Nama Scheme Increases Recorded Property Sales Prices by Approximately 7.5%

In announcing its 80/20 negative equity insurance scheme, Nama management could have, but did not, provide estimates of the implicit cost of the insurance component of the package product. The cost is hidden in the package sales prices, which Nama management describe as “fair value prices” for the property.  With a bit of work, it is possible to reverse-engineer the insurance-component cost from the scanty information provided by Nama. 

This breakdown of the package price into its two components is important for getting the true sales price of the property-only component of the package, and for inferring the profit/loss (net of the cost of providing the insurance) that Nama incurs on each package sale. With reasonable assumptions I get that the insurance component is 7.5% of the package value and the property itself is 92.5%.

The required inputs (in order to use the Black-Scholes options pricing model) are the time to maturity (5 years), risk free rate of interest, implicit rental yield (equivalent cash value of residing in the property), and property price volatility. For convenience the package price is fixed at 100 and therefore the insurance floor price at 80, so that the results are in percentage of total value.

I used 4% per annum as the appropriate risk-free rate of interest. To calibrate the implicit rental yield I used a quote from Ronan Lyon’s blog on Irish property,

“Figures on rents are even harder to get than figures in household income and I’ve only been able to get numbers back to 1996. Nonetheless, over the period 1996-2002, the average yield was about three quarters of a percentage point above the average mortgage interest rate, which was 6%. By coincidence, 6% is the ballpark long-run rate of interest that I think will prevail in Ireland over the coming generation. Thus, we can use that 6.75% yield – and figures on rents up to this year – to calculate an alternative equilibrium house price from 1996 on.”

Hence I use an implicit rental yield of 4.75% which is three-quarters of a percentage point above the calibrated risk-free rate of 4% that I use.

The sample quarterly volatility of log-changes to the Permanent TSB house price index is 0.045153 which implies annualized volatility of .063855.  Index volatilities are lower than the volatilities of individual components of the index (single properties) and the Nama insurance option is written against the single-property-specific price.  Hence this volatility estimate is biased downward. On the other hand, the sample period includes a property bubble which might bias the volatility estimate upward.  Treating these two biases as roughly offsetting, I use .063855 as the annualized volatility of log property price changes. 

The excel spreadsheet performing these calculations can be downloaded from the following url:
http://dl.dropbox.com/u/36105182/namaoption.xlsx

42 thoughts on “Nama Scheme Increases Recorded Property Sales Prices by Approximately 7.5%”

  1. Thanks Greg for doing the number-crunching on this and for leading a good discussion on your earlier post on the same topic. Rather than start another post, can I throw something else into the mix?

    The valuations method NAMA has chosen seems very dodgy. Current valuations are taken seemingly gospel-like from current selling agents, while future valuations are going to be done by a panel of NAMA-approved valuers. Which of those valuers has an incentive to say to NAMA “No, you lose” and thereby risk further business from NAMA?

    If instead they had used a rental multiples valuation – both now and in 2017 – this would not only have made things much more transparent, it might also have taught first-time buyers to think in such terms, rather than in the more dangerous “fall from peak” or “income multiple” terms.

  2. Is “Cash Market Price” at cell B3 on the first worksheet an input or an output??

  3. @Zhou Enlai — The excel search algorithm requires that you put in a “guess” at B3 before it finds the equilibrium value and replaces it. Do not blame me that is Nama’s structure to the product – they fix the package price so the implied cash price of the property has to found implicitly by solvingfor it given the fixed package price.

  4. If NAMA take their sale price as the intial value of the property, and the market value of the actual propert in 5 years time as its value at that point, then the purchaser will not only be reimbursed for the price drop but will also be reimbursed for the “insurance premium”.

    METHODOLOGY ONE:
    Sale price €100,000
    Actual value (according to spreadsheet) – €92,500
    Value after 10% drop – €83,250
    Rebate – €16,750 (comprising market value drop of €9,250 and refund of “insurance premium” of €7,500)

    However, if NAMA applies an index of property values to calculate the price drop (rather than the actual market value of the property), then only a portion of the “insurance premium will be refunded”, viz:

    METHODOLOGY TWO:
    Sale price €100,000
    Actual value (according to spreadsheet) – €92,500
    Apply 10% drop (from index) to sales price – €90,000
    Actual mkt value after 10% price drop – €83,250
    Rebate – €10,000 (comprising market value drop of €9,250 and refund of portion of “insurance premium” of €750).

    Obvliously the contract wording will reveal more. However, I do not think Methodology Two would be in the spirit of the agreement as it would still leave people suffering a loss of 6.75% on what they have ultimately paid (€90,000) versus the market value in 5 years time (€83,250). That is not to say that some smart alec who thinks sharp dealing is the epitomy of business ability won’t try to pull it.

    If Methodology One is applied, then I don’t think your approach stacks up.

    If methodology

  5. @Zhou Enlai — The only problem with my methodology is the scanty detail provided by Nama. I can reliably decompose cash flows into options — not a notable skill since a typical MBA at a top school could do it in 1/2 or 1/10th the time it takes me. But I can do it reliably. So the only unknown is how to interpret the vague plans provided (for an existing product!) by Nama. I followed the sketch the provided carefully and rigorously but perhaps they meant something else. That is clearly possible. Namawinelake has some inkling that they intend to make them American options, which changes is quite notably. Other possibilities abound.

  6. @Gregory Connor

    I should clarify that your spreadsheet is above my pay-grade and I am not competent to comment on same. I withdraw my comment about your approach not stacking up – sorry about that. I was teasing things out because it interests me and got a bit carried away!

  7. @Gregory

    I can’t open the spreadsheet on the machine I am on at the moment, but I note the following:

    You seem to have multiplied the quarterly vol by square root of 2. I think this should factor should be root 4, as it is quarterly data, and so the annualised vol used should be more like 9%.

  8. “I used 4% per annum as the appropriate risk-free rate of interest”

    when will we ever get back to 4% rates of interest?

  9. “I used 4% per annum as the appropriate risk-free rate of interest”

    when will we ever get back to 4% rates of interest?

  10. @Ronan Lyons Think youve hit on the crux of the valuation problem.

    I think 99 out of 100 people still use the comparison method when looking at property. Even on the news last night we got the value of the Nama properties relative to what they were at the height of the boom.

    Until people start using the Investment method to value property we will struggle to value property correctly and get to the point where the market will
    make sense.

  11. @Frank Quinn: “I think 99 out of 100 people still use the comparison method when looking at property.”

    Valuing property for folk to make a home in is something that they will have little or no experience in. Buyers are in the market two or three times over a 30 year time frame. Valuers and estate agents do this task each day. So buyers will latch onto the simplest valuation method they can: history and advertisments.

    Perhaps if the ‘rental valuation method ‘ was taught to Leaving Cert pupils and undergrads and there were regular articles in ‘glossies’ and supplements you might end up with a less ill-informed buyer. Who knows. Then all they would need to do would be to trawl the ads again looking for rental prices. And your back to ‘compare and contrast’ – again!

  12. @Brian Woods The first thing i teach my students is the difference between a valuer and a surveyor. Youd be amazed how many people buy a house without having it checked out first as they assume if the man from the bank says it was worth 240,000 then the roof doesnt leak.

    Likewise with the methods of valuation, attempting to get the Investment method out to the general public is an important step. Myself and karl Deeter make a point of explaing the method in our property reports but id like to see a more general use of the method.

    If a property sale ad was accompanied by a Sale price and the estimated rental income of the property then this would help buyers think in terms of fundamentals.

    Allsops do it for their auctions and it encourages demand if the yield is high enough

  13. @Frank Quinn: Thanks for that update. VIP point about the types of ‘professional critters’ who become involved: lawyers, agents, valuers, surveyors – and others!

    Is there merit is having a mandatory NCT style house checkup – before you can sell, rent? Gas and electricity services are checked and certified? Ventilations are satisfactory, etc, etc. This might increase costings but a home purchase is a mighty big cost itself. I have significant reservations with the notion that a home to live in (and raise family) is actually an investment. Moral Hazard looms large here.

    I would put residential property in the same category as a Strategic National Infrastructure. Abandon the Local Autghority zoning and planning permission ideas and substitute a mandatory National Building Permit regime – based on mandatory building rules and regs – not some wishy-washy ‘guidelines’. Without that permit you cannot construct. Cost again, but a robustly constructed home will last a very long time.

  14. @Brian Woods: In Canada the seller has to provide a package that includes the survey, 3 comparable properties values, property brochure etc.

    Always struck me as crazy that the same property could be surveyed by 10 different buyers.

    As regards the notion of the family home as an investment. I think its the biggest investment and purchase most of us will make in our lifetime and therefore should be thought of in Investment terms.

    Not as a means of getting rich quick but as a way of finding the correct value on the property and buying the property with peace of mind as regards structure, condition etc..

  15. @ Frank Quinn: Thanks again. So IT can be done, and does work.

    Ok, we’ll differ somewhat on the ‘investment’ bit. Its not critical. My frame for investment is that it provides a surplus that has a final value in excess of all costs – and inflation! Res property did meet that criteria, but the financialization of the res property market has upturned it. Now its about maximizing cash flow, not waiting for the surplus in 30 years time – or whatever.

    I expect res property values to continue to decline (absent a significant bout of money inflation and ‘upward only’ interest rate reviews) for some years. So some folks are likely to be a tad miffed when the realise their purchases are now an unrecoverable ‘sunk cost’. Thanks again for the valuable info.

  16. @ Brian Woods. I agree with your assessment of the market, think in our last report we reckoned about 20% to go based on the Investment method basis.

    @ Gregory Connor. Very interesting work on the value of the insurance element of the Nama properties. Shouldnt this be a Contingent Liability in their accounts or is my ISA 37 knowledge out of date ?

  17. @Frank Quinn – My concern is more with possible distortion of Nama’s income statement (rather than balance sheet) and of property price records. I think that you are correct that the contingent liability will appear in a footnote in the balance sheet? But how will it be treated in the income statement? I am not clear on that; others understand this IAS 37 treatment better than I do. I think that this type of contingent liability appears as a footnote on the balance sheet (that seems fine to me) but how does the 7% of package sale value associated with the insurance component impact the profit-loss account? In any case, CSO and auditors are on notice that 7% should be subtracted from the property sales price at appropriate points.

  18. @Gregory,

    Remembering that it is usually the developer or receiver who sells the property and he then repays NAMA, and assume the property is sold for 100 and NAMA has a 150 loan on it that NAMA paid 120 for.

    NAMA’s books
    Pre Sale
    Dr BS Loan 120
    Cr BS NAMA bonds 120

    Sale
    Dr BS Cash 100
    Cr BS Loan 100
    Dr P&L – loss on loan 20
    Cr BS Loan 20

    So Balance sheet will look like this
    Cash 100
    P&L reserve (20)
    NAMA bonds 120

    And there will be an IAS 27 statement to the effect that NAMA may need pay out up to 20 in five years should residential property markets continue to fall.

    Seems fair enough.

    NAMA’s exposure though is expected to be a maximum of €30m when all 750 properties are eventually sold. So it is very small beer in the context of NAMA.

  19. @ Jagdip: Would i be correct in saying that the Contingent Liability which is a note to the accounts at the moment (Ias 37)would have to be provided for if property prices continued to fall over the next few years.

    ie The Possible Contingent Liability would become a Probable one and therefore would have to be recognised in the accounts.

  20. @ Jagdip, but will they have to recognise the probable loss in their accounts in say 2-3 years if the property market continues to fall ?

  21. @Frank, I understand you. So if property falls by say 50% from the purchase price in year 2 which would make the prospect of a NAMA payout in 2017 a near certainty, then would the contingent liability need to come onto the balance sheet as a provision.

    Tough call, can NAMA convince the auditors that there is still sufficient uncertainty about the payout? And on what basis might the auditors and NAMA use to determine it one way or the other?

  22. @ Jagdip If property prices fell by even 20% over the next 2 years i dont think the Contingent liability could be acceptable as a possible loss.

    At that point it is a probable loss and must be provided for. I assume the auditors would use the cso statistics to determine the falls or could look at comparable sales to the properties sold

    We may even have a real price database up and running by then or is that just wishful thinking.

  23. @Frank Quinn

    “We may even have a real price database up and running by then or is that just wishful thinking.”

    2 years?

    H’mmmm. First you would have to have civil service style tendering for one of the biggies to land the contract to deliver it at a fantastic price (PWC, CGS, Accenture, etc.). That’s going to take 9 months. By the time the legals have been completed say a year.

    They’re going to ask for 12 months just to specify the requirements.

    Then they’ll tell you that they are going to use some super-duper new development methodology (so that all their guys can get trained in it at the client’s expense) such as ‘Superfast Agile Scrum III’ which will mean a learning curve of 6 months and a development timescale of another 18 months.

    Testing will find it’s full of holes after 6 months and the contract will then be re-tendered and back to square one.

    How many years am I at now?

    Rinse and repeat.

  24. To sum up the Irish issue – The majority of Irish voters own a property and they act in their own interest.
    However two wolves and a sheep deciding whats for lunch is not the way democracy is supposed to work, so democracy is not working as well as it should in Ireland. The sheep have/are emigrating.

    Over recent years the majority of property owners have abused non-owners (generally referred to as ‘losers’ in the boom years)
    1. First they decided to support policies that supported a massive increase in their house prices.
    2. As the bubble burst they supported policies which most could see could bankrupt the country in order to bail out banks. This meant that they were maintaing their house prices for as long as possible as banks were not forced to sell their property portfolios.
    3. They supported NAMA which is basically a ‘buy up all the houses to keep them off the market’ scheme. Never mind the fact that there are over 100,000 people looking for social housing while the other more than 300,000 properties lie empty. Shelter may be a basic human right and while Ireland may claim to be interested in human rights, that is pretty poor evidence.

    Now we have property owners asking all taxpayers to foot the bill again to stop NAMA selling properties at real prices.

  25. This scheme should be only for 1st time buyer owner occupiers if there was any pretence of not robbing peter to pay paul.

  26. @ Chris: “The majority of Irish voters own a property and they act in their own interest.”

    This may not be factually accurate. Many ‘owners’ maybe tenants.

    “The majority of property owners have abused non-owners.”

    This need to be proven up. Otherwise I suggest you acknowledge it as such – an assertion.

    Ditto for points 1, 2 and 3.

    The biggest looters and thieves of the theIrish taxpayer are our governments, their backbench deputies and the vested interests who constantly whine like Oliver Twist “Please Minister gives us some more” – and they do!

    The debris of the residential property bubble has multiple causal factors. Singling out some ‘they’ to attach responsibility to is well – somewhat irresponsible itself.

    The NAMA scheme is a complete disgrace. Its just another exercise in looting the taxpayer.

  27. The least useful piece of information one can have about an Irish property is what it price it sold for, at any stage, but particularly at the peak. In fact, there is a good argument to the effect that having that information is not useful in any way but is actually a negative.

  28. @ Brian
    A quick search on google shows up this document with a graph on page 12 to back up the facts on household ownership in Ireland. Irelands rate of ownership is around 77% and Germanys 43%.

    http://epp.eurostat.ec.europa.eu/cache/ITY_OFFPUB/KS-RA-10-023/EN/KS-RA-10-023-EN.PDF

    The responsibilty for the Irish crisis is very broad, including areas where Irish voters did not have much influence such as the stream of low cost credit resulting from financial integration into European Wholesale markets and poor governance in Private banks.
    The assestions that Irish property owners acting in their own interest shoulder most of the burden stands supported by the various reports into the crisis. Here are some quotes from Reglings 2 page Ex summary
    First line – “Ireland’s banking crisis bears the clear imprint of global influences, yet it was in crucial ways“home-made.”
    “Another factor,with even deeper roots, was the strong and pervasive preference in Irish society for property as an asset”
    “Ireland was also unusual in having tax deductibility for mortgages, and significant and distortive subsidies for commercial real estate development, yet no property tax.”
    “Domestically, moreover, there was a socio-political context in which it would havetaken some courage to act more toughly in restraining bank credit.”

    Meanwhile the Nyberg report singled out group think and herding as the major cause of the crisis. See page 99. 5.6.2.
    http://www.pmca.ie/2011/04/nyberg-report-into-the-irish-banking-crisis-published/

  29. @ RamuJohn,

    Transparent pricing and reporting of sales price is important for preventing property overpricing and bubbles.
    Shanghai introduced this measure as a way of cooling its property bubble and it worked very well along with other measures.

  30. @ Chris: Got that ref. Will take some time to go thru it.

    I have little time for Regling or Nyberg. They are simply repeating something that some of us knew as far back as 2005 – three years into Part II of the Irish property boom. The main culprits were those who conjured up virtual money from nothing and extended it as ‘cheap and easy credit’.

    They, our so-called regulators, and all the politicians and their economic advisors in Leinster House are individually and collectively responsible – in part or in whole for this mess. The individuals who carelessly and stupidly venured into that bubble are victims. Not blameless; but stupid, misguided, misled, over-enthusiastic victims.

    Your’e quite correct to lay some blame on our very distorted tax system. It is heavily tilted toward the better-off sections of our society. But that is what they voted for – many times. The poor and disadvantaged have a poor record of attending the polling station. We got what we did not deserve. Now the Irish taxpayer (the ones that actually pay tax) have to foot someone elses bill. And that is solely due to two persons: with some help from a mendacious bunch of bankers and out-of-depth officials. It was a completely avoidable calamity. Not that we faced no calamity:but debt slavery for a generation?

    The rest as they say is, “Its downhill all the way”.

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