We will defy history if the bubble doesn't burst

[Ausprop]

there are a lot of points to address there, but my main repsonses would be:

- the CF- needs to be kept to a minimum. ideally neutral or positive. Point 5 is therefore negated.
- point 6 fair enough. Comm properties probably respond quicker but they all do over the course of a coupe of years
- I think you are under estimating inflations effect on asset prices. housing is significantly constituted by labour and product and is a large driver of cap growth, if not one of the biggest. right down to the fuel used to cut up a block, government levies etc

your summary of r'ships is quite good but the elephant in the room throughout our discussion is the extent of the CF-. the worse it is the harder it is to claw it back, obviously

 

[Ausprop]

OK, let's look at this inflation thing carefully.


A model based on today's real life data.

gross wage = 80k
tax rates FY10
cpi = 3%
ip purchase price = 400k
LVR = 80%
Mortgage rate 7.3%
in costs = 5%
gross rent = 5%,
holding costs = 1.6%

term deposit rate = 6.5%pa

Result???
The breakeven growth rate is 3.5% pa for 5 years.
Lower growth leads to an IP underperforming a term deposit.

There's lots of property that has underperformed this rate since GFC (Sunshine Coast, Gold Coast, regional Aust). Indeed, some of it is still sub pre GFC values.

so ignoring tax for now...

cash return deflated = $80k + $20k x 6.5% less 3% (ha ha) = $3500 year 1

IP return = debt deflation $9600 less hold costs $12480* plus cap gain $12000 = $9,120 year 1. in costs to be amortised over 30 years say. or, in other words the debt deflation covers your hold costs, cap gain is the bonus (aka inflation of the property)

please pick the numbers apart. I would like the correct answer, not to convince anyone of an answer

* mortgage $320k @ 7.3% less rent 5% plus hold costs 1.6%

 

[WinstonWolfe]

so ignoring tax for now...

cash return deflated = $80k + $20k x 6.5% less 3% (ha ha) = $3500 year 1

IP return = debt deflation $9600 less hold costs $12480* plus cap gain $12000 = $9,120 year 1. in costs to be amortised over 30 years say. or, in other words the debt deflation covers your hold costs, cap gain is the bonus (aka inflation of the property)

please pick the numbers apart. I would like the correct answer, not to convince anyone of an answer

* mortgage $320k @ 7.3% less rent 5% plus hold costs 1.6%

edit: tax is ignored in the numbers below:

IP return
= debt deflation + cg + rent - interest on 320,000 - hold costs (exc interest)
= 9600 + 12000 + (20000 - 23360 - 6400)
= 9600 + 12000 - 9760
= 11840

but 9760 -CF puts a hole in cash flow external to IP investment....it is a 'loan' from wages...and must be paid back to external source if external cash flows are ignored, as they are in the above analysis.

-> 11840 - 9760
= 2080


Term Deposit
Year 1 Term Deposit = cash injected into IP = 100,000
100000 * .065 = 6500

Subsequent years will have the wages lent to the IP investment to cover -CF, added to the term deposit. This ensures a fair comparison by covering opportunity cost.

The difference 6500 less 2080 is reduced by TD interest being taxed, and IP holding costs reducing taxable income.

 

[Ausprop]

ok so we can agree that PI outperforms if you ignore cashflow... because it can be argued that the deflating debt is a loan back to the individual that they will eventually benefoit from. Personally I wouldn't concern myself with internal borrowings other than the opportunity cost of interst on the CF- vaccuum. And the closer the CF- gets to neutral or +, the more PI outperforms.

this all assumes we dont hit financial disaster, which clearly the future does not look good. you have to do somehting tho (and doing nothing is something) so am happy to invest in oz on the assumption we won;t have hyperinflation. bankrupcty is the fall back position, woth some gold bars in the safe.

 

[HiEquity]

but 9760 -CF puts a hole in cash flow external to IP investment....it is a 'loan' from wages...and must be paid back to external source if external cash flows are ignored, as they are in the above analysis.

Hi WW

I don't agree with this. As Ausprop says you can call both the gains and the losses "loans". To all intents and purposes from what I can see is that you are counting this twice? In any case, the relevant numbers are actually post tax, in which case the story turns more in favour of PI.

And yes, a 3.4% net return is too low from a property. This seems to be the main source of the problem...

 

[Ausprop]

Then I just read somehtign about the threat of deflation. arghh! can't win. the world is so confused. you need to make a bet on inflation or deflation and there seems no clear signal. personally I wll bet on inflation - seems an easier option for govts than serious austerity measures

 

[Aaron Sice]

i'm just not paying for the "privilege" to take on a banks' risk anymore, in the "hope" for CG coming to me as a controlling party.

i think i'm done with resi.

 

[Ausprop]

i'm just not paying for the "privelege" to take on a banks' risk anymore, in the "hope" for CG.

i think i'm done with resi.

meaning? you have taken Dazz's advice? sonehting we all shoul dhave done 20 years ago?

 

[WinstonWolfe]

AP and HE, I can see how it looks like I am counting some things twice....but I am not.

What I have done is spreadsheet the two scenarios side by side, starting with a guy who earns an 80k wage.

I calculate his comparative "net worth" at the end of each year for 5 years. When you do it this way, you see where the PI -CF (-9760) is subtracted from wage's contribution to net worth.

Sure, you don't have to pay it back to wages, because it is all internal lending.....but if you don't, you have to reduce wages' contribution to net worth by that amount. The reason I said it had to be paid back above, is because the 9760 is an external injection into the IP, and those figures were ignoring wages contribution to net worth.

I'll post the xls later this arvo when I get back in.

 

[Ausprop]

yes but there is an injection back - the defalted debt adjustment.

 

[WinstonWolfe]

yes but there is an injection back - the defalted debt adjustment.

Hopefully the xls can clarify. Click on the pic to get the xls.

You can 'discover' the breakeven growth rate using
Solver add in
or
tools/goal seek (set cell L25 to 0, by changing C4).

I can't be sure I've got all the bugs out....made it in a hurry.

 

[WinstonWolfe]

Hi WW

I don't agree with this. As Ausprop says you can call both the gains and the losses "loans". To all intents and purposes from what I can see is that you are counting this twice? In any case, the relevant numbers are actually post tax, in which case the story turns more in favour of PI.

And yes, a 3.4% net return is too low from a property. This seems to be the main source of the problem...

yes but there is an injection back - the defalted debt adjustment.

I've been pondering how best to explain my view on this. How about this.

We've both been erring in considering debt deflation in the calculation.
Yes, it is relevant in the first year, but for every year after, capital gain and cash flow must also be deflated by the rate of inflation. You cannot selectively deflate values in a series of cash flows. Either all values are inflation adjusted, or none.

We have both inflated the property value (ergo capital gain) by the nominal rate, and selectively deflated the loan.....This is double dipping....

I've been messing with how to xls this, and the two ways I am firming up on for avoiding deception is:

1. Inflate all values (cg and all cf) at respective inflation inclusive nominal rate. Doing so effectively deflates the original debt.

2. Trying to compare cash and IP in today's dollars by NPV and IRR introduces a complication. When calculating this way using inflated future cash flows, you not only discount the bank interest rate, but also inflation. The NPV discount rate thus becomes

(1+bank interest)*(1+cpi)-1
thus
(1+6.25%)*(1+3%)-1 = 9.44%

NPV formula then becomes

=NPV(9.44%,all cash flows except start value)-start value.

Start value is usually an external injection, so must have a negative sign in the formula.

Finally, it is fraught with traps to compare cash and -cf ip without proper consideration of pre and post tax free cash flow.

 

[ToDo]

Grantham was referring to multiples of family income.

If you look at valuations in terms of average income, prices have risen significantly over the past decades:
http://www.ibhb.com.au/resources/valuations.htm


Sure the number of dual income families has increased from the 60s, but if prices and wages keep rising at historical rates, it will eventually require multiple generational incomes to purchase the same property.

How nice would have been if people who do not have foggiest idea about the subject did not write property books. It would have add on effect that people with even less understanding would not read them, therefore not being infected with the false ideas.

Lets take Sydney, say Wilmot - median price $219K. Means that it is not real problem to find a house for $200K. $200K it is just 1.5 years worth of half decent income for double income family. So, the problem is NOT in mythical "multiples of income" - problem is in something else. I know exactly what the problem is.

Gen Y parasites just simply do not want to work hard, they do not want to start at outer suburbs and gradually upgrade. They want to move straight to $1M++ ones.

Pls do not start me on "low socio-economics" of Wilmot or Tregear. Want example from Sydney's North Shore ?

Look at this one:

http://www.realestate.com.au/property-residential+land-nsw-mount+colah-2693707

Say if you manage get this land down to $330K , base price to build 3 bed brick homes start at $75K. Say $20K site costs, and for just $430K you get brand new house that would be worth immediately at the region of $650K.

Do you know what - no idiot has bent over and picked up $220K worth of instrant capital gain from the ground. This block is on the market for over a year.

Too blunt? Far from station?

OK, there is another one for you:

http://cgi.ebay.com.au/ws/eBayISAPI.dll?ViewItem&item=260602423529&ssPageName=ADME:X:RTQ:AU:1123

Views, 10 min walk to station, approved 4 bed house. Over the fence from this one - five lots new subdivision, latest sale of 4 bedder - $780K. Do yu think someone will pick quarter of a million from the ground? I doubt.

I am sure in 6 months time they both will still be there, then I will buy them and make a killing. If not - I do not care - at the moment I have even better deals.

Tattoo it on your forehead - we no longer have space in the expensive suburbs for people who care about "multiple of incomes". They will be squeezed out by people who are capable of making money.

 

[HiEquity]

Hi WW

IRR and NPV are only useful for evaluating a series of cashflows. To apply them to property investing, you have to assume a cashflow in to purchase and a cashflow out on sale, including all costs. It just doesn't work for comparing "buy and hold" to TDs or other "pure" cashflow investments. It's not made for that purpose - it's just used to value a series of cashflows.

As I think you mention in another thread, at the end of the day, it is the differential between IRs and inflation, rental increases and inflation and property values and inflation that determines everything. It's all in the assumptions used and there are many defensible variations on each of the above, with a small direction either way making a massive difference in the long term.

I prefer to keep it relatively simple - looking at firstly whether the property pays for itself today and if so, assume:
- that in the long term rents and values will outpace inflation due to scarcity factor and the increasing marginal cost of new supply.
- that the IR margin over inflation will remain relatively constant as it is more dependent on banking competition than anything else and most of those margin increases have already happened.

If those assumptions hold, you will get ahead and get some exposure to hopefully some decent upside when rents eventually reach a decent level.

 

[Intrinsic_Value]

out of curiosity has anyone looked at this current period compared to post 1987.
I see alot of similarities, the only structural difference is i dont think we will need to have the recession that we had to have.

But the investment pyschology seems very similar.

Just a thought, and remember history never cycles exactly..

I still think all in all australia will be the 'lucky country' (or maybe i should say the COMPARITIVE LUCKY COUNTRY) so long as Mr Rudd doesnt completely stuff it up.

Another point to highlight this, has anyone done a comparison of dividend ylds from the share market to net income ylds from residential property.
I dont think i have seen a wider variance in a long time.

Boz you are our technical genius in this regard, maybe you can input.

 

[WinstonWolfe]

IRR and NPV are only useful for evaluating a series of cashflows. To apply them to property investing, you have to assume a cashflow in to purchase and a cashflow out on sale, including all costs. It just doesn't work for comparing "buy and hold" to TDs or other "pure" cashflow investments. It's not made for that purpose - it's just used to value a series of cashflows.

I realize that HE, but afaik they are the only tools available to compare two investment opportunities by discounting the time value of money. and save a lot of spreadsheeting flows long hand.

I also appreciate buy and hold annual equity gains are not cash flows, but they can be treated as such......in effect, used to discount the time value of flows towards 'net worth'....net worth being the sum of cash flows and equity flows.

As I think you mention in another thread, at the end of the day, it is the differential between IRs and inflation, rental increases and inflation and property values and inflation that determines everything. It's all in the assumptions used and there are many defensible variations on each of the above, with a small direction either way making a massive difference in the long term.

In my modeling, PI performance is most strongly effected by growth, then interest, then 'initial' rent yield. Inflation is insignificant.

I prefer to keep it relatively simple - looking at firstly whether the property pays for itself today and if so, assume:

when you say pay for itself, I presume you mean after tax cash flow, with no consideration of equity gains balancing -CF property. ok, that's a straight forward calculation. but many need to evaluate the strength of a -CF property with good cg potential.

- that in the long term rents and values will outpace inflation due to scarcity factor and the increasing marginal cost of new supply.

my view is our prices are 1/4 dependent on bloated foreign credit.....and no matter how legitimate demand fundamentals are, if global credit is scaled down or demands higher returns, then our property prices have serious downside risk. that's risk I take into account.

- that the IR margin over inflation will remain relatively constant as it is more dependent on banking competition than anything else and most of those margin increases have already happened.

yes, banking competition is a downwards pressure on IR margin.
but a shortage of foreign wholesale funding is an upwards pressure, which along with the govt guarantee, sank our non bank lender sector.

If those assumptions hold, you will get ahead and get some exposure to hopefully some decent upside when rents eventually reach a decent level.

Many older PIers I know are moving more towards build to rent, and value adding. They are forgetting build to sell and passive B&H, because they see mounting risk to future growth. With reduced growth potential, -CF doesn't work in a timely manner.

If credit does tighten significantly in the future, as I suspect, it will become even more difficult to increase housing supply....and that will put even more pressure on rents. But whether that rent pressure is enough to counter sluggish growth, is the $64million question.

There's more than one way to make a million, which makes Somersoft interesting reading.

 

[Bill.L]

Hi all,

IV,

out of curiosity has anyone looked at this current period compared to post 1987.

Yes. Even last year I was comparing this period with the post '87 crash. You are right, the similarities with that period are uncanny. Right now I would think we are at about late '89 for comparison purposes, just as the stockmarket starts to tank again after the long recovery.

If the analogy continues, then property prices should start to stagnate very soon followed by falls or lack of sales. Just like the recession we had to have, there is a high probability of one coming in the 'one we couldn't avoid', especially if the RB decides to not lower rates because of inflation due to the dropping $Aus.

bye

 

[Nicko]

Started a business in 94 which has been the key to my current financial position

Which business did you own?

Thanks.

 

[urbanprospector]

no shortage in perth market flooded with rentals .
so rents here wont be going up any time soon .. page ads of rentals in local rags .. for lease signs on many houses .. flood of ads on notice boards.

 

[Jebb]

no shortage in perth market flooded with rentals .
so rents here wont be going up any time soon .. page ads of rentals in local rags .. for lease signs on many houses .. flood of ads on notice boards.

I was wondering why this was. There is meant to be a "mining boom" happening, and there are boatloads of people moving over west. Where did all these rentals come from? Investors bought a ton of properties in the last 6 months?