Property no longer 'Safe as Houses'?

[awfish]

I am a 25 year old, and recently decided that maybe I should start thinking about buying my first house. Not an investment, just a home to live in. However, when I started researching, the sums just don't add up!

I've written a short article on why I feel this way, and I'd like some seasoned investors to give me another take on it - perhaps to show me something I'm missing.

The article is hosted at http://www.digitalfish.com.au/property

Thanks in advance! Any input absolutely 100% appreciated!

 

[WildDog]

I am a 25 year old, and recently decided that maybe I should start thinking about buying my first house. Not an investment, just a home to live in. However, when I started researching, the sums just don't add up!

I've written a short article on why I feel this way, and I'd like some seasoned investors to give me another take on it - perhaps to show me something I'm missing.

The article is hosted at http://www.digitalfish.com.au/property

Thanks in advance! Any input absolutely 100% appreciated!

Only 2 sure things happen in life and that is deadth and tax
anything else has some degree of risk

 

[MarkB]

Quotes from your article in red


The median house price in Australia is currently around $350,000. The average wage is around $55,000/yr and the interest rate you’ll pay on your mortgage is likely around 7.3% p.a. So assuming that you finance the full amount (deposit notwithstanding) you’ll be paying $2,135/month for the interest on the loan only. If you wanted to pay that $350,000 off over say, 20 years, the monthly repayment will be about $2,775 (assuming interest rates stay static). That’s nearly 80% of the average wage after tax – leaving a whopping $164 a week to live off. If you do the same thing with a 20% deposit, it will still take 63% of your after tax income – leaving around $300 a week to live off.

When there are 40 year mortgages out there, why would anyone choose to pay a loan off in 20 years and live of as little as $164 pw?


“Property always doubles in value every 7-10 years” is what my parents tell me. Well, yeah, that was true during their experience of the 70s and 80s where inflation averaged 9% p.a. But the piece of paper their mortgage was written on doubled in value every 7-10 years too! [emphasis added]

This is wrong.

Mortgages do not increase over time unless you either extend them or fall so far behind in repayments that the bank forces a mortgagee sale.

And, as you can appreciate, even on an I/O mortgage (where the principal is not repayed) the real value of the mortgage decreases over time owing to the effect of inflation.


Compare that chart with the next, where prices increased 125% over six years. It really looks quite similar to the 1880s Melbourne boom – worse even. It’s frightening then, to know that this graph illustrates the actual price of the median Australian home over the past 20-odd years – along with a 13-year projection of what house prices must do, in order to be brought back into line with historical valuations and affordability [emphasis original]

Personally I think it is very very dangerous to start looking at historical values. So many things are different now - not least of all that access to finance has been made considerably easier than the days when banks were instructed what and when they could lend.

And since the Government has decided to maintain the aged pension at a level you could barely feed a dog on, we are now all largely responsible for funding our own retirement. There's billions of dollars of investment in residential property in this country - and while maybe the market in a place like Melbourne isn't as fierce as it was 4 - 5 years ago, the money that would have gone into IPs has found its way into other assets (namely equities). Some day in the not too distant future - maybe this year, maybe next year, maybe the year after that - I don't know - investors will get nervous about the viability of the equity investments and look for an asset class with greater security - and investment property will be there waiting for them and the cycle will begin all over again.





Awfish - are you an economist?

M

 

[duncan_m]

Economics and risk aside.. buying a modest home gives you the freedom to enjoy yourself, put in a shed, restore a car, install a pool, remodel the kitchen, hang up pictures, paint, decorate, live as you see fit and it gives you surety of residence.. its yours as long as you want it.. dont discard these factors..

I too think housing is way, way overpriced, but it wouldnt be hard to find a modestly priced home that even if a significant fall occurs you wont be too badly off.

 

[MarkB]

And to respond to your "safe as houses" comment consider this -

(This is about the 5th time I have posted this, in various forms)

Depending on your marginal tax rate and the interest rate payable on your mortgage, each dollar put in your offset account [linked to your PPOR mortgage] could be earning you as much as 13% pre-tax equivalent (remembering that PPOR mortgages are paid from after-tax dollars in many, not all, cases).

For an income earner earning between $25,000 and $75,000 pa (and with a marginal tax rate of 30 cents in the dollar) the return (depending on the interest rate they pay on their mortgage) will be about 10.6%.

In a low-yield, low-capital gain market (perhaps what we have atm?), it certainly could be argued that parking excess cash in mortgage offset accounts is a very effective use of your money - and with close to ZERO risk too!

Why is it zero risk?

Because the vast majority of us (salary earners in particular) are able to forecast our taxable earnings and hence marginal tax rate very accurately and the interest rates on loans are also relatively stable. Hence, the pre-tax % return is very low risk.

So, if you can earn (say) 10% pretty much risk-free on your money by using an offset account linked to a non-tax deductible mortgage - what % return (with risk) do you have to earn from IPs (or some other investment) to compensate for the higher risk?

Financial advisers will say that the government bond rate is as close to risk free as you can get, and at the moment, the 10 year bond yield is about 6.00%.

We all know that risk = return and that as you seek a higher return you have to accept greater risk (Investing 101, I know).

Therefore, taking 6.00% as a risk-free benchmark, you then consider other options and whether their increased return (better than 6.00%) justifies their risks.

But what we have really is a new benchmark (and it is alot more applicable and accessible for the vast majority of people) and it is that owing to the taxation treatment of PPOR mortgages as much as 13% can be achieved with minimal risk.

In a slow (slowing) property market this is a pretty high bar to have to hurdle!

I am not saying that it is impossible to achieve 13% at the moment, but what I am talking about is not smoke and mirrors and it doesn't rely on assumed capital gains, or occupancy rates (both of which are, imho, riskier than most individuals personal incomes).

Look hard enough and smart enough and yee shall find, but for many people perhaps the wisest, most profitable, and safest real estate investment they could make at the moment is their own home.

Got a better return for as little risk, awfish?

M

 

[WillG]

mmm ... You got me to check out your website.

What sort of comments would you like to hear ? I would say that it is general. Perhaps the title could read "Only professional couples wthout children can afford property"

It would be more interesting to see some examples of different types of people and affordability. You may want to make comparisons between the different states and areas (in terms of distance to CBD) where they can afford to buy

Sample set of people

1. Average couple without kids
2. Professional Couple without kids
3. Average couple with kids
4. Professional Couple with kids
5. Professional person
6. Average person
7. Below average couple
8. Below average person

 

[awfish]

What sort of comments would you like to hear ?

What I would like to hear is for someone to completely prove me wrong and blow me out of the water.

I'd love to buy a house, and duncan_m's reasoning is the best I've come across - my own thoughts also. However I'd be looking at a house around the $500k mark, and - fundamentally at least - It appears that home should really be worth less than $400k.

I've always been pretty choosy about my investments, and while a house does certainly have an emotional attachment that I need to deal with, I still need to feel comfortable with the risk.

I made the effort to write my thoughts down so I could better understand them - I still don't, so I'm asking the professionals for their point-of-view.

 

[awfish]

BTW, I am not an economist, but I do have a degree in Economics.

And the comment about the paper was about the physical piece of paper - A tongue-in-cheek gibe that at 9% inflation, almost everything doubles in value over 8 years!

 

[awfish]

(This is about the 5th time I have posted this, in various forms)...

You're going to have to dumb that down for me a bit... I can't get my head around it. PPOR mortgages are paid out of after tax income, therefore I don't see what sort of implication tax could ever have on mortgage repayments.

 

[Rystar]

"that’s nearly 80% of the average wage after tax – leaving a whopping $164 a week to live off."


i think one of the other assumptions the baby boomers have is getting married and doing it together.
so if you simply double the monthly wage to create a household wage, your only looking at about 40% going towards interest.
that leaves about $900 a month to live off.

or if you want to stay single, have one or 2 mates move in with you and get rent off them. my brother did this for the first 5 or so years he built his house.
made a big difference to him.

there are always ways to do things....

cheers
Ryan

 

[MarkB]

Say you have some money to invest (whatever amount) and you have a non-tax deductible PPOR mortgage.

How do you compare the choice you face between making a a pre-tax investment (such as one in equities, or IPs) with a post-tax one in your PPOR?

Answer - you ascertain the pre-tax equivalent earnings of every dollar put into an offset account linked to a PPOR mortgage.

So, to use the example of a 30% marginal tax rate and an interest rate of 7.3% - every extra dollar you can throw at that mortgage earns you the equivalent of 10.66% pre-tax.

You can then take that benchmark and compare it with your potential returns in other investments and see if you can better the 10.66% and, if so, whether the potential higher return is worthwhile when the risk is considered.

My main point is a very simple one - and it is that for most people every extra dollar in their PPOR mortgage is invested at close to zero risk with (depending on your marginal tax rate) a pre-tax equivalent return of as high as 13%.

Houses can be very safe.

M

 

[awfish]

Aha - gotchya.

 

[lizzie]

and who dictated that you had to start with the average house? i'm sure you will find the majority here who have become successful over time started with a way below average - reno'd or subdivided or in some other way increased the value of the property then moved onwards and upwards.

my first house was a $74,000 dog box in the burbs bought in 1989. we extended, renovated and landscaped over the next 9 years - sold it when divorced - took my half share of the profits and bought a $140,000 dog box in the inner suburbs. new hubby (not so new now) and i have done all the above - reno'd, subdivided and landscaped both our ppor's and ip's.

we now live in a house 9 years later bought for $1mil - and with a bit of reno-ing again will be worth $1.5.

and all through that time we have increased our ip portfolio from 0 to 11 (was up to 13 but sold 2) and now looking for a development site for our next ip investment.

be realistic in your sums and don't be disgrunted - those who think outside the square end up wealthy and those that don't end up still paying their initial mortgage when they are 60.

 

[WillG]

What I would like to hear is for someone to completely prove me wrong and blow me out of the water.

I agree that times have changed for first home owners. Just raising a 20% deposit for a $350k house would require years of aggressive saving. First home buyers may have to invest (either in shares or property) to raise enough $$'s for a decent deposit on their first property.

 

[awfish]

be realistic in your sums and don't be disgrunted - those who think outside the square end up wealthy and those that don't end up still paying their initial mortgage when they are 60.

Lizzie, I'm really interested to hear your experiences of entering the market, as it was during a time when high interest rates made property even less affordable than it is today. Do you remember how much of the deposit you were able to put up? Were you on an average income at the time? Double income?

I'm not disgruntled either - far from it. I can afford to buy property - quite comfortably. What I'm trying to decide is if it's a financially-secure decision to do so. Looking at history is dangerous according to Pitt St (I assume because it may lead to missed opportunities). But I believe history has a tendency to repeat itself - Although it's very hard to find any boom quite like the global housing boom... Maybe Japan?

Surely the recent boom felt a lot more forceful to you than anything previous? (I am too young to know )

 

[luce.rocks]

if the global housing boom was because baby boomers realised that they couldn't rely on their governments to support them in retirement, and if that made housing less affordable for gens x and y, maybe as gens x and y start to approach middle age, and think about retirement, they'll make a grab for the next safest or most understandable asset class (i've got nfi what that is, cos i've never put $ into anything other than houses) that they can use as their nest egg? and maybe that will make another global boom? i mean people like to hold on to stuff right? if they don't understand trading, they don't want to do it. but maybe things like gold, or other resources/commodities that are more tangible, physical, understandable, arguably safer, maybe they'll grab for those if they can't buy property? or maybe the government will introduce something like medicare but for financial advisors? i want to be a financial advisor... what a rambling and ill thought out post... i need a cup of tea

 

[Peter 14.7]

Dear Awfish

I have to wet a line ( pun intended)

Why buy a PPOR or IP?

Simple. You either invest what you need to provide for you in shares or property.

Unlike perhaps the optomistic GEN Y us boomers (even though I am cusp) dont have any faith at all in the Gov provided in for us. In fact, even now a far few pensioners live on bread and water. The Government will not and super may not be there when you are 60.

For 95% of Australians thier home will be the biggest and only investment of worth they will have in retirement. Why is this?

It is easiest to get loans for, makes tax sense (good one Pitt St) , is 99.9% safe, you can value add, easy to understand, has a guaranteed future value, and you have significant control.

With Shares you cannot get the same level of loan, are taxed on the dividends and CG, is 0% safe, you cannot value add to your David Jones Shares shares by painting your local DJ's, and you have very littel actual control ( director options, bad loans, competitiors, gov regulation).

I could go on but in simple terms you could invest $300wk in rent of $400wk in repayment.

So assuming you take the $100 wk and invest elsewhere you need to get better than 14% per annum before tax to equal the tax free saving you are making on paying back your home.

And the crunch is most don't put aside that $100 a week but very few default on repayments. And where can you get low risk 14% per annum?

Peter 14.7

 

[Ausprop]

"I am not saying that it is impossible to achieve 13% at the moment, but what I am talking about is not smoke and mirrors and it doesn't rely on assumed capital gains, or occupancy rates (both of which are, imho, riskier than most individuals personal incomes)."

just when I was about to comment that the argument was smokes and mirrors you came out with that!

for someone that doesn't have a mortgage, you can't argue that if they get a mortgage and pay it down they are earning pre tax returns upon the savings because nothing has been saved - they just aren't paying a cost that they never had. Rents are approximately 1/4 to 1/2 the equivalent of the cost of ownership of a property. In a period of low CG it is hard to argue that a house is a good investment. It is purely a lifestyle decision - you just have to decide if a porsche or a house does it for your more. at least the house will hold its value. then again so do some cars, boats etc

for someone already in home ownership with a mortgage tho, the argument is clear... you need to be earning a very good and safe return to justify doing that rather than just paying down your mortgage.

 

[alexlee]

BTW, I am not an economist, but I do have a degree in Economics.

And the comment about the paper was about the physical piece of paper - A tongue-in-cheek gibe that at 9% inflation, almost everything doubles in value over 8 years!

I'll repeat this basic point again.

Gearing makes sense when your returns are above your interest rates.

You put $35k down for a $200k property. At 9% inflation, the property dobles in 8 years. So 8 years later, it's a $400k property. Have your real (inflation adjusted) assets grown?

Not on that the original equity, but you've also received a 9% return on the money the BANK lent you. That's extra return you wouldn't have had if you hadn't borrowed the money. Of course you also have to count the interest you paid and the rent you 'saved' by buying.

To put it another way, your MORTGAGE doesn't go up with inflation. If something's numeric value stays the same (as an IO mortgage would) in an inflationary environment, its value drops. If it's a debt, you owe less in real terms as inflation erodes the debt. ($200k now is a lot less than $200k 20 years ago). With gearing what you have is 'extra' assets that is tracking inflation (technically zero real return) but balanced by a debt that is DECREASING in real terms. That's what I call a POSITIVE real return. Stripping out inflation, it's like the bank saying 'we'll decrease the balance of your loan every year while your asset stays the same'. Of COURSE you're making money!

A simple example. $200k IP. 100% LVR. Assume rent totally covers the mortgage (in reality will be negative at first but positive at the end).

After 8 years at 9% inflation. Your mortgage stays at $200k. Your property is $400k. Equity is $200k. You started the strategy with zero equity. Your equity now is $200k. Inflation adjusted you've created $100k in current dollars. Still think it's a bad investment?

Incidentally, I view the PPOR as, at best, a medium form of savings. It's not even particularly good. What would be better is to buy IPs.

I still don't understand why there are suddenly so many 'academics' wanting to prove what many of us have been doing, and have been profitably doing, is wrong. You're arguing using textbook theory and your own thoughts. We can see what's happening to our balance sheets. Time to START BUYING, people!!!! The market is turning if people are starting to say 'this is why I don't think property is a good investment' while saying 'shares will never go down'!!!!
Alex

 

[Sunfish]

Time to START BUYING, people!!!! The market is turning if people are starting to say 'this is why I don't think property is a good investment' while saying 'shares will never go down'!!!!
Alex

Could you please quote your licenced investment advisor number when giving such advice.

Past performance is no guarantee of future returns!!! But you know that.