Why property prices in terms of multiples of average salary doesn't work:

nesf · 22-03-2010 03:10AM #1

So, a lot of the time you'll see numbers like 3 or 4 being bandied about as the correct property/earnings ratio which we should see a correction to. This just doesn't work for a very basic reason. The ratio is dictated by two things, the degree of inflation (i.e. are we in a bubble, a contraction or whatever) and current interest rates. With high interest rate periods like the 70s and 80s in Ireland, you have low ratios. With low interest periods like the 90s and 00s, you have high ratios.

Averaging over the past 30-40 years and saying "this is the ratio the market will correct to" does not work. You can't decouple property prices from interest rates and interest rates over the last 30 years have varied quite a bit from the high teens to under 5% in much of the developed world.

If anything remains constant it's the proportion of earnings paid out in repayments on mortgages (or the ratio of repayments to rents). If you talk to people who bought their homes in the 70s or 80s, the house didn't cost that much but the mortgage hit their pay packet very hard. Similar to what happens now. And even this is imperfect since over the past 50 years the % of disposable income has changed in developed countries as a % of net pay quite a bit as food prices fell etc.

BostonB · 22-03-2010 03:24AM

Theres an element of common sense to be applied here.

You work on worst case scenerio. Could I pay this if I/my partner lost their job, salary was reduced, couldn't work, or interest rates, doubled, tripled.

Dob74 · 22-03-2010 08:38AM

nesf wrote: »

So, a lot of the time you'll see numbers like 3 or 4 being bandied about as the correct property/earnings ratio which we should see a correction to. This just doesn't work for a very basic reason. The ratio is dictated by two things, the degree of inflation (i.e. are we in a bubble, a contraction or whatever) and current interest rates. With high interest rate periods like the 70s and 80s in Ireland, you have low ratios. With low interest periods like the 90s and 00s, you have high ratios.

Averaging over the past 30-40 years and saying "this is the ratio the market will correct to" does not work. You can't decouple property prices from interest rates and interest rates over the last 30 years have varied quite a bit from the high teens to under 5% in much of the developed world.

If anything remains constant it's the proportion of earnings paid out in repayments on mortgages (or the ratio of repayments to rents). If you talk to people who bought their homes in the 70s or 80s, the house didn't cost that much but the mortgage hit their pay packet very hard. Similar to what happens now. And even this is imperfect since over the past 50 years the % of disposable income has changed in developed countries as a % of net pay quite a bit as food prices fell etc.

Is this Neary?
Or are you running one of our Banks?

This is the exact reason why we are in it up to our necks.
If we kept to the 3 times earning ratio we woud not be in this mess.
If we used our disposalable income to invest new age technology we would have been much better served.
Instead of paying each other a few million for rubbish property.
A semi-d on the south side of Dublin for a few mil!

silverharp · 22-03-2010 09:09AM

nesf wrote: »

Averaging over the past 30-40 years and saying "this is the ratio the market will correct to" does not work. You can't decouple property prices from interest rates and interest rates over the last 30 years have varied quite a bit from the high teens to under 5% in much of the developed world.

Averaging over the last 40 years isnt a bad "tool". The worst thing anyone could do is take on a 40 year contract when house prices are at a record multiple of salaries, taxes were at secular lows and interest rates similar, because it happens to be affordable at that point in time.
Clearily when the market is at the other extreme everyone will be acting in a conservative manner anyway and it would be near impossible to front run it expecting a turn.

The ideal strategy in a boom is to work out what would happen if interest rates, taxes, lending standards and house prices reverted to mean (at least). From the lending institutions point of view their "models" should have required them to ask for larger deposits as prices increased, not the opposite.

ei.sdraob · 22-03-2010 10:08AM

nesf wrote: »

So, a lot of the time you'll see numbers like 3 or 4 being bandied about as the correct property/earnings ratio which we should see a correction to. This just doesn't work for a very basic reason. The ratio is dictated by two things, the degree of inflation (i.e. are we in a bubble, a contraction or whatever) and current interest rates. With high interest rate periods like the 70s and 80s in Ireland, you have low ratios. With low interest periods like the 90s and 00s, you have high ratios.

Averaging over the past 30-40 years and saying "this is the ratio the market will correct to" does not work. You can't decouple property prices from interest rates and interest rates over the last 30 years have varied quite a bit from the high teens to under 5% in much of the developed world.

If anything remains constant it's the proportion of earnings paid out in repayments on mortgages (or the ratio of repayments to rents). If you talk to people who bought their homes in the 70s or 80s, the house didn't cost that much but the mortgage hit their pay packet very hard. Similar to what happens now. And even this is imperfect since over the past 50 years the % of disposable income has changed in developed countries as a % of net pay quite a bit as food prices fell etc.

so what happens to your theory when interest rates go up

food did go down in that period, but things such as healthcare, transport and insurance have not, there was a good lecture on the subject of comparing the cost of living for average family in last few years, gonna try to find it

ei.sdraob · 22-03-2010 10:13AM

for that matter what will happen when more and more of your disposable income is taxed, and that it will

subway · 22-03-2010 10:15AM

nesf wrote: »

the house didn't cost that much but the mortgage hit their pay packet very hard. Similar to what happens now.

give me a break, its the exact opposite now.
the house costs a ton and hits the pay packet hard.

low house prices are a symptom low wages (supply of money)
high interest rates are a complementary factor in this (high cost of money)

buying when wages are low and interest is high means pretty much 2 things can happen - wages go up or interest goes down (or both) meaning you are sitting pretty after a few years
buying when wages are high and interest rates are low means whichever way it goes, you are screwed (or doubly when you get a pay cut and an interest hike)

finally, as others have said, you will be paying your mortgage for 25-40 years so you would certainly want to be looking at long term trends

gurramok · 22-03-2010 10:17AM

BostonB hit the nail on the head there.

Dual income is a key factor. In the last 10yrs especially, its been based on dual incomes only with 35yr terms available as calculating 'multiple of incomes'

Singletons hadn't a hope of buying at several times income. Those that bought overpriced homes as couples find it extremely tough financially when that partner has a child. Instead of one parent looking after the child, the parent is forced to work to service the mortgage and the child is thrown into expensive childcare.

Its an unsustainable model of calculating affordability as not everyone is part of a couple hence not every house should reflect 'a couples joint earning potential'

Inflation won't make that mortgage cheap over time like what our parents experienced as inflation is at record lows and its ECB policy to keep it that way.

The mulitple of incomes is somewhere in the middle between a single buyer and a couple buying depending on the demographic make up of the demand that is buying.

Mr. Presentable · 22-03-2010 10:17AM

Things will get tight (yeah, I know) like when in the late 70s and interest rates were in the high teens. It was no party then either.

nesf · 23-03-2010 12:26AM

I'm bemused that people automatically read it as some argument for higher house prices. I was merely pointing out that repayments tend to form a big chunk of people's income regardless of interest rate levels because we're dumb like that and borrow to the hilt regardless of whether interest rates are 3% or 13%. I'm not saying this is a good thing, just how things happen because people are dumb that way.

I'm pointing out that looking at house prices as multiples of income independently of accounting of interest rates is extremely misleading. Low multiples generally indicate higher interest rates.

We'll only get multiples of 3 or 2.5 if interest rates get far far higher. Pointing out they existed for much of the 70s and 80s doesn't mean much other than to underlie the true point that high interest rate periods are very much a possbility (that house price multiples were low is merely a side effect of that).

kippy · 23-03-2010 12:30AM

BostonB wrote: »

Theres an element of common sense to be applied here.

You work on worst case scenerio. Could I pay this if I/my partner lost their job, salary was reduced, couldn't work, or interest rates, doubled, tripled.

I think if everyone followed that to the letter no one would buy a house.

Firetrap · 23-03-2010 12:44AM

Unfortunately for a lot of people, those things have come true. There was an article in yesterday' Sunday Tribune that stated that 38% of mortgage arrears were due to reduced incomes. Another 25% were caused by ongoing unemployment.

nesf · 23-03-2010 12:44AM

ei.sdraob wrote: »

so what happens to your theory when interest rates go up

Interest rates go up, house prices go down, bringing down the multiples.

ei.sdraob wrote: »

food did go down in that period, but things such as healthcare, transport and insurance have not, there was a good lecture on the subject of comparing the cost of living for average family in last few years, gonna try to find it

The only real stuff I've seen is for the States. Real incomes have stayed flat while transitioning to needing dual incomes for the same level of living. The hidden costs of womens' lib etc.

nesf · 23-03-2010 12:47AM

Firetrap wrote: »

Unfortunately for a lot of people, those things have come true. There was an article in yesterday' Sunday Tribune that stated that 38% of mortgage arrears were due to reduced incomes. Another 25% were caused by ongoing unemployment.

Unsurprising how easily banks gave out cash during the boom. Only real way out of it is to provide people an easy bankrupt route to get the debt off their back if they are in a position which creates huge problems with moral hazard of course.

silverharp · 23-03-2010 12:57AM

nesf wrote: »

I'm bemused that people automatically read it as some argument for higher house prices. I was merely pointing out that repayments tend to form a big chunk of people's income regardless of interest rate levels because we're dumb like that and borrow to the hilt regardless of whether interest rates are 3% or 13%. I'm not saying this is a good thing, just how things happen because people are dumb that way.

I'm pointing out that looking at house prices as multiples of income independently of accounting of interest rates is extremely misleading. Low multiples generally indicate higher interest rates.

its kind of obvious that people will normally want to spend 30%+- of their net income on housing, people will buy the biggest/best house they can "afford" The payment will be in the form of interest and capital and the mix will change based on the various variables.

nesf wrote: »

We'll only get multiples of 3 or 2.5 if interest rates get far far higher. Pointing out they existed for much of the 70s and 80s doesn't mean much other than to underlie the true point that high interest rate periods are very much a possbility (that house price multiples were low is merely a side effect of that).

Thats not the only scenario. In a deflation interest rates could fall but if the punters are unsure about the future or because asset prices are still falling they would be unwilling to take on debt, big difference between a 20 year mortgage versus a 40 year mortgage at the same interest rate.

ardmacha · 23-03-2010 01:14AM

The 80s were a different situation. People were absolutely crucified in the first year or two of their mortgage, but they got a few old items of furniture from the family and lived on beans. But with high inflation and some element of promotion then you were soon earning twice what you had been and the mortgage become affordable enough and you could buy the furniture. Deflation is a whole other situation, someone who bought a house in 2004 may now find their salary the same as then, even if they haven't lost a job. With low inflation the real burden of the load remains high beyond the period you can easily predict and beyond cycles in the economy.

shoegirl · 23-03-2010 03:02PM

Firetrap wrote: »

Unfortunately for a lot of people, those things have come true. There was an article in yesterday' Sunday Tribune that stated that 38% of mortgage arrears were due to reduced incomes. Another 25% were caused by ongoing unemployment.

Thats an interesting and pertinent point. There was of course, a level of constant arrears over the last 10 years due to repayments being high due to high amounts borrowed. This would make anybody very vulnerable, not only in the event of an income drop, but levies, pension levies and possibly increased taxes could reduce your income enough to make things very hard.

I started seeing people having money difficulties due to heavy consumer borrowing from about 2002 onwards on AAM. There was a minor downturn particularly in IT at the time, it hit some people hard. Also those were the days when incremental borrowing exploded, mostly facilitiated by lenders hiking up credit card maximums. To give you an idea, my mother, who hasn't worked since about 1973, had her limit increased from about 500 pounds to over 4500 euros despite having no income.

Some small traders who had managed for years also have collapsed over the last few years as things tightened. Self employed people find it difficult to get the dole so many people could be running into trouble this way, even though a partner or spouse is still working and keeping things going.
Add to this normal levels of relationship breakup that would be less of a problem if the mortgage was only 450-500 a month.

Why property prices in terms of multiples of average salary doesn't work:

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