Now I’d like to caveat this blog post by stating that I am neither a real estate expert nor a personal finance expert. In fact, me writing this blog is a bit like Kim Lund writing a blog on the employment market. But hey, he’s a smart guy with his finger on the pulse and I’m sure he’d have something valid to say.
I wanted to take a look at this because it’s something that pops up time and again during dinner party conversation but that I always feel ill-equipped to discuss without the aid of a spreadsheet. Tempting as it is, I’m not sure it’s really appropriate to interject “hold on, I’ll just grab my laptop and bring up Excel”. Having said that it probably wouldn’t come as much of a surprise to my friends if I did, which is probably why we don’t get invited to more dinner parties.
Surprisingly, for a place with so many financial services professionals, there seems to be this stubborn misconception that buying is always better than renting on principle, because renting is simply “throwing money away”. This is a good illustration that conventional wisdom is often nothing more than a widely-held fallacy. Is mortgage interest any less “thrown away” than rent? And throwing money away is your thing, nothing burns through a stack of money faster than 7% stamp duty.
There is a handy short cut to considering whether to buy or let. Are landlords generally making money, or losing money? The landlord/tenant relationship is something of a zero sum game; the more he or she is making, the less of a good deal you are getting as a tenant. That’s pretty obvious.
As my family recently outgrew our two-bed condo, after considering buying for some time, my wife and I opted to rent a larger place while letting the old place which we had purchased back in 2006. Therefore, I can tell you from personal experience that landlords in the two-bed condo market are not making money.
In fact, rents have fallen precipitously in the last 18 months to the point that most landlords that bought in the last 3-4 years are struggling to cover their mortgages alone, let alone other significant costs such as maintenance and strata fees. (For the overseas reader, a strata is a cooperative which looks after common interests for owners in an apartment or townhouse complex. Strata fees are paid monthly and normally include such things as insurance, landscaping, cable TV and some maintenance). Rents have come down by between 10 and 30%. Great news for renters.
Worse still for landlords, I don’t believe we’ve reached the bottom. The reason is a case study in micro-economics. There has been a well-publicised reduction in the number of work permit holders on the island. Reports vary, but possibly as many as 5,000 in the last year (mostly in construction and hospitality; financial services only has 2,000 work permit holders). In terms of population, add non-working partners and dependents to that 5,000. Then consider that even 5,000 people would have meant at least 2,000 homes.
Add to that the ongoing development of 2 and 3 bed town-home complexes and you get a picture of significant over-supply in this segment of the market. If there are even 5% more condos than renters looking for them, that 5% will be constantly reducing their price to compete with each other and occupied units, and setting the market rates in the process. The value of the unit is almost irrelevant. Any amount of rent is better than none, and that is what 5% of landlords will have at any one time.
This dynamic is also putting downward pressure on home values. Eventually a landlord will decide that renting at a loss isn’t worth it and put the property up for sale. Of course, if selling would also mean making a loss (which again it likely will for buyers in the last 3-4 years), then it will come down to the relative size of the losses and the landlord’s expectations for the future.
Thankfully, there are a great many Caymanian landlords that own property outright. This prevents them flooding the sale market, but it does mean they can afford to drop rents to maintain occupancy.
Whether the situation for landlords improves depends on two things: economic performance (and in turn the effect on population) and movement in inventory (i.e. new condo developments coming “on line”).
In terms of inventory there is always a lag between the supply and demand conditions and the pace of development. Residential development projects surely take between three and five years from business plan to keys in hand. That means that many projects will be well advanced by the time a crunch comes – too advanced for the developer to slam on the brakes.
An idiosyncrasy of the Cayman real estate market is that new homes are nearly always cheaper than used homes as buyers are able to avoid stamp duty on new homes by taking title to the land before the home is built and thus paying stamp duty on the land alone. This is a loophole that needs to be closed. The value of the land on a CI$2-300,000 apartment is peanuts. Not only is this costing the government some much-needed revenue, it is also fuelling over-supply conditions in the real estate market by acting as a government subsidy on new condos.
At the same time, there are few signs that the economy will improve dramatically enough to plug the 5,000 person strong hole in the population.
Therefore, the outlook for landlords is, in my opinion, bleak. That means rents will drop further, and therefore so will sale prices.
Needless to say, my family and I will be renting for the foreseeable future.
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