential for additional supply to come on-stream through loan book restructuring, the recent increase in Dublin property prices looks set to continue. Meanwhile provincial markets outside the prime locations in Cork and Galway are likely to remain under pressure.

John McCartney is director of research at estate agents Savills

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