The Profile of an Investment in Property in Dublin and Its Dramatic Changes - Research Paper Example

Introduction Dublin, the capital city of Ireland happens to be the prime engine of employment as well as all economic activities in the Ireland. Dublin is equipped with a highly skilled workforce as more than 50 per cent of Ireland’s university graduates are in Dublin. Economy of Dublin largely depends upon the service industries that include but are not limited to the financial services sector, and the tourism sector. In the contemporary age, Dublin qualifies as a global city as it has been a center of international trade and investment for the past few decades. Dublin had been doing quite well since the start of the 21st century in that it gained the attention of a lot of international investors of residential property. Market for the residential property in Dublin started to decline around the mid of 2006, and continued to decline until the circumstances worsened till the end of 2007. However, with the onset of the global financial crisis, the investment in residential property in Dublin went very low under the influence of a multitude of factors that included but were not limited to the increased rate of unemployment, lack of funds, and decline in the number of foreign investors. “Draconian cuts [introduced] in public spending [since the onset of the global financial crisis] and an ongoing decline in revenue will continue to have a serious impact on the city’s budget for some time to come” (Guidoum, 2010, p. 3). Investment in the Residential Property in Ireland from 2001 to 2012 The boom in the price of residential property in Ireland was one of the biggest booms ever experienced in Europe. This can be estimated from the fact that the prices of second-hand homes in Ireland increased in the decade between 1996 and 2006 by 330 per cent. In Dublin, prices of new homes increased by 318 per cent in this decade while those of the second-hand homes raised by 391 per cent. Several factors contributed to the boom in the price of residential property in this decade that included but were not limited to rapid economic growth, generous tax incentives, increased immigration, and government subsidies. Funds were made readily available to the prospective investors from banks upon loose credit conditions and low rates of interest. Boom in the price of property in Ireland and specifically Dublin started to recede as hikes in the interest rate started to show up in the year 2006 and 2007. As a result, it became very difficult for the leaving borrowers to pay off their debts which laid the basis of a crash in the housing market. The US subprime mortgage crisis between 2006 and 2007 that paved way for the onset of the global financial crisis in the year 2008, aggravated the problems for the investors manifolds and it became nearly impossible for the Irish banks to make up for the losses thus made. Numerous organizations and agencies have been held responsible for the crash of property price in Ireland that include but are not limited to the Financial Services Consultative Consumer Panel, and the Construction Industry Federation. The bubble burst with the onset of the global financial crisis in 2008. Just like the boom of property price in Ireland was the biggest in Europe, the burst of the bubble was also the biggest ever seen across the world. “It has been longer than a typical housing market downturn, marking its 5th year of falling prices this year (2012), in contrast to the typical crash range of four and a half years suggested by OECD research” (Global Property Guide, 2012). For the last five years, the downturn of property in Ireland has sustained, and has shown a net decline of 53 per cent from the peak in the first quarter of the year 2012. In June 2012, the number of properties in the Irish market summed up to 53000 units that were 63000 units at their peak. “OECD research suggests that the typical housing market downturn lasts over four and a half years, so the crash is already longer than the usual one. Not only is it longer however, it is also sharper” (daft.ie, 2012). Investment Criteria of the Investors There are a multitude of investment criteria that are considered by the interested investors. One criterion is identification of the population that would like to rent the property depending upon the tenant type preferred by the investor (Moving.ie, 2009). The population can range from professionals to students and families. Cost of property is a very important criterion of investment. Investors tend to invest in the property at a time when the price of property is low so that there is room for more profitability once they are interested in selling the property at a later point in time. Investors also consider the ease of renting, and whether the rent service would mortgage. Impact of the Global Financial Crisis on the Property Investment in Dublin Ireland was the first country in Europe to be hit by the economic recession since the onset of the global financial crisis. Dublin, the capital of Ireland offered the worst prospects for investment in the real estate among all main urban markets of Europe in the year 2009. Results of an annual survey conducted in 2009 based on the responses of 520 professionals of real estate indicated the last rank for Dublin among 27 European cities when they were evaluated for the abundance of opportunities of development and property investment (Packard, 2009). The survey also identified Dublin as the second to last riskiest market. The researcher Investment Property Databank based in London declared that the values of commercial real estate in Ireland went down by 24 per cent in one year between 30 September 2008 and 30 September 2009. The rate of unemployment in Dublin which was only 2.6 per cent in the year 2000 reached 10.8 per cent by the end of the year 2009 (Guidoum, 2010, p. 3). In the period starting late 2007 and ending early 2010, the economy of Ireland declined steeply. In March 2010, as many as 146 companies in Ireland became insolvent, and Dublin accounted for more than 40 per cent of these insolvencies. As the housing market collapsed and the economic growth of Ireland became slow as a result of limited lending of funds by the banks, the demand of commercial space was reduced. According to PwC’s head of the real estate, John Forbes, “[The Irish] were the longest at the party and now have the biggest hangover. We’re moving from a capital market crisis to an occupier crisis” (Forbes cited in Packard, 2009). In 2009, the value of both the commercial and residential buildings in the European cities fell under the influence of the global financial crisis, which made it difficult for the tenants to pay their rent. The slide noticed in the values of property deterred the investors holding cash. Slump in the capital markets and decreased prices of oil brought a decline in the investable money by the sovereign wealth funds. Besides, the institutional investors like life insurance agencies and endowments were also reluctant to increase allocations for the real estate. 2009 was a very challenging year for the investors who had purchased the real estate in Dublin when it was at its peak and were totally dependent upon the debt to manage the finances. In a report generated by Karl Deeter about the suitability of time to invest in the property in Ireland, it was mentioned, “The news is not positive, we have determined, using our valuation methods; that property as an investment is still unattractive in the spring of 2010, in order for it to make sense prices would need to fall significantly in our major cities in the range of about 39% on average” (Deeter, 2010). The crash of the residential property in Dublin that commenced with the global financial crisis caused a large expansion of the rent offers. Within just two years between August 2007 and August 2009, the number of units available for rent increased from 6200 to 23400 respectively. In Dublin, rents are increasing modestly. So far in 2012, the rents of residential property in Dublin have remained about 30 per cent lesser than what they were at their peak. However, in the first quarter of 2012, West County Dublin, and South Dublin City saw a 2 per cent increase of rent as compared to the rent of 2011, though hardly any change of rents has been noticed in the remaining parts of Dublin from 2011 to 2012. Availability of Finance for Investment in Property in Dublin “The [European Central Bank] ECB’s decision to cut its key interest rate by 25 basis points to a record low of 0.75% in July 2012, is expected to push Irish rates down” (Global Property Guide, 2012). In spite of the low costs of borrowing, the tendency or willingness of the Irish banks to lend money for the purchase of residential property has declined as stricter criteria have been implemented. Almost 31 per cent of all outstanding mortgages in the year 2010 were in negative equity, and this percentage raised to 47.5 per cent till the end of the year 2011. With the key drop of interest rate proposed by the ECB, the Irish interest rates are expected to decline in the coming years. In 2011, the average rate of interest was 3.30 per cent for the initial rate fixation (IRF) of a year, and this interest rate went down to 3.05 per cent by May 2012. According to the Central Bank of Ireland, lending for the purchase of residential property has decreased by 2.5 per cent since the start of 2012 till May 2012 in spite of the low rates of interest. There has occurred a continuous decline in the outstanding housing loans in Ireland. The outstanding housing loans which were €125.1 billion in the first quarter of the year 2008 have now declined to €79.874 billion in the first quarter of the year 2012. In 2010, the lending of residential mortgage in Ireland was 64 per cent of the GDP and it dropped to 51 per cent at the end of the year 2011. Low lending of the mortgage by the financial institutions partly occurred as a result of reduced flexibility of the credit standards and a decline in the demand of loans in the first quarter of the year 2012 during which, the loan-to-value ratios remained more limiting and the loan maturities were reduced. Collapse of the residential property market in Ireland since the onset of the global financial crisis has placed the Irish banks under heavy load of bad debt. In November 2010, Ireland sought a bailout worth €67.5 billion from the International Monetary Fund (IMF) and the European Union (EU) in an attempt to keep the banking sector from collapsing. Ireland committed to undergo the harshest austerity program of Europe to control the increasing deficit as an exchange for the bailout. “[T]he volume of transactions will continue to be constrained by the lack of quality assets being offered for sale and fears around the legislative change on upward only rent reviews, which will undoubtedly deter some investors” (Hunt cited in O’Connor, 2010). Is this a suitable time to invest in residential property in Dublin? The Operations Manager of Irish Mortgage Brokers wrote in the Spring 2009 report of the residential property investment, “Residential property does not look good as an investment option in the current market. Falling rents, declining property prices and changes in both lending and taxation policies have combined to bring enthusiasm and confidence in this sector to all-time lows” (Deeter and Quinn, n.d.). The investment landscape for the residential property in Ireland and Dublin has not changed much since then as the prices of property are much higher than the sustainable values. The asking price average in Dublin today is €310,089 compared to €1,070 which is the average renting price. The range of investment method in Dublin is from €151,268 to €176,585 while the range of price of the discounted cash flow is €224,684 to €256,293. The current rate of return is 3.87 per cent considering the increase of rent per annum equal to 1 per cent. 3.87 per cent is a high rate of return in Dublin that is based on the assumption of increase of rent in the coming years. In spite of this assumption, Dublin’s rate of return is lower than the risk free rate of the 10 yr treasury of Ireland i.e. 4.4 per cent. This is why it does not succeed in taking risk for reward. The investment purchasing with the existing rate of return in Dublin cannot be justified unless the risk free return of the property is beaten by 50 per cent as the property in Dublin as well as all major cities of Ireland is presently overvalued by as much as 20 to 50 per cent. “[R]esidential investment property is overvalued currently by an average of 37% in Dublin, 43% in Cork, and 39% in Galway” (Whelan, n.d.). Prices of the property need to considerably decline in order to gain the attention of wise investors. According to the statistics recorded by the Central Statistics Office Ireland, from January 2012 to May 2012, the index of national residential property price has remained low by 15.27 per cent, thus causing the housing market in Ireland to remain in a deep slump. The Central Bank recorded undervaluation of the house prices from 12 per cent to 26 per cent till December 2011, and still this could not keep the house prices from declining. “The national average asking price for residential properties fell to €172,000 in Q2 2012, 53% below the 2007 peak of €366,000, according to Daft.ie. The asking price index fell by 13.9% during the year to June 2012” (Global Property Guide, 2012). The high rate of unemployment, deleveraging, low fiscal confidence, and weak commercial property are amongst the most significant obstacles of international growth in Dublin for many years to come, though the existence of these factors is certainly not indefinite. Growth of residential property investment in Ireland will be impressive once these factors recede. The Irish government had started taking measures to tackle these challenges since the impact of the global financial crisis on the value of property and profile of investment in it started to show up. “Investment activity so far in 2010 has been considerably stronger than 2009 with increased appetite from private, domestic investors dominating demand for smaller lot sizes. The profile of investors interested in the Irish market includes institutional investors, property companies, opportunity funds and private investors from the UK, Germany, the US and the Middle East” (O’Farrell cited in Clancy, 2010). However, since the fundamental destination of the market economies is to expand, it cannot be said with utmost surety when and how the growth of residential property in Dublin returns. Considering the overdevelopment and the economy’s demographics, the first to return will most probably be the second-hand market. Nevertheless, future bears many opportunities for prudent investors that make use of objective valuation methods, are watchful of the financing costs, and have the guidance of professional advisers in Dublin. Conclusion The profile of investment in property in Dublin and the profit made from it has shown dramatic changes from 2001 to 2012. The period from 2000 to 2007 is known as the bubble years to signify the massive increase in the value of property all across Ireland and specially Dublin, whereas the period from 2007 to 2012 is known as the bubble burst period owing to the massive loss incurred by the investors as well as the debt lending institutions in Ireland. In the first half of the year 2009, Ireland was hit by a property price crash that was predicted in several reports generated in 2006 and 2007. The very initial signs of recession in the property market in Ireland appeared around the mid of the year 2006. The situation aggravated in the second quarter of the year 2007 when the prices of the property started to fall, and the recession reached its apogee around the end of the year 2008. The crash in property price in Ireland started with the rise of global financial crisis in the late 2008. Till June 2009, the loss of price escalation had reached about 40 per cent of what it had been between 2001 and 2007 which are remembered as the property bubble years. House prices in the year 2012 have fallen below what they were in 2001 and the loss is more than the whole profit gained during the property bubble years. The global financial crisis has affected Ireland in general and Dublin in particular very badly. Dublin fundamentally relied on profits made from construction and development in the city and the financial services both of which were adversely affected during the global financial crisis, and yielded potentially risky circumstances for the citizens. Since 2010, the rate of unemployment in Dublin has increased though at a slow rate. Currently, the whole of Ireland and particularly Dublin are exposed to numerous challenges including problems of the labor market, and high rate of unemployment. Loans are not easily retrievable from the banks or other financial institutions for investment in property. Thus it requires not only a significant amount of capital for the investors to try their luck in Dublin at present, but also they have to bear a lot of risk. This is certainly not a very suitable time to invest in the property in Dublin, and for the next few years, the credit standards regarding loans are likely to become more restrictive particularly for the purchase of residential property. However, Ireland is making very hard effort to come out from the consequences of the global financial crisis, and hopefully, within the next five to six years, the situation will be significantly different and opportunistic for the prospective international investors in Dublin. References: Clancy, R 2010, Irish property investment sector much improved since 2009 but outlook still subdued, Investment International, [Online] Available at . Daft.ie 2012, Taking stock of Ireland's property market, five years into the crash, [Online] Available at . Deeter, K, and Quinn, F n.d., Residential Property Investor Report, Third Quarter 2009, [Online] Available at . viewed, 12 August, 2012. Deeter, K 2010, Irish Property Investor Report: Spring 2010, [Online] Available at . Global Property Guide 2012, Housing slump in Ireland continues, [Online] Available at . viewed, 12 August, 2012. Guidoum, Y 2010, URBACT cities respond to the economic crisis: Dublin, [Online] Available at . viewed, 12 August, 2012. Moving.ie 2009, Buying Investment Property In Ireland - The Basics, [Online] Available at . viewed, 12 August, 2012. O’Connor, F 2010, Irish investment property declines 60 percent – report, Business and Finance, [Online] Available at . viewed, 12 August, 2012. Packard, S 2009, Dublin 'worst value' in Europe for property investment, Independent.ie, [Online] Available at . viewed, 12 August, 2012. Whelan, K n.d., Residential Property Investor Report, The Irish Economy, [Online] Available at . viewed, 12 August, 2012. Read More