January 9, 2007

The Dundrum Paradox — Don’t be Paddy Last!

Posted in Debt · 15 comments ·

This article was originally published in the November 2004 issue of “The McWilliams Agenda” a subscription based newsletter. As the topic is just as relevant today, it has been published in place of David’s usual article while he is on sabbatical

Now that the housing market is showing serious signs of a slowdown, it is probably worth revisiting the wisdom of all the foreign apartments, houses, condos and the like that were bought by us Irish over the past five years.

Little did we know when we were kids playing in the school yard that coming “Paddy Last” could cost us our financial security. However, with the Paddies scouring the globe for property deals, the old adage “Don’t be Paddy Last” applies like never before. From Cape Town to Gateshead, Bulgaria, Budapest and Boston, Paddies are driving up property prices and driving down yields to dangerously low levels in the process. Almost everyone is at it. This weekend, in all the papers, properties from the four corners of the globe were still on display and investor appetite was still palpable. Where will it all end and how?

Let’s start in the air. This summer’s Malev (Hungarian Airlines) in-flight magazine had a full page on Budapest’s property market. The writer was ascribing the recent gains in prices in Budapest to a variety of factors: political stability, demographic factors, credit etc. Finally, the magazine highlighted what it called the “Irish effect”, not the “overseas buyer” effect or “international investor” effect, but simply the Irish effect. Anyone visiting Budapest this year will know exactly what the magazine was getting at. For example, last August there were more GAA shirts in the lobby of the swanky Marriott Hotel in Budapest than in the Burlo’. Paddy was there, cheque book open, ready to spend. The local estate agents say that in Budapest there are three prices — one for the locals, another for the foreigners and a third for the Irish. Although, yields have been pushed down to perilously low levels (that’s if the property can achieve decent occupancy), Paddy feels he has a bargain because relative to Dundrum, Budapest appears cheap.

The same story applies in Cape Town. Landing in the international airport is one of the least African experiences that you can experience in Africa. Everything is spotless, efficient and clean. The largely white, immigration staff are pleasant to a fault. Contrast this with landing, for example, in Abidjan in the Ivory Coast, where stoned, gun-totting soldiers hassle you for cash at the customs desk. South Africa is different. This, at least, is what the estate agents say to you and granted, Cape Town is a magnificent city. Tourist numbers are up, property prices are sky rocketing, yields are holding up reasonably well and the Paddies are swarming all over the market.

When seen from Table Mountain, Cape Town appears like a shining beacon of what South Africa and its “Rainbow Nation” could be like. Yet the drive in from the airport takes you round the back of Table Mountain, the part you do not see from the glamorous Waterfront.

There, shantytowns extend for miles, hidden away in the flood-prone plain called appropriately the Cape Flats. The only major question for the investor in bricks and mortar in Cape Town, is at what stage do the millions of shanty town dwellers say “Enough” and demand some of the action. In other words, is buying in South Africa today a bit like buying an idyllic Big House from an Anglo-Irish landlord in 1912? We all know what happened to Big House dwellers in the 1920’s in Ireland. They were burned out, driven out and even when they did reach a settlement with the new nationalist government, the compensation for their property was derisory.

My hunch is that South Africa’s ANC government and the emerging black middle class is loath to let anything cataclysmic occur and a type of Faustian pact has been arrived at between the power bases on both sides. This arrangement was best described over dinner in Jo’burg in 2002 by the most senior black industrialist to emerge since Mandela took power who, when I asked him how come there appeared to be so little recrimination on the black side towards whites, answered “they pretend it never happened and we pretend to forgive them”.

Two years ago, I was back in South Africa and in the car park of the Cape Town’s Newlands Stadium ahead of the Ireland-South Africa test match, one of the great rituals of modern Afrikaaner culture is taking place. The Springbok-mad Afrikaaners arrive from all over South Africa to pay homage to the national rugby team. Before the game, they wedge their pick-up trucks into a field, put on the “braai” and drink ferocious amounts beer — in a superannuated display of rugger-buggerdom. Yet even amongst these Afrikaaners there was a great love for Mandela and an equally great fear about “AM” — After Mandela. Even these intimidating farmers are concerned about “What will happen when he dies”? None had an answer.

But this does not matter to Paddy because (like Budapest) prices in Cape Town are cheap compared to Dundrum and as long as the Irish market is ridiculously expensive, the whole world looks like a bargain.

And this is where the “Dundrum Paradox” comes into play. Some of the world’s property markets are now being impacted by how much leverage Irish banks are willing to lend on the back of the Irish property boom.

Most small Irish investors are buying property abroad on the back of equity withdrawals on their Dundrum semi-d’s or something similar. The Irish banks, which are finding it hard to make the silly valuations and profits demanded by their shareholders, have to generate huge volumes of business to make money. They are thus facilitating practically every proposed equity withdrawal. The Irish property market is therefore being leveraged at least twice. If anyone believes that the banks are staying within the Central Bank’s multiple of income guidelines when it comes to lending, they need to have their heads examined. So the “Dundrum” equity withdrawal is a credit derivative that is driving up property prices in Budapest.

Forget that the locals couldn’t afford to buy at the prices the Paddies are paying. The locals do not matter in this hermetically sealed Irish ponzi-scheme. The Paddies are largely now buying from other Paddies and the exit strategy is to sell to another Paddy when you want out. As long as the ponzi-scheme keeps going, fuelled by equity withdrawals, abundant credit and low interest rates, Paddies can make money by playing “beggar my neighbour” with other Paddies. The name of the game is to avoid being Paddy Last when the deck of cards comes crashing down.
Finally, there are a few pitfalls to watch out for before the ponzi-scheme implodes. Beware a devaluation or a series of devaluations in eastern Europe, particularly Hungary.

Like Ireland in the early 1990s, a run on the currencies of all these countries including Poland, the Czech Republic and Slovakia, is likely. In Hungary, it is highly likely. The reason is simple. To be competitive, these countries need an undervalued currency.

At the moment, all the countries have overvalued currencies in an effort to keep up with the euro. This will become increasingly difficult as the euro strengthens against the dollar. So with low growth, high unemployment and current account imbalances, the more the euro strengthens, the higher the currency risk in these countries. Interest rates are likely therefore to rise. No country can endure higher interest rates for long when jobs are scarce, so expect either managed or messy devaluations. This will have the short-term effect of knocking value off your property, but in the longer term might it be positive for the property market as it was in Ireland. But again be warned. Whatever internal growth there might be will be insufficient to make any of your purchases affordable to the locals.

Don’t be Paddy Last!

  1. ray

    The debate between paddy the bear and paddy the property bull is well under way over at boards.

    There is also more debate at http://www.thepropertypin.com/forum/index.php

    and to a lesser extent http://forum.globalhousepricecrash.com/index.php?showforum=16

  2. Glen Quinn

    Well you got it bang right. All we ned know is wait for the Irish property to go bang.

  3. MB

    David’s analysis makes perfect sense and is based on sound, tried-and-tested economic principles: the only problem is that the crazy, irrational and overvalued Irish property market has been ignoring sound econoimc principles for about 7 years now and hasn’t gone bust yet. That’s not a good thing as the longer the insanity goes on the worse things will be when it hits a brick wall (a heavily leveraged, over-valued one). The more people who are sucked into the market and the more the banks rely on lending revenues to turn a profit, the more the country’s future economic prosperity is at stake. This also disincentivises the government from intervening in the market as they’d rather stave off the day of doom, again making it worse in the long run. As J.M. Keynes said: “The market can stay irrational for much longer than you can stay solvent”. Well, we’ve been waiting so long for a crash now that it seems like an impossibility… and yet we know it’s inevitable.

  4. Ronan

    Actually the slump has already started. Any regular reader (I remember reading the original article) will know that it’s been coming a long time.

    Prices continue to rise after the beginning of a slump. It’s the volume of sales that decreases. But a large number of completions are driven by people who paid deposits 2 years ago and whose apartments have just been finished.

    The key for me to see that it’s started was yesterdays Irish Times Residental Property section. It’s long been an indicator of the boom and there’s plenty there to indicate the boom is continuing. Record price for an apartment in Dalkey (really a house) etc.

    Something wasn’t quite right though but I let it slip my mind. Then it occured to me a few minutes ago and I dug it out to check: It’s really short, at only 14 pages, there really isn’t that much in there. 4 of those pages were full page ads

  5. Dan Hayes

    David & Co.:

    Just to add to your cautionary comments about South Africa. It wasn’t too long ago that investors flocked into newly “liberated” Rhodesia (soon to become Zimbabwe). Let me remind your readers that in its first years of “liberation” Robert Mugawbe warned other African states “to keep your Whites.” Well we all know, or should know, what happened there. That too will also happen in South Africa. For now, only the white South African farmers are being killed. That’s for now. For now, the other whites are “only” being subjected to second-class citizenship (they do the work; while their incompetent kleptomaniacal bosses reap the credit and lucre). But liquidation time too will come for them!

    On a sadder note, I am sorry to learn that you will be going on sabbatical. Now how am I ever going to monitor the self-destruction of Ireland?

  6. [...] Best Blog Post -  David McWilliams on something even more important than blogging (!) the impending property market crash. [...]

  7. If you (McWilliams) have been predicting a fall in house prices since 1997 you are either very stubborn or making a long wait in order to be right.

    Since you believe so much in economics and ask everyone such details don’t remain so secretive about your own situation. Is it true the rumour that you yourself are still renting and hope prices will go down soon so you can buy one?

  8. Garry

    Fair play, great article…

    Looks like you called hungary right back in 2004….

  9. laura farrell

    The real problem as I see it is not so much even the implications of the end the property boom (or beginning of a property implosion), but the fact that so many pundits and industry analysts are desperately trying to talk Ireland out of the imminent meltdown. For example: today I heard on the news that 350 jobs were to be lost in a factory – yet almost immediately there was the “annoucements” of another “800 jobs.” No mention (there never is) of the fact that as many of 50% of these proposed “jobs” never actually materialise. No mention of the fact that in a significant number of cases the jobs that do materialise are dependent on industry factors, and many vanish within a couple of years. No mention of the fact that a rapidly increasing proportion of new jobs are paying lower and lower wages, demand a level of “flexibility” from the workforce hithero unknown and are often isolated break-outs with few if any, long term career prospects. (Oh I’ve worked for several of these!) About 80% of Ireland inc. is living a delusion, much of it fuelled by SSIAs, massive property paper values and an appetite for the obscene propoganda machine of the current government.

    The big problem is the total lack of joined-up thinking – somethng which is typified by the way in which more and more traffic is simply dumped onto already heavily congested roads. The scariest thing about all this is the blindness evident in the majority of the population and its willingness to vote straight back in the undertakers who bled dry Ireland Inc’s coffers when the going was good.

  10. John

    A crash in near future maybe or maybe not the fact is only couple of non – irish people really know. -I believe that property prices are being fuelled to the most part by foriegn investment in our economy which is the byproduct of our situation in Europe and low tax rate. The fact is US and many other foriegn companies choose to locate here because of the low corporate tax rates; access to well educated english speaking staff and a goverment that when asked to jump says “how high?”. We are effectly the Cayman Island(s) of Europe. I believe property will level off once we have finished building the infastructure to support these companies. However if this ‘Cayman’ situation were change we would find ourselves in a very different situation in essence we really have no control over the economy here in Ireland. We have little or no real industry here in Ireland the fate of the house prices lies in decisions taken in a number of big corporate boardrooms in the US and other countries. What is in these guys heads I have no idea – as they are looking at picture of the global economy which not many of us will ever see and are asking themselves “how best can I progress the operations of this corporation in order to raise the share price hence my year end bonus. I believe Paddy is doing exactly the right thing buying foreign property – make hay while sunshines – maybe we should all bail over to China and India buy up all the green fields around the undeveloped major cities around the world. However I believe if you are heavily leveraged with your home in Dundrum I think you probably ok for the moment however you should probably keep your ear to the ground for the murmurings of the global strategic plans of our big corporate cash cows here in Ireland. For example if you own a house in Lexslip listen to what Intel are doing.

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  12. john

    I’m not sure if David has been to Hungary for more than a few days in the past five years. The ‘facts’ given here are simply not true. From living in the country and being in daily contact with local economists, the difference between informed local opinion and articles such as this is bizarre. Devaluation of the HUF is extremely unlikely in the near future and it only referred to in international accounts of the Hungarian economy, which seem to know little about what is really going on here.

  13. jimmy bond

    he certainly called it right on budapest , you cannot give aways residential property right now in budapest , like a fool i bought an appartment in 2005 and done it up , its worth less now than what i paid for it
    the slowdown in the irish property market will only add to this as the hungarian property boom if there ever really was one was built on the back of the irish and to a lesser extent brittish property boom
    regular irish people here took out loans to purchase appartments in budapest safe in the knowledge that there own house back home would continue to appreciate , well property back home has ceased to appreciate and so will end the possitive effect irish property had on hungarian property , theres one thing sure , there was nothing in hungary itself to suggest property there should rise

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