Serious Money: Not unreasonably, several readers have challenged me to justify the assertion, made in last week's column, that equities would outperform property on a five-year view. At the very least, why five years? And why so gloomy about Ireland?
Taking a base year of 1985, Ireland has had the second-highest rate of real property price inflation in the 17 largest OECD economies. Spain has actually witnessed a faster rate of price appreciation. The UK is not far behind Ireland, while the Netherlands has had almost the same inflation. So the Irish experience is by no means as unique as some commentators seem to suggest.
Real Irish property prices fell between the mid-1970s and mid-1980s and were virtually stagnant for the following decade: the bulk of the boom is really a phenomenon of the last decade. Further afield, the Spanish boom is a much more recent affair - real property prices actually fell for most of the 1990s. Australia, one market where prices are now falling, never came close to matching Ireland's rise. The UK, another falling market, didn't get going until 1996.
According to nominal price data compiled by the Economist, Irish house prices have risen by around 180 per cent since 1997; the UK is second with 147 per cent, Spain third at 131 per cent and Australia fourth at 113 per cent.
Proper models of house price determination look at both demand and supply factors. Household disposable income, demographics, tax changes, interest rates, availability of land and construction costs all play vital roles over both the short and longer run. Planning processes can have significant shorter-term effects.
Given the complexity of modelling these variables, we might be tempted to be sceptical about conclusions. Models tend, however, to point in the same direction: house prices are overvalued.
Another, slightly similar, approach is to view property as just another asset class. If we apply the same techniques as are used in the analysis of stock prices, we can reach some kind of conclusion about the valuation of property. The key insight here is that property rents are analogous to equity dividend yields and can be analysed in a similar fashion.
Equities that carry low dividend yields are always considered to be expensive, unless there is a strong case for believing that growth in the share price will be sufficient to compensate for low cash payouts by the company. By "low", we usually mean a dividend yield relative to either a short-term interest rate or a long-term Government bond. The game then becomes one of forecasting the likely future growth in the company's profits, and hence its future dividends and share price.
For an investment in housing, the equivalent yield is given, of course, by the rents that can be achieved. Right now, the average rental yield in Ireland is around 2.5 per cent. This is slightly less than available, say, from a Nationwide Building Society deposit account.
So the investor in Irish property is making the same bet as the investor in a low-yielding equity: the price of the asset is going to rise. Simple arithmetic using prevailing rental and bond yields suggests that the property investor is making a big bet, one that requires many years of further large price appreciation to come right.
It was right to make this bet five or 10 years ago, but not now. The same factors that drove house prices up created the Celtic Tiger. All the signs are that the economy has now matured. And this is the key point: arguing that equities will outperform property over the long-haul is not the same thing as expecting a property crash. I own a flat in central London that has not changed in price for at least the last three years. Overvalued properties in growing economies do not crash, they merely stagnate. This, I think, is the right model for Ireland. It would be silly to forecast a property slump but eminently sensible to expect prices to move sideways.
Bulls of property point to continuing favourable demographics and the shrinking likelihood of higher interest rates. I look at people getting 25-year, interest-only mortgages at six times income and become ever more certain that the end is in sight.
Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.
