Investing in Maltese property

On September 11, The Times published an article on its website entitled 'Conflicting signals on property prices in Malta', a topic that has been a highlight in local and international media. In line with what is being experienced internationally, the boom in property prices in Malta might be nearing an end.

The index, compiled by the Central Bank of Malta, showed that overall property prices fell by 2.7 per cent by June this year when compared to June last year, excluding the effects of inflation, which stood at 2.8 per cent at the end of the same month (National Statistics Office). Therefore, in real terms, by June this year, house prices in Malta were 5.5 per cent lower than last year.

One may disagree with the use of an index, because, after all, it is an average and by default cannot reflect every individual circumstance. Nevertheless, indices are useful in gauging the direction of the overall trend.

I will look only at residential property, strictly from an investment point of view. When one buys property as a home, one can derive intangible benefits (such as security and belonging) that are much less available in the rental market and are extremely hard to value.

Investment return is generated from two sources: capital appreciation and income yield. Capital appreciation is the difference between the price paid at the point of purchase and current market value. In the case of property, income yield is income generated by letting out the property.

Within a normal efficient market, the price of any good or service is dependant on two factors: demand and supply. Let us start with supply.

I compare Malta with two other European countries that are currently experiencing significant house price falls - Spain and the UK.

As can be seen, the supply of dwellings in Malta has risen at a hefty pace, outdoing Spain. Spain has experienced a massive construction boom and is currently suffering from supply overhang.

Future demand for property is difficult to measure with certainty, but in the case of residential property it is highly dependant on sentiment and availability of bank finances. There are those in Malta who believe that investing in property is rock solid and supported by a highly liquid financial system. I, too, believe that, in the short- to medium-term, there is no threat to property prices coming from the demand side.

Supporting this view is the level of family formation. With the population expected to increase, demand will also benefit from this aspect. Demand by foreigners is much harder to ascertain. As many point out, the current slowdown is global in nature and it seems that the notion of investing entirely in the global property markets is currently being tested. This reduces the allure of Maltese property as an investment.

One method to measure the strength of buyer demand is to look at buyer affordability. If a buyer wants to buy property but cannot afford it, he won't be able to buy it. Buyer affordability is usually measured by dividing average house prices by average earnings. The data needed for this calculation is not easy to find.

Take an average house price of €100,000 and the latest available average salary quoted by Eurostat. The ratio equates to 8.6 times. The same ratio for the UK, using the Halifax house price data and average earnings by Eurostat, is currently 4.9 times.

According to the Global Property Guide website, which, classifies the property market in Malta as one of the weakest 10 in Europe, overall rental yield stands at 3.1 per cent. To ascertain whether this is a decent return or not, one needs to look at comparables. Five-year government bonds make for a useful benchmark in this case.

The yield that is currently available on the 7.8 per cent Malta Government Stock, maturing in 2013, stands at 4.8 per cent. The yield available on top rated five-year benchmark German Government Bond is 3.9 per cent. I therefore believe that the level of rental property yields is quite poor, as, firstly, it just beats inflation by a small margin, and secondly, yield is lower than that available on government bonds.

Ideally, yields should compensate for the risk inherent in property investments, such as market opacity and lack of liquidity. The same website reports that the price to rent ratio stands at 35 years.

This means that it would take 35 years of current rent to earn as much as the cost of buying the property. The same measures for the UK and Spain stand at 24 and 27 years respectively.