Affordability calculator

[Peter Parker]

Was a graduate teacher in 81 buying the worst possible (or close to) realestate in the city? That is the question.

I knew teachers in the 1980s.

They were renting asbestos commission-type houses not unlike this:

http://www.realestate.com.au/cgi-bi...er=&cc=&c=27089415&s=wa&snf=rbs&tm=1214029238

What about city teachers?

Apart from some rich households, most familes with kids are in the middle and outer suburbs. It would follow that most of their schools are as well. This puts teachers in a better position than other professions since they'll likely be able to afford a good-sized home not far from work.

 

[Mike&Wendy]

What many don't realise is that a certain amount of borrowing can actually REDUCE risk of poor performance relative to paying cash. If a property goes up by 2% pa then you naturally think you'd be better off with the money in a term deposit if you paid cash for it.

But if you borrowed 90% then that 2% gain is measured relative to the 10% put in, resulting in a very respectable 20% gain.

Taking the 2% per annum rise in prices, if you buy a property for $100,000 and borrow 90%, at the end of the year your 10,000 investment will be worth House Price+2%-mortgage-interest = 102,000-90,000-9,000 = 3000. You lost $7000 or 70% of your investment. (Assumed interest only loan at 10% for easy numbers, at 5% its still a 2500 loss)

Or am I missing something?

Mike.

 

[Peter Parker]

Taking the 2% per annum rise in prices, if you buy a property for $100,000 and borrow 90%, at the end of the year your 10,000 investment will be worth House Price+2%-mortgage-interest = 102,000-90,000-9,000 = 3000. You lost $7000 or 70% of your investment. (Assumed interest only loan at 10% for easy numbers, at 5% its still a 2500 loss)

Or am I missing something?

The tenants in there pay rent, do they not?

 

[Lukey13]

If you assume property (broadly speaking) moves at a higher rate than wages then eventually nobody will be able to buy it. This of course won't happen - people will have to sell at a price people can afford to pay.

Or perhaps it won't matter that nobody will be able to buy property? Perhaps only those who already own property (inherited) will be able to afford to own?

It's an interesting discussion though...

 

[Mike&Wendy]

The tenants in there pay rent, do they not?

Indeed they would. A 7% yield will enable you to break even. The person who paid cash will have 102,000+7000 = a 9% return.

I just don't follow the gearing argument when interest rates are higher than yield unless you have good capital gains.

Mike.

 

[peastman]

Just found this Monash uni study
http://www.latrobe.edu.au/amw/assets/downloads/papers/Madsen.pdf
Its going to take a while to digest.
Interesting statement in the conclusion
"the model implies that house prices may by influenced more by wheat prices than income and interest rates"
Thats something I have never considered.

 

[peastman]

Something else of interest
http://www.aph.gov.au/Library/Pubs/rn/2006-07/07rn07.htm

 

[Peter Parker]

I just don't follow the gearing argument when interest rates are higher than yield unless you have good capital gains.

The level of gearing is critical since it influences cashflow which determines whether the portfolio can be sustainably held for the longer term.

Suppose you required 12% gross yield for a property to be CF neutral from Day 1 based on 100% borrowing.

If you were to only borrow 50% of the property value, you'd be about CF neutral on a 6% yield - much more achieveable!

At 50% LVR you're doubling the size of the achieveable portfolio compared to 0% LVR.

And you're also doubling your return compared to if you paid 100% cash. Buying two places at 50% LVR instead of one place at 0% LVR permits spreading of risk (eg vacancy) and allows faster growth while still avoiding large negative cashflows and the portfolio highly dependent on your job (which would probably be the case with a higher LVR).


Eg if a $200k grows by 2% then that's only 2% growth if you paid cash, but 4% if you compared it to the 50% ($100k) deposit. Not great but better and still very low risk.

If rents do rise with CPI (current predictions are for beyond CPI increases) or you can make small value-adding then the rental income will increase relative to your interest costs. Hence the property will become easier to hold.

If you're happy with slight negative gearing, a 60 or 65% LVR might be affordable. Or about 50% now and if rents rise and the properties go towards cashflow+ then this level can rise a bit buy buying another place. This gives a bigger asset base yet is still fairly safe and doesn't require much capital growth for you not to go backwards.

 

[jingo]

But was it of similar standard? The physical structure might have been. But back in 81 that structure was a modern house - now it is old.

Actually, I think the house in Bill's example is an early to mid 70's design. So by 1981 it probably wouldn't have been 'modern' anymore. By the 80's walk in robes, ensuites and double garages were all the rage. But not wanting to get too pedantic!

http://www.realestate.com.au/cgi-bi...r=&cc=&c=71316345&s=vic&snf=ras&tm=1214015498

The same building itself today would be worthless. The value is in the land.

Having said that, the beauty of Brick Veneer homes is that they lend themselves well to renovation. Structurally they are sound. They can be modernized very easily (Both internally and externally) and fitted out with today's creature comforts.

Further to that what about all the things outside of the structure - the community, the infrastructure, the travel time to work etc.

An assessment of the strength of the community, infrastructure and travel time to work is a personal judgement shaped by individual circumstances. For a graduate teacher working at a school in the area, travel time would be a matter of minutes. Many people living in Cranbourne would be employed within the local area. (Much like Frankston).

Was a graduate teacher in 81 buying the worst possible (or close to) realestate in the city? That is the question.

Personal bias aside, Bill gave an example of a style of house in a location that was affordable by a graduate teacher in 1981. The point is that this same house is still affordable for a graduate teacher today.

Paying it down and then upgrading is just extending the loan term - nothing more.

A person upgrading to a 'better quality' home would think beyond the loan term. Aside from the equity an upgrader would have in the new property from the sale of their previous PPOR, the life style benefits of moving to the new home would be their primary consideration.

Regards Jason.

 

[yieldmatters]

Personal bias aside, Bill gave an example of a style of house in a location that was affordable by a graduate teacher in 1981. The point is that this same house is still affordable for a graduate teacher today.

I think you missed my point. I am questioning whether it is the "same house". There is much more to a house than a picture on RE.com. You said yourself the value is in the land. I suspect what Bill purchased in 1981 was a modest house in a middle socieconomic community. The one he linked to was a package near the bottom of the barrel. Not the same thing.

I find it hard to believe people can't accept there is an affordability problem when 1) They accept holding housing as an asset is good for "capital gain" (an obvious contradiction - if people said holding particular houses was good for capital gain then it is less of a contradiction and 2) The RBA, the senate committees, commentators, academics - almost everybody who has done any real analysis says housing relating to incomes has become very, very expensive.

 

[Bill.L]

Hi all,

Perhaps I should clear up a couple of things.

The house we bought in 1981, was built in 1956. It was 25 years old at purchase. The house I chose, pretty much at random, in Cranbourne looks like it is 20+ years old.

The house we bought was at 42 Wilma Ave Mulgrave. That area was not the best. We were a long way from any major shopping centre, not near the train, but were near factories. Our house was broken into 3 times that I can remember, and a car stolen from our driveway. Oh, that's right, and a trailer stolen from the driveway on another occasion. In fact the crime/ambience of the area was one of the main reasons why we sold.

At the time we could have bought in a better suburb, further up Springvale road, say in Nunawading/Forest hill, Vermont, etc, but the prices were $55-65 k, and we would have really had to stretch ourselves to buy them. (I never approached any banks to see if they would lend us that much).

bye

 

[jingo]

I think you missed my point. I am questioning whether it is the "same house". There is much more to a house than a picture on RE.com. You said yourself the value is in the land. I suspect what Bill purchased in 1981 was a modest house in a middle socieconomic community. The one he linked to was a package near the bottom of the barrel. Not the same thing.

I find it hard to believe people can't accept there is an affordability problem when 1) They accept holding housing as an asset is good for "capital gain" (an obvious contradiction - if people said holding particular houses was good for capital gain then it is less of a contradiction and 2) The RBA, the senate committees, commentators, academics - almost everybody who has done any real analysis says housing relating to incomes has become very, very expensive.

YM,

I don't believe I have missed your point. Literally speaking, using Bill's example, a beginning teacher would pay around 3X their income to buy the same house in 1981 and today. Add a renovation and you would have pretty much the same standard as back in 1981 - albeit it not in keeping with today's contemporary building styles. I don't see this as a problem...(But you obviously do).

I didn't want this to become a social commentary, but here goes......

The affordability problem exists if you are trying to buy a home that should not be bought by a FHB in the first place! Bill highlighted above that the place he bought in Mulgrave was not in the best area at the time. He could have bought in a better area, but he would have had to pay more, and he was unwilling too as he didn't want to overcommit himself. Very sensible.

What has changed between today and 30 years ago is the willingness of FHB to buy in areas they can comfortably afford to. Today, many FHB's (not all) believe they are entitled to live in a modern house in an area 3 or 4 km's from the CBD! That is where the true problem lies. The government, academics etc will jump on the band wagon because a lot of noise is being created by FHB's who are demanding to live in first class accommodation in expensive areas for their first homes! A totally unrealistic expectation.

I remember my Uncles and Aunties who are babyboomers buying their first homes. They were dumps. They spent the energy (time and money) doing them up which added value. A pity some FHB couldn't spend the time working out where they can afford to buy instead of lamenting that they can't afford to buy straight away in Toorak on an average salary!!

Regards Jason.

 

[yieldmatters]

The house we bought in 1981, was built in 1956. It was 25 years old at purchase. The house I chose, pretty much at random, in Cranbourne looks like it is 20+ years old.

The house we bought was at 42 Wilma Ave Mulgrave. That area was not the best. We were a long way from any major shopping centre, not near the train, but were near factories. Our house was broken into 3 times that I can remember, and a car stolen from our driveway. Oh, that's right, and a trailer stolen from the driveway on another occasion. In fact the crime/ambience of the area was one of the main reasons why we sold.

But were there any worse places you could have bought in 1981? Relative to other people I'm interested to know where a 2nd year teacher would fit in to the housing market.

From memory my grade 5 teacher who was young lived around the corner from me (mid 80's) and the area was firmly middle to lower class - not the worst or cheapest around.

 

[yieldmatters]

YM,

I don't believe I have missed your point. Literally speaking, using Bill's example, a beginning teacher would pay around 3X their income to buy the same house in 1981 and today. Add a renovation and you would have pretty much the same standard as back in 1981 - albeit it not in keeping with today's contemporary building styles. I don't see this as a problem...(But you obviously do).

I think you are missing the point. You keep focusing on the house itself - I'm saying it's a much bigger evaluation than that. The house I am living physically looks much like a first home for somebody in the 1940s - it also happens to worth close to $1M. Bill gets it - he gave some more detail about the area around the house which helps.

I didn't want this to become a social commentary, but here goes......

The affordability problem exists if you are trying to buy a home that should not be bought by a FHB in the first place! Bill highlighted above that the place he bought in Mulgrave was not in the best area at the time. He could have bought in a better area, but he would have had to pay more, and he was unwilling too as he didn't want to overcommit himself. Very sensible.

What has changed between today and 30 years ago is the willingness of FHB to buy in areas they can comfortably afford to. Today, many FHB's (not all) believe they are entitled to live in a modern house in an area 3 or 4 km's from the CBD! That is where the true problem lies. The government, academics etc will jump on the band wagon because a lot of noise is being created by FHB's who are demanding to live in first class accommodation in expensive areas for their first homes! A totally unrealistic expectation.

I remember my Uncles and Aunties who are babyboomers buying their first homes. They were dumps. They spent the energy (time and money) doing them up which added value. A pity some FHB couldn't spend the time working out where they can afford to buy instead of lamenting that they can't afford to buy straight away in Toorak on an average salary!!

Regards Jason.

As for the rest of your social commentary I completely disagree. I think it's obvious that affordability has worsened but those with vested interests (those that hold property) are blind to it. What you guys are doing is taking the bottom 5% of houses available and saying "there you go - the bottom 30% of society can live in those - what's wrong with them - they are affordable". It's a mismatch of enormous proportions. A teacher with a 3 year university education should (even as a first home) be buying something better than the very bottom of what is available.

 

[yieldmatters]

Bit of an afterthought - this debate is fun but in 12 months I think it will be a moot point. There will be plenty of property available at reasonable prices for first home buyers. Not sure if they'll have a job though.

 

[keithj]

Measuring affordability by comparing wages with median house prices is less than useful (according to the RBA). YM knows this because he read it in this thread - however he choses to ignore it.

The RBA prefers to use the ratio of disposable income of 25-35yos to the cost of a 30th percentile house - as BillL is alluding to. And the RBA thinks that affordability of that group of FHBs is just fine.

Comparing a median priced house to average wages doesn't take into account the large deposit that an OO puts down when they sell their old house.


On average wages (at 4%pa) are rising faster than CPI (3%pa).

Eg Last yr a teacher took home $1000pw, spent $700 on groceries (& other CPI items) and had $300pw for discretionary spending.
This year she takes home $1040pw, spends $721 on CPI items and so has $319 for discretionary items (an increase of 6%).

The net result is that discretionary income is rising faster than either wages or CPI - around twice as fast. And with this extra disposable income we can afford to service more debt.

 

[yieldmatters]

The RBA prefers to use the ratio of disposable income of 25-35yos to the cost of a 30th percentile house - as BillL is alluding to. And the RBA thinks that affordability of that group of FHBs is just fine.

Comparing a median priced house to average wages doesn't take into account the large deposit that an OO puts down when they sell their old house.

Yes - I must consider the pyramid scheme when looking at affordability!

On average wages (at 4%pa) are rising faster than CPI (3%pa).

Eg Last yr a teacher took home $1000pw, spent $700 on groceries (& other CPI items) and had $300pw for discretionary spending.
This year she takes home $1040pw, spends $721 on CPI items and so has $319 for discretionary items (an increase of 6%).

The net result is that discretionary income is rising faster than either wages or CPI - around twice as fast. And with this extra disposable income we can afford to service more debt.

Wages rising higher than CPI is productivity increases - it is new wealth for the economy. What you've just described Keith is all new wealth earned by 25 to 35 year olds being handed over to the generation before them in the form of higher house prices.

 

[Peter Parker]

Bit of an afterthought - this debate is fun but in 12 months I think it will be a moot point. There will be plenty of property available at reasonable prices for first home buyers. Not sure if they'll have a job though.

In which case the house price to income ratio (ie affordability) will have deteriorated to 10:1 or worse for these people, even on a $200k house.

And in 1981 there'd have been worse suburbs than Mulgrave. Eg Heidelberg West, Braybrook, West Footscary, Yarraville, etc.

 

[keithj]

Yes - I must consider the pyramid scheme when looking at affordability!

You may consider it a pyramid scheme, though I doubt that the RBA does . It's a wealth limiting conception that you continue to cling to.

Wages rising higher than CPI is productivity increases - it is new wealth for the economy. What you've just described Keith is all new wealth earned by 25 to 35 year olds being handed over to the generation before them in the form of higher house prices.

And in 10 years time, they will have wealth 'handed over to them' from the next batch of 25-35 year olds - this has happened for generations.

It always comes back to the old point that the 25-35 years olds want it all NOW, they're not prepared to put in the hard yards, SAVE for a deposit and start at a 30th percentile house and then wait for a WHOLE 10 years for capital appreciation to do it's stuff, and suddenly a HUGE deposit appears for their next PPOR with absolutely no effort on their part (except for the minor impost of paying the P&I premium over rent).

 

[jingo]

I think you are missing the point. You keep focusing on the house itself - I'm saying it's a much bigger evaluation than that. The house I am living physically looks much like a first home for somebody in the 1940s - it also happens to worth close to $1M. Bill gets it - he gave some more detail about the area around the house which helps.

As I have pointed out in previous posts, the details 'surrounding' the house are for an individual to evaluate with their own personal preferences and bias in mind.

A teacher with a 3 year university education should (even as a first home) be buying something better than the very bottom of what is available.

This is the problem. Many academics believe they deserve better because of their education and the 'time' they have taken to study a degree. Their belief is that they are contributing to society (and yes, they may well be) and they deserve something in return. Be it a good quality home, nice car etc.

Academica has the tendency to foster an 'entitlement' mentality, as you aptly illustrated by the use of the word should above....

There is an affordability problem for those who cannot or do not think they should save a decent deposit to buy a decent house in a decent area, (which in itself is subjective).

For those who can, there is no affordability problem!

Enjoy buying a bargain in the next year or so. Many investors are also waiting on the side lines. I look forward to reading what you end up buying. (I am also looking in Brisbane!)

Regards Jason.