Tag Archives: Capital growth

Buying, Selling

Have we reached the peak of the property market?

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housing-bubble2

Is it possible that property prices can continue to go up? How can anyone pay more than the lofty heights properties are currently selling for? Do we have a property bubble? And if so, will it ever burst??

Sydney has seen property prices soar in some suburbs by over 20% in the last 12 months. Melbourne is also achieving considerable price increases, with other Australian cities experiencing flat to down prices. The RBA cut the cash rate again last month to 2%, while acknowledging that Australia does not have a property bubble, just Sydney. So maybe I am in the eye of the storm.

I am seeing firsthand and hearing of these whirlwind auctions. Just recently I and a friend attended two separate auctions with the final selling price 10% higher than the passed in amount and absolute upper budget respectively. These auctions were across different price ranges ($1.6mio and $680k) and different types of properties (3bdrm house and 1bdrm apt) so this situation doesn’t seem isolated to a niche of the property market.

Coupled with the never ending articles on apartments selling for $1mio over their reserve, and an inner city terrace no wider than a Queen bed selling for just under $1mio, and the Sydney auction clearance rates at a high on 9 May 2015 of 89.2%, these two scenarios do not seem isolated.

The people benefiting from this situation are the sellers, clearly. Especially sellers who don’t have to buy or trade up in the same market: investors, downsizers, or families moving to QLD! If you can or need to sell a property in the current market, it seems like now is the right time. But without a crystal ball, how do we know prices won’t continue to increase. And can they?

Prominent and controversial ideas for curbing this bubble have been made to all corners of the industry: changes to property laws with regards to Capital Gains Tax (CGT), Self Managed Super Funds (SMSFs) and foreign investors; changes to lending practices for investment and interest only loans; and changes to selling practices with more policing of price guides and mandatory publishing of sale prices. But you could argue for and against all of these suggestions, and quantifying actually how much of an impact these would have is speculative.

Then there have been discussions on requiring fundamental shifts in how we perceive property: implementing a long term rental market with more support for tenants with longer leases, like in Switzerland; coupling this with changing the Australian dream of owning your home, and a house specifically; to moving perceptions towards other high returning assets as investments, such as shares. I think all of these ideas have merit, but would take significant time to implement.

What about the simple economics of supply and demand? Sydney, and particularly within a 10km radius of the CBD, is somewhere Australians and migrants will always want to live. That will never change. So is the solution to build more properties in this area? How can this be achieved with little to no new land available? And there is a lead time to building of at least 18 months (for an apartment block). So what then?

The quickest and simplest solution is to get more sellers to sell. The more properties on the more market the more supply, buyers then have more choice and there are fewer buyers competing for the same properties. So how do we get more sellers to sell? Keep spending big buyers… sellers won’t be able to resist selling at these astronomical prices!!

 

Investing, Renting

Gearing: understanding the buzzword

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Gearing relates to how you structure the financial position on an investment property (or any income producing asset). You can be positively, neutral or negatively geared.

I have a friend who has some big ideas on property, some of which are great and others I question whether he is regurgitating buzzwords without necessarily understanding what they mean. My friend wants to buy an investment property and negatively gear it, but what he hasn’t considered is that negative gearing requires a cash outflow on his part, and when he isn’t in a surplus cash position to start with this could be a financial burden. “Negative Gearing” is a big tax buzzword but for most normal people it can live up to it’s name and just be… negative.

Negative Gearing

Negative gearing is where expenses outweigh income. For example, you own an apartment with a mortgage that you rent out. Typical expenses would be, for example:

$    1,200 / mth mortgage payments (assume interest only)

$     800 / qtr strata fees

$    1,000 / yr council rates and water bills

$     500 / yr occasional repairs and maintenance

$     300 / yr rental agency fees

$19,400 annual expenses

You receive rent of $350 per week, which is $18,200 of annual income. Therefore the property costs you a loss of $1,200 per year. This means you have to spend $1,200 of your own cash each year on this property.

There are two main reasons why people chose to negatively gear:

  1. They are high-income earners who are looking for a tax deduction. The cash outlay of $1,200 will be used to offset against their income to lower their tax obligations. For the highest earning tax bracket this means they will receive a credit against their tax of $588 but the net effect is they still need to outlay $612 cash against the property. Great for someone who has lots of cash.
  1. They are hoping that the capital gain on the property will outweigh the costs of negatively gearing it. For instance, the apartment cost you $380k to buy and if you sell in three years time for $430k, less stamp duty, selling agency fees etc you have made a gain of approx $20k, of which you can keep just over half after paying your tax bill, which means for $1,836 cash outlay, you have made a net gain of $8,164 (which is not a great return, but that’s for another post!).

All good reasons to negatively gear, but if you don’t have surplus cash, are not on a high tax rate and/or expect some capital growth in the property regardless, negative gearing might not be for you.

Neutral Gearing

This is where you manage the expenses and income of the property to effectively net out to zero.

I have chosen this option in the past because I wanted my investment property to just “pay for itself” while it grew in value.

Positive Gearing

This is where you want to earn an income from your property. Great if you don’t earn a salary, i.e. you’re a non-working parent, or you are retired and are living off your assets.

This is where the rental income on the property is greater than the expenses. You may pay tax on the net income earned (depending on your overall tax position), but you will be receiving income and therefore a cash inflow.

Before I went on maternity leave I prepaid a year of mortgage repayments on the investment loan on my mortgage to bring forward greater expenses in the year I was still earning a wage (i.e. the property was negatively geared in that year). The year I wasn’t earning an income while on maternity leave my property was positively geared, which provided a small but helpful income. So you can change your gearing depending on your situation.

So please don’t get caught up in buzzwords like “negative gearing” without fully understanding what they mean to you. If anyone has any other buzzwords they would like clarification on, please include in the comments below…