House prices to keep falling for years

[chops_a_must]

Prawn, Chops - as well as capital gains its important to consider how rent fits into the equation.

Simple example - here in Sydney (where prices boomed till 2003 but have been far less heated since), down the road a few blocks from me - there are second hand studio apartments for sale for $240k - they are pretty much the same price now as they were 5 years ago. 5 years ago the rents were $220/week, now the rents are $330/week.

If you got a place for $220k (assume some further price reductions) then add on $10k buying costs to make $230k purchase. The net interest cost on $230k at 7.7% is $17710/year. Add on $2k levees and rates to get $19710 per year as net 'cost of ownership', which is $380/week. That is based on 100% cost of borrowing.

So if you were a young bloke, fed up with living with flatmates (share accom in the area is about $200+/week) and wanting to get into a place of your own, then the cost of renting a studio is $330 while the cost of owning one is $380. (based on 100% borrowing).

By the way - in the mid 90's those same apartments were available for $80k to $100k and the rents were around $120 to $150 a week.

As I said, owner occupied is different.

Would I buy something if I won/ inherited/ whatever a million $? I'd say almost certainly. Would I invest in property if I had that much? Probably not, unless it was compelling.

 

[chops_a_must]

Having said that, most investors are long term - you use the negative gearing/negative cash-flow situation AT FIRST, with the tax benefit helping make up the difference. Over a period of time, the RENT goes up - your interest payments GO DOWN (as the principle is paid off). At some point all investment properties will turn cash-flow positive - at that point the property investor is sitting pretty..... Get it yet??

You guys here deride property investors so much,as if they are all a bunch of idiots. But I think the vast majority are actually well aware of their cash-flow position, state of the market, and how you actually make money from property etc. The key though is a LONG TERM VIEW.

Cheers,

Beej

I can buy a property correlated stock, be cashflow positive from day 1, and sell each June if it is in a negative capital position.

I don't get your point.

The only time I can see property being good to negatively gear, is if it was property that was able to be developed for a larger gain later on, than what I am likely to lose in the short/ medium term. I guess the same applies if it is a cracker of a property in any case, that wasn't likely to be on the market often.

 

[Beej]

I can buy a property correlated stock, be cashflow positive from day 1, and sell each June if it is in a negative capital position.

I don't get your point.

The only time I can see property being good to negatively gear, is if it was property that was able to be developed for a larger gain later on, than what I am likely to lose in the short/ medium term. I guess the same applies if it is a cracker of a property in any case, that wasn't likely to be on the market often.

The point is that you get exposure to long term capital gain as well, with little/no invested capital up front, and a small amount of cash flow subsidy for the first few years to make up the negative cash flow minus tax deduction portion. This "cash flow subsidy" would usually represent something in the order of 0.5% -> 1.5% max of the property purchase price initially, reducing each year until the cash-flow positive cross-over point is reached (that's what I always aimed for anyway). You don't need very much actual capital gain to get in front. Long term you will get massive capital gain, as well as significant positive cash-flow.

Of course there are always many alternative investments available. No one is saying property is always the best of the many available alternatives at all times. None the less, it is an asset class that will generate significant cash flow and capital gain over the long term, and in my view is an essential component of any diversified personal asset portfolio mix.

It only doesn't make sense if you honestly believe that in say 10 or 20 or even 30 years, a given existing property will not be worth more in absolute $$$ terms than it costs today. It has always been a long term investment - the fact that some people have been lucky with extra-ordinary capital gains in the past 5-10 years is just a bonus, and has given some people the idea there is easy short term money in property investment. Of course no-one here (not even the property bulls) believe that will be the case going forward from here (unless you develop). The easy money has come and gone (and of course some of us got a piece of that action, and some haven't!). But long term property will still prove to be a solid investment. Buy well and do your sums properly.

Cheers,

Beej

 

[cuttlefish]

As I said, owner occupied is different.

Would I buy something if I won/ inherited/ whatever a million $? I'd say almost certainly. Would I invest in property if I had that much? Probably not, unless it was compelling.

The thing is - even with 100% down - as an investment with the tax benefits (i.e. tax departments pays 46.5% of your costs if you're in the top tax bracket) - that apartment would only cost an investor about $30 a week to own. And every year the rent goes up, even if its just $10/year rental increase, that gap gets smaller. History says the rents in that area will go up - there is limited land supply, a complex and tedious approval process for new developments and it is in a location that has historically always had high demand for accomodation.

Now if you can take advantage of a dead market to buy developable land investments in the area without paying the bull market premium the multiplier effect on capital gains if/when they do come is enormous - but that is obviously more speculative than buying an established sound property returning a predictable income.

 

[chops_a_must]

Of course there are always many alternative investments available. No one is saying property is always the best of the many available alternatives at all times. None the less, it is an asset class that will generate significant cash flow and capital gain over the long term, and in my view is an essential component of any diversified personal asset portfolio mix.

I don't disagree with you. Actually, I strongly agree with you.

For me, if I was investing in property, it would purely be for income. Obviously people over the last 5-10 years depending, have got the idea that capital gains are what property is about. For me, in my mind, it's not the right way to go about it.

Transaction costs are far too high, and it is too much of an illiquid market at any one time to be able to target that. There are many better methods to capture capital gains elsewhere in other assets.

In my mind, and the risk that I would be prepared to take, would limit me from buying investment property unless it was cashflow positive, or likely to become so in the short term. But that's just what is acceptable to me. And I haven't seen an argument at this stage that has convinced me to view it in a different way.

 

[cuttlefish]

I don't disagree with you. Actually, I strongly agree with you.

For me, if I was investing in property, it would purely be for income. Obviously people over the last 5-10 years depending, have got the idea that capital gains are what property is about. For me, in my mind, it's not the right way to go about it.

Transaction costs are far too high, and it is too much of an illiquid market at any one time to be able to target that. There are many better methods to capture capital gains elsewhere in other assets.

In my mind, and the risk that I would be prepared to take, would limit me from buying investment property unless it was cashflow positive, or likely to become so in the short term. But that's just what is acceptable to me. And I haven't seen an argument at this stage that has convinced me to view it in a different way.

I actually think this is a very sensible way to view property investment. Property is a good place to store wealth and to generate a hassle free, inflation safe income.

 

[numbercruncher]

The thing is - even with 100% down - as an investment with the tax benefits (i.e. tax departments pays 46.5% of your costs if you're in the top tax bracket) - that apartment would only cost an investor about $30 a week to own. .

Can you please walk us through this equation were an average priced unit fully financed only costs 30 bucks a week to own for an infestor.

It only works for top tax bracket people ?

 

[finnsk]

For me, if I was investing in property, it would purely be for income. Obviously people over the last 5-10 years depending, have got the idea that capital gains are what property is about. For me, in my mind, it's not the right way to go about it.

Transaction costs are far too high, and it is too much of an illiquid market at any one time to be able to target that. There are many better methods to capture capital gains elsewhere in other assets.

In my mind, and the risk that I would be prepared to take, would limit me from buying investment property unless it was cashflow positive, or likely to become so in the short term. But that's just what is acceptable to me. And I haven't seen an argument at this stage that has convinced me to view it in a different way.

I agree with you on this I would never invest in property if it is negative geared what will happen if my income disappeared for what ever reason eg. accident, sickness. With no income the investment property will be gone and properly also my PPOR.

 

[cuttlefish]

Can you please walk us through this equation were an average priced unit fully financed only costs 30 bucks a week to own for an infestor.

It only works for top tax bracket people ?

Current advertised asking price $240k
Current rent $330/week.
Assumed purchase price circa 10% discount to current market ($220k).
Add purchase costs ($10k).

Net cost $230k, 100% financed.

Interest cost (cost of ownership) @ 7.7% = $17710/annum
rates and levees circa $2,500/annum

Total cost of ownership = $389/week.
Rental income = $330/week.
Net loss = $59/week
Loss is tax deductable so comes off income. If in top tax bracket that income would have been taxed at 46.5%. Thus tax saving is .465*59 = $27.40/week Thus cost to investor is approx $32 per week to own the unit.

(I've increased the rates/levees to $2500/year compared to my example earlier in the thread because that is probably more realistic).

 

[Pommiegranite]

The market seems to be capitulating!

http://www.news.com.au/business/money/story/0,25479,24696467-5013951,00.html

 

[Pommiegranite]

Current advertised asking price $240k
Current rent $330/week.
Assumed purchase price circa 10% discount to current market ($220k).
Add purchase costs ($10k).

Net cost $230k, 100% financed.

Interest cost (cost of ownership) @ 7.7% = $17710/annum
rates and levees circa $2,500/annum

Total cost of ownership = $389/week.
Rental income = $330/week.
Net loss = $59/week
Loss is tax deductable so comes off income. If in top tax bracket that income would have been taxed at 46.5%. Thus tax saving is .465*59 = $27.40/week Thus cost to investor is approx $32 per week to own the unit.

(I've increased the rates/levees to $2500/year compared to my example earlier in the thread because that is probably more realistic).

As this if for an interest only mortgage, where is the money going to come from to pay the capital at the end of the mortgage term?

 

[CamKawa]

A home loan is not like a margin loan for shares! Ie the bank WILL NOT come knocking asking for extra cash because they think the value of a security has fallen!

I not 100% sure about that. If when the bank gets anxious enough about falling house prices I think they may do a quick drive buy the house for a re-evaluation and if the owners LVR is too far out of wack ask them to either sell or cough up the difference with cash, which maybe a sizeable amount. Either way a forced sale is on the cards. I know it's caught specuvestors out in NZ before.

 

[Mofra]

Do mortgage documents specifically say this ? Has it never happened before ?

I assume you mean the UCCC standard loan contract issued with the bog-standard mortgage documentation issued upon approval.

There isn't a specific provision that states a lender will (or even can) revalue a property, however upon extending a loan (term or credit) a lender will have the option of revaluing the property as these cases are often treated as a new loan with a new contract required to be issued.

I've had one case a years ago where a client wanted to borrow a little more for renovations, problem was they ripped out the entire kitchen before the valuation. Unfortunately there isn't an IQ test stapled to the front on loan contracts, would save evryone alot of hassle.

BTW, non-confirming lenders (bluestone, liberty, etc) may have something a little diffrent but they only represent a very small segment of the mortgage market.

 

[prawn_86]

Intersting cuttlefish

Problem where we live, is that an apartment of that value only rents for $230 - $250 pw, so a long way off the $330 you used. Thats just different markets for you i guess

EDIT - and Pommies point of interest only, whats your take on that?

 

[numbercruncher]

Current advertised asking price $240k
Current rent $330/week.
Assumed purchase price circa 10% discount to current market ($220k).
Add purchase costs ($10k).

Net cost $230k, 100% financed.

Interest cost (cost of ownership) @ 7.7% = $17710/annum
rates and levees circa $2,500/annum

Total cost of ownership = $389/week.
Rental income = $330/week.
Net loss = $59/week
Loss is tax deductable so comes off income. If in top tax bracket that income would have been taxed at 46.5%. Thus tax saving is .465*59 = $27.40/week Thus cost to investor is approx $32 per week to own the unit.

(I've increased the rates/levees to $2500/year compared to my example earlier in the thread because that is probably more realistic).

Thanks.

Is that typical in your target market, I mean 230k properties that rent for 330 a week ?

Where I live its pretty much the opposite a 350k property would get 300 a week rent. But prices seem to be levelling rapidly, have they crashed in your market ?

 

[numbercruncher]

But at this rate Cuttle up here in Qld we will have returns like you very soon do you think ?

THE number of properties sold in Brisbane has slumped by 18.6 per cent in the past 12 months - the worst property market decline recorded in Australia.

Sales were down 10,000 compared with the same period last year. Just 40,868 homes changed hands during the year, compared with 50,211 in the 12 months to October 2007

http://www.news.com.au/couriermail/story/0...5011140,00.html

Still rather early in the great recession to hey

 

[Beej]

I not 100% sure about that. If when the bank gets anxious enough about falling house prices I think they may do a quick drive buy the house for a re-evaluation and if the owners LVR is too far out of wack ask them to either sell or cough up the difference with cash, which maybe a sizeable amount. Either way a forced sale is on the cards. I know it's caught specuvestors out in NZ before.

No way can't happen with any mortgage contract I have ever signed. As Mofra said, maybe if you were re-financing or trying to extend the loan, but not otherwise. Just keep up the payments and you are sweet.

Cheers,

Beej

 

[chops_a_must]

No way can't happen with any mortgage contract I have ever signed. As Mofra said, maybe if you were re-financing or trying to extend the loan, but not otherwise. Just keep up the payments and you are sweet.

Cheers,

Beej

What about equity loans?

 

[Beej]

What about equity loans?

Depends what you mean? An equity loan is still just a mortgage underneath. Again, if you are trying to change your existing loan into an equity loan, or extend an existing facility, maybe... but otherwise, no way. I suppose it would be worth a careful read of any new contract you were entering into to be sure, but I have never, ever heard of this happening, or being able to happen.

Beej

 

[cuttlefish]

Thanks.

Is that typical in your target market, I mean 230k properties that rent for 330 a week ?

Where I live its pretty much the opposite a 350k property would get 300 a week rent. But prices seem to be levelling rapidly, have they crashed in your market ?

I think its a reflection of how different markets are at different stages. I probably wouldn't be buying in the current market in our area because I see room on the downside, and stocks offer better value at the moment imo.

In my part of Sydney the real boom period for development ended in around 2003. There has been ongoing strength but not at the same heated rate - and the reality is that some prices - like the units I refer to - have stayed fairly flat over the past 5 years. But the other thing it highlights is that if there is genuine demand for accomodation and lack of supply of accomodation it has to be reflected somehow - either in rents or in prices - which is again why the old 'location, location, location' adage is so important in property.

If you buy in the outer suburbs of a regional town there is a lot of land supply but in the centre of a large and growing city land supply (and thus new accomodation supply) is more limited - and typically land supply that does appear comes from consolidation/gentrification. (even an apartment investment can be a land investment if purchasing in a small block because consolidating several small blocks and demolishing them to build a larger complex is something that occurs).