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Buying or selling? Get the right advice

Too many houses under construction?

By johnboy - 21 February 2011 29

The ABC has the happy news that so many houses are under construction at the moment there’s a possibility prices could come down.

To avoid the horror of housing affordability BIS Shrapnel are recommending builders slow down to manipulate the market.

At least they’re being honest about it one supposes.

What’s Your opinion?


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Too many houses under construction?
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georgesgenitals 4:22 pm 23 Feb 11

urchin said :

hi george,

yes i reckon we will agree to disagree in the end.

No problem, and thanks for your sensible response.

urchin said :

The only conclusion i can reach is that you believe that your properties really will appreciate substantially in value (though most others will decrease). that’s fine, but it seems odd to expect that the larger market trend will leave your properties untouched.

Although your numbers make sense, it’s an individual’s situation that complicates things.

First, I expect my properties to outperform the market. I’ve chosen them for exactly this purpose, and also paid significantly under market price for some of them (even compared to similar properties at the time of purchase), resulting in gains right from the start (and yes, there’s further complexity as to how this can be done). Whilst I think the market will stagnate by around 30% across the next 8 years, I don’t expect my properties to do the same. I expect them to hold their value or to change in real value by only a small amount. This brings me to my second point.

Second, I am able to increase both value and rent through carefully thought out renovation. For example, I have just finished doing a renovation (none of it myself, all using a builder) for about $14k, that has directly resulted in an increase in rent of $70 per week. The reno took 3 weeks and new tenants are signed up. That’s a return of 26%p.a. on that $14k, and an increase of value in the underlying property also. I’ve done this several times before, and have another couple of properties where I think this will work well.

The overall plan is to get some modest gains over the next 10 years, but to be in a position to take advantage of the boom that will eventually follow. I’ve thought and read a lot about the other factors I mentioned in my previous post, and I don’t see a great deal of change ocurring, except for the possibility of credit becoming harder to obtain (although I don’t think it will be much more expensive than now). It’s worth noting that property is usually only in ‘growth’ phase for a third or less of the property cycle, and the property doesn’t necessarily operate on a fixed timeframe.

In the next upswing following the current stagnation, I would expect property to rise by around 100%. This would mean that property has doubled in price (on average, remember) between now and perhaps 2025 – an average of just under 5% per year. This is of course a guess – it could be anywhere from 50% to hundreds of percent. But my situation means than even a 50% gain in the next 15 years will directly result in a couple of million dollars return, and I don’t have to pay while I wait.

I’m not for a second investing successfully in property is easy – it’s not. It requires lots of thought and management of risk. But I believe it’s possible.

urchin 2:39 pm 23 Feb 11

hi george,

yes i reckon we will agree to disagree in the end.

i am a bit skeptical of your argument that increased supplies will drive up prices (just as, presumably, constrained supply will also drive up prices). Nor do I think that the canberra labour market is as insulated as you suggest. in 07-08 kevin’s awkward rhetoric of “taking a blowtorch to the shaky sauce bottle” of PS was enough to put a chill on the canberra housing market. we are extremely vulnerable as so much of our population is directly or indirectly dependent on one employer.

i am still puzzled as to why one would hold an investment that one thinks will underperform inflation for the next 8 years to the tune of 30%. yes, the rent and neg. gearing benefits might be paying the mortgage, but you’re still moving backwards all the same.

let’s run some numbers.

Lets assume:
1. your total portfolio is worth 1 million (round numbers are easy)
2. your share of that is 20% or 200k (the amount you actually put into it).

The idea is that houses underperform inflation to the tune of 30% over 8 years (taking the most gradual of the scenarios you posit)

If we assume 4% inflation (less than that would mean nominal and real declines in prices) then houses will appreciate an average of 0.75% per year over 8 years.

i.e., if i’ve done my maths right (probably not)

in 2019 ~$1.37 million will have the same purchasing power as a million today.
in 2019 your property portfolio will be worth $1.06 million (give or take). if you sell in 2019 you will receive 60,000 dollars above what you would receive today. Subtract cap gains of ~15% and you walk away with $51k.

That’s assuming that your rents cover the mortgage payments. the figure might increase somewhat as you’re paying off principal and interest. so let’s boost it another 29k to $80,000

Now, as an alternative, let’s say you put that 200k into a 6.5% deposit account. We’ll knock off ~1.5% for taxes for post-tax of 5% interest. Assuming interest compounded daily, that will give you around 298k at the end of 8 years.

so by doing absolutely nothing other than sticking the money in a deposit account, you come out 20% ahead of investing in houses.

if you really believe that this is the situation for the next 8 years why invest in property? the numbers don’t add up. sure, rents will increase a bit but if housing is stagnant and there is so much supply coming onto the market what will be the impetus for increased rents?

it seems like a lot of risk for a sub-par return.

The only conclusion i can reach is that you believe that your properties really will appreciate substantially in value (though most others will decrease). that’s fine, but it seems odd to expect that the larger market trend will leave your properties untouched.

georgesgenitals 12:17 pm 23 Feb 11

Hey Urchin – you made a couple of comments that are directed at my posts, so let’s tackle them one at a time:

1) If I’m calmly predicting 30% falls, why aren’t I selling up?

I’m not selling because my property portfolio (overall) is not negatively geared, and is performing as I expected it to. I didn’t buy my properties all in the last 12 months, but over a number of years, and as such the portfolio is cashflow positive, and becoming more cashflow positive as time goes by. I have some properties that generate significantly more $$ than their holding costs, and some that are pretty close to neutral cashflow. What this means is that my property portfolio costs me nothing to hold on. I can literally sit back and wait for the next upswing, which I think is probably 7 or 8 years away. Also, why would I want to incur and pay Capital Gains Tax on assets which, from a long term perspective, are performing within their expected targets given the amount of risk involved? My plan has always been to accumulate and hold, and to gradually pay down the loans (which I do consistently). Over time, the holding costs get smaller and smaller (don’t forget that regardless of current value, I’m paying back a loan on values from years earlier). For many investors (including me) property is just one aspect of a larger strategy.

That said, those property investors who subscribe to the old, buy, hold for 7 years, sell rule won’t do so well if buying in now.

2) Glut of housing – 17000 lots.

First, where do we think all the builders will come from? The labourers? Suppliers of all the extra building materials? Eventually, of course, it will all get done, but the process will take years. Tradies are all flat out as it is. Of course, we can bring in more builders and tradies, who will then need shops, schools, roads, houses, entertainment, etc, and this will add to the local economy.

Second, as a property investor, I don’t own any property in outer suburbs. For my plan, it just doesn’t make sense. For others it may. If we do end up building heaps more properties in the outer suburbs that’s a dream come true for me, because I will then have a larger population desiring my (very) inner city rentals, and both values and rents will be pushed upward. Look at what’s happened with Sydney’s urban sprawl for clues here.

3) Employment.

Local and state governments are the main recipients of property related income. The feds get our income taxes and excise, and they pass on our GST. At the moment, there’s little real incentive for government to cut the federal public service back. Consider also what happened with Gershon – contractors got cut back, and lots of them left town. Now you have federal projects on hold, because they simply can’t get the staff. We actually have a fairly serious skills shortage here! Consider too what happened when the feds went through the public service and culled lots of jobs during the 1990s. Remember what happened to the ACT property market? It sagged and basically stagnated for nearly a decade.

I suspect we won’t agree on some or all of these points, and that’s ok. I’ve been watching and reading closely on this for some years now, and my opinion is simply that we are due for a market correction, but high incomes (relative to the rest of Australia), consistent employment and slow land release are all stopping prices from crashing. You also have other factors (eg disposable income increases, two parents working, larger houses, cheaper credit, etc) stopping prices from dropping rapidly. Of course, I could be wrong and if so I’ll wear the consequences.

But it seems to me that having a multi million dollar property portfolio that pays me money while I wait for future growth is not such a bad thing.

urchin 11:47 am 23 Feb 11

georgesgenitals said :

Chop71 said :

pfff, as if.
I still see shop signs wanting staff, construction sites with cheap overseas workers.
The Ghetto will eventually house the new workforce revolution of Canberra.
If you build it, they will come.

We’re in no immediate danger of having an oversupply of housing in Canberra. It will take years to catch up to demand. Throw in the most reliable incomes in the country, and we’re unlikely to see any major drops in the short term.

maybe you missed the bit in the original article about 17000 lots coming onto the market and the huge flood of properties in gunghalin? i think we are a lot closer than you think. building has been outpacing pop growth for several years already.

as far as employment security goes, i think you need to consider this more carefully. if there is an extended decline in housing the biggest loser (after construction companies) will be local and federal governments. they have grown excessively dependent upon real estate as a source of funds. if RE declines, the gov’t will go into cost-cutting mode and you can bet your bippy that the PS will be on the chopping block. it will be a double whammy for canberra, made all the worse because people blissfully leveraged themselves to the hilt thinking they had jobs for life.

urchin 11:42 am 23 Feb 11

wildturkeycanoe said :

Urchin – Rentals in my neighbourhood are presently around $400/week+ for small 3 bed on small block of land under 12 months old. I pay just over $500/week for my mortgage. Sure, there’s rates [another $1000/year], but for a new home you won’t be needing any maintenance money. Renters also have to put up with annual inspections, the possibility that the house may be sold from under them and keeping the place immaculate. At least I can let my yard turn into a jungle if I want, or pin photo frames to any wall with nails or sticky tape. Location dictates how much you pay – yes inner north might be a bit different but you can buy cheap from the new fringe developments.
By the way, I didn’t buy 10 years ago [else I’d have 3 houses by now] but only 12 months ago without any deposit [thanks Kev07]. It wasn’t that difficult but now the opportunity has gone for most.

it may be that in certain areas of canberra rent/buy differentials are not as large as in others. in other parts of the town, however, rent is so much cheaper than buying the only real incentive to buy is the expectation that prices will continue their astronomical climb. and *that* is speculation. And not very clever speculation given the high multiple of price/income and the fact that we will likely have a housing glut soon enough.

for some people it might be worth double their rent and the loss of financial freedom to tack stuff to their walls (my landlord lets me anyway), to not have endure inspections (I haven’t had one in 2 years) and to let their house and yard go to ruin (not my preferred approach in any case), but it seems like an awfully big price to pay for privileges of dubious value. Getting the boot because the house is being sold etc. is a real inconvenience but, on the other hand, it is a great incentive for getting rid of all the crap that one inevitably accumulates over the years.

the elephant in the room is negatively geared property investors who can’t afford to see a flat market. it’s a losing venture for them if prices are not constantly growing at a healthy rate. if they start to fear an extended plateau or decline we will see a mad rush to the exit when all these over-leveraged investors try to protect what is left of their retirement fund. at present most aussies are still in the “we are different” and “house prices never fall” mindset. but how long will this last when property investors are calmly predicting 30% falls in real terms (which makes one wonder why he isn’t selling up….)?

georgesgenitals 10:45 am 23 Feb 11

allyroger said :

Housing IMHO is overvalued by 30% in the ACT, at some point theresurely is a tipping point and it will all come tumbling down. A correction is required.

I tend to agree. A couple of things to watch out for, though:
1) “Tumbling down” is more likely to take years than months, and will likely be achieved through prices stagnating and/or dropping slightly while everything else creeps forward. 5-8 years should do nicely.
2) Don’t expect any correction to be applied evenly across the market. Although the average may be 30%, that will likely be made up of a range of drops across various property types and locations. I’d expect the outer suburbs to do badly, and some of the real top end stuff can drop off also. Well located properties priced at or around suburb median won’t drop off much, I reckon.

I guess we have to wait and see. Regardless of our analysis, no-one has a crystal ball!

wildturkeycanoe 6:10 am 23 Feb 11

Urchin – Rentals in my neighbourhood are presently around $400/week+ for small 3 bed on small block of land under 12 months old. I pay just over $500/week for my mortgage. Sure, there’s rates [another $1000/year], but for a new home you won’t be needing any maintenance money. Renters also have to put up with annual inspections, the possibility that the house may be sold from under them and keeping the place immaculate. At least I can let my yard turn into a jungle if I want, or pin photo frames to any wall with nails or sticky tape. Location dictates how much you pay – yes inner north might be a bit different but you can buy cheap from the new fringe developments.
By the way, I didn’t buy 10 years ago [else I’d have 3 houses by now] but only 12 months ago without any deposit [thanks Kev07]. It wasn’t that difficult but now the opportunity has gone for most.

georgesgenitals 10:44 pm 22 Feb 11

Chop71 said :

pfff, as if.
I still see shop signs wanting staff, construction sites with cheap overseas workers.
The Ghetto will eventually house the new workforce revolution of Canberra.
If you build it, they will come.

We’re in no immediate danger of having an oversupply of housing in Canberra. It will take years to catch up to demand. Throw in the most reliable incomes in the country, and we’re unlikely to see any major drops in the short term.

Chop71 9:17 pm 22 Feb 11

pfff, as if.
I still see shop signs wanting staff, construction sites with cheap overseas workers.
The Ghetto will eventually house the new workforce revolution of Canberra.
If you build it, they will come.

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