Sooooo what I have done is some analysis regarding where your financial position would be taking into account varying factors at the end of a 5 and 10 year projection. The factors I took into consideration were capital growth-for which I did two scenarios, one at 5% per annum (which is a conservative projection) and one at 2.5% which is a pesimistic kind of scenario that may occur if interest rates continue to increase and the property market flattens. I have kept the interest rate capped at the value currently offered by Westapac today for its standard variable loan of 8.57%. What I did was using these factors calculate the projected outcomes based on loans of $450k and $350k (for properties worth $450 and $350k respectively) and what your net gain or loss would be at the end of each period for each scenario. I came up with the following results:
$450K loan after 5 years, 5% capital gain per annum: $30k loss
$450K loan after 5 years, 2.5% capital gain per annum: $95k loss
$350K loan after 5 years, 5% capital gain per annum: $23k loss
$350K loan after 5 years, 2.5% capital gain per annum: $74k loss
$450K loan after 10 years, 5% capital gain per annum: $8k profit
$450K loan after 10 years, 2.5% capital gain per annum: $148k loss
$350K loan after 10 years, 5% capital gain per annum: $7k profit
$350K loan after 10 years, 2.5% capital gain per annum: $115k loss
I then looked at how it would turn out if you repaid the $350k loan with the same repayments you would the $450k loan:
$350K loan after 5 years, 5% capital gain per annum repaid at the same monthly repayment reqd for a $450k loan: $49k profit
$350K loan after 5 years, 2.5% capital gain per annum repaid at the same monthly repayment reqd for a $450k loan: $2k loss
$350K loan after 10 years, 5% capital gain per annum repaid at the same monthly repayment reqd for a $450k loan: $215k profit
$350K loan after 10 years, 2.5% capital gain per annum repaid at the same monthly repayment reqd for a $450k loan: $93k profit
Seems to me it would be a hell of a lot more profitable to just save the mortgage money and invest it in shares or anything and still be way out in fron than property investing moving morward? I understand you still need somewhere to live but that asside we are talking hundreds of thousands of dollars here that only returns slightly better than break even after 5-10 years??? Seems a suckers game to me?Hi Phil,
First of all, welcome to the forum.
Its an interesting point you have raised but there are few things you should consider:
1. You should consider income from rent. What are the projectiosn if you assume a 5% yield.
2. The capital growth you have taken are very conservative. What are the projections when you use a more realistic growth of around 8-9% (this is based on long term trend including the 1980s and early 1990s when interest rates were high).
3. What happens if you calculate cash on cash return rather than return on the total value of the property. As an example, lets say we buy $450k property. To buy it we need 20% deposit ($90k) and the rest is borrowed. What is the % return on your investment of $90k?
PS: To do more accurate modelling you should consider other buying costs like stamp duty, legals etc and ongoing costs like rates, body corp, etc.Would be interesting to see the new numbers.
remember that the most capital cities have averaged close to or above 10% growth long term,…. and the rent generally increases faster than inflation,
Guys, that 8-10%pa cap growth you are quoting is for desirable surburbs close to the city and to buy into a suburb like that at the moment you would need a million dollars. Plus that growth has only been relevant for the past 25 years or so – when the baby boomers started to buy investment properties. Once the boomers start to move into nursing homes, sell their properties to access cash and just plain die off (and thus have their kids sell their properties to access cash) starting in 3-4 years in my opinion you will see the market flatten if not fall.
I think 5% average growth is a good figure to use… But to answer the original question – Because of the mining boom at the moment, I think shares would be a better invstment choice if you had cash. But keep in mind that a bank will lend you more money for a house (sometimes up to 100%, where shares are usually 75% max for blue chip)
Phil,
welcome to this forum, I hope you enjoy it and learn as much as we all do. This argument comes up frequently, and many people are unaware of the other factors that make property investing such a good thing to do. It is more involved and can be more tedious than buying a share, and you don't need lots of money to buy them and that's why so many people buy shares and not property, as well as the fact that you can make some spectacular short-term gains (but also losses) with shares. Financial planners love to use the above types of figures to put their clients off property and talk them into managed funds and the like. The planners make more money out of those products of course.
I'm not saying that shares are better than property; there are plusses and minuses on both sides, but your example is missing a few bits which distort what can really happen.
You are also missing what your cash-on-cash return is; this is the return you get per year on the cash you use for the investment.
The factors that you haven't included are the rental income and the tax benefits, and the leveraging. With property, you can depreciate the entire building and its fixtures and fittings if it was built after 1987.
So, let's assume the building was completed in 1989, and the rent return is a paultry 5% return and we use the $350k property you mentioned. This will be a buy-and-hold strategy, which I use.
With property you can borrow up to 80% without having to pay Mortgage Insurance, but let's say you can only dig up 10% deposit, and you take out an interest only loan. As mentioned by Tyson, the cap growth rate has averaged well above your 5%, but let's stick with that. Your interest rate is rather high; mine just went up to 7.87%, so let's use 8% interest only, with an offset account on the loan. We will assume that the rates rise and fall over the 10 years, but average at 8%.
Costs on buying a property are usually around the 6% mark (or slightly less; but in this case we need to take Mortgage Insurance), so, the all-up cost for the property is $371k. Your required cash deposit is then $56,000. Keep in mind also that you can buy a far cheaper property than this with a much smaller cash input. Cheaper properties usually have much better rent returns as well.
Let's run this example over 10 years, and it will be in approximate figures for ease.
So, here goes;
Initial Cash Investment: $56,000
Cap Growth: $350k x 5% x 10 years = $175,000
Rent Return: 5% x 10 years = $175,000 (rent will increase each year, but not in this model)
Depreciation and Tax Return: $2,000 x 10 years = $20,000 (this is an unknown, and will vary from year to year, but would be more than this conservatively based on my experience, so I used a consistent, conservative amount).Total Return on the property = $370,000
Now, let's deduct all the costs from this amount.
Loan Interest: $350k x 8% x 10 years = $280k
20% of rent for All Holding Costs: = $35k (this is an over-estimated figure, and includes 4 weeks vacancy per year. From my experience it is more like 12-15%, and includes such things as management, repairs, insurance, rates etc).Total Costs = $315k.
Total Nett Return on the Property = $55k
Your cash-on-cash return per year is 9.82%. That is not that great a return, but it is after tax, as the tax returns have already been factored in., and it is a positive number; not a negative as you depicted in your example.
Of course; there are a few factors with this model that are easily improved which further improve the COCR;
1. the tax returns would be re-invested back into the loan via the offset account, thus decreasing the loan.
2. it is easy to get a rent return of around 7-8% if you choose cheaper properties and select better areas (not cap cities).
3. it is easy to get a cap growth rate of around 8-10% by selecting better areas; towns/cities that are experiencing above average growth.
4. the tax returns themselves would probably be higher; in my experience this is the case.
5. due to the decreasing debt from the re-invested tax return and the cap growth, you can purchase again after around year 6 with no cash input, thus accelerating the cash-on-cash return.
7. there will be rent increases along the way, which I didn't include.
8. lower holding costs with fewer vacancies; I have 2 properties that have never been vacant in the time I've owned them).The good thing about this compared to say, a managed fund, or a share, or superannuation is there is far less likelihood of a negative return. You have far more control over the investment return; you can select the area, the rent return, the building type etc, etc and maximise every aspect of the investment factors.
My preferred option is to buy 2 x $175k properties rather than 1 x $350k property as it is easier to improve the rent returns, and also acts as a hedge against slower cap growth if they are bought in different areas.
srobins wrote:Guys, that 8-10%pa cap growth you are quoting is for desirable surburbs close to the city and to buy into a suburb like that at the moment you would need a million dollars. Plus that growth has only been relevant for the past 25 years or so – when the baby boomers started to buy investment properties. Once the boomers start to move into nursing homes, sell their properties to access cash and just plain die off (and thus have their kids sell their properties to access cash) starting in 3-4 years in my opinion you will see the market flatten if not fall.I think 5% average growth is a good figure to use… But to answer the original question – Because of the mining boom at the moment, I think shares would be a better invstment choice if you had cash. But keep in mind that a bank will lend you more money for a house (sometimes up to 100%, where shares are usually 75% max for blue chip)
Assuming you borrowed the entire allowable amount for the shares, at what point would you get a margin call if they dropped in value?
Phil,
I was just wondering if capital growth in the above equations was calculated using compounding growth?
When you calculate profit and loss statements, rough enough is not good enough. Minor exclusions create huge variances in the results. As a general rule using compounding growth, a property that increases 10% per year will double in value every 7 years compared to 10 years at 7% growth per year.Phil visit http://www.knowledgecentre.com.au/ I can recommend reading How to achieve Wealth for Life Today!
But at the end of the day each of us need to make our own choices, I believe in property and invest as much as I can afford into growing my portfolio. I also buy shares and only pay interest only on all of my loans including the one on my PPOR. So far the returns I have generated have made my efforts worth while.
What ever you choose good luck but read lots it might just change your view.Tysonboss1 wrote:remember that the most capital cities have averaged close to or above 10% growth long term,…. and the rent generally increases faster than inflation,Rubbish!
foundation wrote:Tysonboss1 wrote:remember that the most capital cities have averaged close to or above 10% growth long term,…. and the rent generally increases faster than inflation,Rubbish!
what is rubbish,… over the last 30 years most capital cities have achieve close to 10% growth,
And rent has increased faster than inflation? Here's a chart I prepared earlier:
Real (inflation adjusted) rent versus real (inflation adjusted) interest costs on the average house.As for the last 30 years of house price growth… well, let's say it aint gonna repeat over the next 30 years. Here's something I wrote a while back which began as a spiel about interest rates but ended with the unsustainability of our present trend.
Quote:I notice that many responses to the Have Your Say thingy feel that the RBA are misguided in their ‘suggestion’ that people should curb their spending. They seem to think that by raising interest rates, the RBA is only reducing expenditure by home-loaners, when the real culprits, the cashed-up home owners (sans mortgage) and renters are the ones with the disposable income to burn. I think they’re right and wrong. They’re right in so far as the spending patterns of people without mortgages won’t change. They’re also right that people who are savvy enough to rent for half the cost will be relatively unaffected. In fact, those with sizeable savings will have greater spending power as interest rates rise. But these posters are missing the point, failing to see the bigger, non-immediate picture.Aggregate demand increases as the money supply grows. The largest contributors to this are currently business borrowing and household mortgages. These two combined are currently adding $220 billion dollars annually to the money supply, hence aggregate demand. This compares to a total of 40 billion dollars of productivity growth over the same period (year to March). Debt is rising faster than production. No big surprises there, it’s been happening for years. Leaving aside for now the fact that this is unsustainable…
The RBA isn’t simply putting up interest rates to curb the spending of existing debtors. This would be silly as these people have limits; the posters correctly note they already have less disposable income than renters and owners. The RBA are raising rates to reduce the future growth of the money supply. Higher rates increase the propensity for people to borrow and encourage them to save. Saving is more rewarding, borrowing is more expensive. People who would consider borrowing money in the future will be more likely to not borrow that money or at least likely to borrow less money. People who are currently being squeezed by higher repayments have simply been too short-sighted. They should have realised that interest rates would trend up, after all, when the money supply is growing faster than productivity inflation and interest rates will follow.
The really scary part is that not only is the money supply rising faster than GDP, but our GDP (increasingly) relies on the increasing money supply just to keep on growing. Remember, $40 billion in GDP growth that cost us $220 billion in additional debt to achieve!
If the growth in the money supply stays above $40 billion we face higher inflation and higher interest rates. If it falls below $40 billion we face a massive crash in the housing market and a severe, spiralling recession. This is not scare-mongering, it is the reality of the future, one which we have brought upon ourselves, aided and abetted by government ‘strong economy’ propaganda (sorry sense
) and a reserve bank that held interest rates too low for too long.Choose your own adventure: Inflation and higher interest rates or a recession (probably deep enough and long enough to be called a depression).
The biggest problem is the degree to which we rely on monetary inflation (through debt) to keep our economy growing and looking ship-shape. The following chart, my current favrite, shows the depth of our predicament. This charts our total bank credit as a percentage of GDP over the last 150 years.
What should be immediately, bleedingly freaking obvious is that credit growth as a proportion of our national income has been growing exponentially for the last 30 odd years. What is less obvious to the mug punter and to many commentators and economists is that this is not ‘normal’. Blinded by ignorance, most of these people (who really should know better) only ever glance at a much shorter chart of 30 odd (yes I know, “very odd”: ha ha) years and surmise that things are proceeding ‘as normal’. Alternatively, they consider only how much the rate of growth has changed from one period to the next. Ugh.
‘Sure,’ they think, ‘credit growth is exponential, but this must be normal because it’s been that way for decades and nothing really bad has happened’
F__k off! At the very least, this ratio of credit to GDP must flatten at some point, otherwise we’ll soon be paying every cent of our national income just to service our debts. At some point, whether tomorrow, next week, next month or in ten years time, the upward slope has to stop.
The staggering truth is… it can’t!
As we’ve seen, last year total credit grew by $220 billion while GDP grew by just $40 billion. What would happen to our economy if credit had just grown at the rate of GDP? The simple, ignorant answer would be “GDP and total credit would have both grown at $40 billion and that stupid chart would have levelled off”.
"Wrong", "wrong" and “uh-uh buddy, what are you a blockhead, a crackhead (sorry CL), a government (sorry sense) goon (sorry goon) or all three?”
Suppose for a second that total credit did grow at just $40 billion. If corporate/business debt had not grown at all that would still have required a 60% drop in mortgage debt growth, hence a 50% reduction in prices. That aside, debt growth and therefore money supply growth would have been $180 billion lower, which would have lowered demand by $180 billion or thereabouts. And with that scale of demand drop, productivity also would have fallen… in other words GDP would have declined, rather than grown by $40 billion.
If you were Microsoft, you’d be telling me by now that we had a circular reference. Really? An economy that relies on ever increasing quantities of debt to produce ever decreasing (relative) measures of growth is ‘circular’? Blow me down.
Of course if we have a declining GDP (due to ‘sustainable’ credit growth), even a static amount of credit would be too high. The ratio, and our chart, would continue its upward trend. So credit has to decline? But that would precipitate a further plunge in the prices of debt-backed assets (houses) and further declines in credit, and further declines in GDP! Damn right it’s circular!Incidentally, if somebody were to ask me to describe the economic conditions in the decade leading up to the depression of the 1890s or the far less significant 'Great' depression of the 1930s I'd say the period was dominated by a credit-fuelled boom. If somebody were to ask me to describe the economic conditions leading up to today?…
Cheers, F. [cowboy2]
Just a few more bits…
foundation wrote:I might say to you:
“Make no mistake about it Devo my boy, an unsustainable trend in debt is the driving force of our economy today and will be the most influential factor in our economic future over the next decade or so (either by its continuation or by its absence).”You might try to refute this statement, but you’d have a hard time trying. That debt growth is following an unsustainable trend is proven beyond doubt. That without this unsustainable trend our economy would be in recession is adequately arguable on empirical grounds, and certainly stronger than any counter-argument. Thus, the (continuation or absence of this) unsustainable trend will decide whether we will have an economy of growing or declining productivity in the future.
Given that the very definition of unsustainable is that it cannot be sustained, I’ll leave you to make your own assessment of the probabilities of various futures.
Don't forget that a back-of-the-fag-packet calculation can indicate roughly the percentage impact on house prices that a slowing of debt growth to a sustainable rate would have. Do report back when you're done!
lostie wrote:can you please spell out the long and short of for us newcomers.
Lostie (by name, not necessarily by nature)Hi Lostie. Everything you need to know about this subject can be found on Steve Keen’s Debt Deflation blog here:
http://debtdeflation.com/blogs/SK is a mathematician and professor of economics, so some of his work is very technical, but his argument is sound and his blog itself is an easy read. Check through the comments and you’ll find I’ve tried to make my point over there too (probably better so than here). There are also plenty of clever people reading there, so anything you don’t understand can be sorted out with a quick question. Oh, and PM me – I’ll link you to an interesting site.
If you don't feel like checking out those sites, I'll break it down to "the short" as you requested:
The past 30 or so years of house price growth has been dependent on an unsustainable trend in debt growth. This trend is reaching it's limit. Anybody who is basing their expectation of house price growth over the next 30 years on their experience or knowledge of house price growth over the last 30 years is deluding themselves.
And even if they turn out not to be entirely deluding themselves, they might simply be abusing mathematics. For example, by assuming house price growth is exponential* (based on a poorly fitted historical function), and entirely disconnected from real drivers, such as wage growth…
* An example of this would be parroting "house prices double every seven to ten years", which not only assumes exponential growth, but assumes that only price and time are relevant. Something like "historically, house prices have tended to track slightly higher than wages, but this gap has been bridged by increasing mortgage debt" would be more accurate…
Anybody needing a refresher on exponential (compound) growth versus other functions? Here ye go:
Next time somebody tells you that house prices have "grown by 9% per year on average over the last 10 years", ask them to point to which one matches house price growth…
https://www.propertyinvesting.com/forums/property-investing/help-needed/25921?&page=4#comment-154617
Cheers, F. [cowboy2]
PS – Incidentally, if you project that pre-1890s crash average Victorian price out at 10% per year, the average value of a Victorian Rateable property should be $524,288,000 by 2013. Sweet.
Woah, Foundation(sorry don’t know your first name).
Your throwing lots of stuff at us and you are kinda scaring the s**t out of me.I have also read your other thread here https://www.propertyinvesting.com/forums/property-investing/general-property/4322827
So what I get from what your saying is;
Rent rises depend on wage rises, so rent goes up with wages.
Now do wages go up with inflation??(as that would show me how rent rises relate to inflation).House values rely on the amount of money credit banks are willing to lend. With this crazy curve you have going up there with credit flying up, you say there is gonna be a squeeze??
and hence bank will not be lending extra money out.
So if property prices rely on the willingness of banks to lend more and more, and then banks stop lending more(or less), does this mean that property prices will stagnate or fall for long periods of time.
What do we do, your scaring me, I thought property was safe and i was going to be set, i’m now afraid of getting into the property market….Yours scared s**hless,
Chris.couldn't agree more, there are some very misguided people out there putting it mildly!
Property prices have grown way beyond wages increase, something has to give.
Rental income has no where near kept up with the cost of borrowing and PROPERTY Maintenance costs.
The cost of a $400,000 property in terms of interest, management, repairs,council etc easily amounts to $35,000 pa.
Rental income does not even cover half of that cost.
The rent per week would have to be around $700, to just cover costs, that's about half the weekly average gross wage.
Property owners therefore are subsidizing housing HEAVILY and no wonder we need negative gearing, to keep people of the streets.
why would you even bother unless you assume that property will continue to increase every year, beyond the holding costs (out of pocket 15-to 20,000 per year and ignoring the tax deduction) and ignoring the possibility of a recession/depression.
The rot has started in America, the cost of borrowing is increasing and finally, easy credit is starting to dry up.
Government (both parties) continue to make spending promises with OUR TAX money like there is no tomorrow.
I read with amazement how, even on this web site, people seek max themselves out with borrowings to buy yet another property!!Are you an Economist Foundation?
In 1994 I purchased my first property for $95k. Prices were almost at their peak in Bris and I was lucky enough to purchase at the bargain price as the unit was very orange (orange walls, orange curtains, smoke-stained orange chandeliers, and a very bitter neighbour). I painted it and the bank re-valued it in 1995 at $116K. In 1999 when I tried to sell it the first offer I received was $95k from an investor. I declined and then received an offer from an owner occupier a couple of months later for $104k. I certainly agree that property can go backwards, but only if you're desperate to sell. Today the property would sell in a minute for about $350k. I agree that if you are purchasing a property now and stretching yourself it could be a bit dangerous.
Compounding interest makes a big difference to the earlier calculations both in gain and ROI and if you borrow the lot what does that do to the ROI or CoC?
There is risk in everything you could play it safe and do nothing.
I have no problem borowing the lot for houses but dont have the nerve to do that with shares.
At least its legal and if it doesn't work out you dont get locked up its only other peoples money after all, six strings on your guitar, blue skies and start again this time more the wiser it doesn't really matter if your wealthy or not. I am here on a working holiday and I arrived with a backpack anything more than that is a gain.
If you sail close to the wind thats up to you and the only thing you need to know is that is what you are doing.
Keep your own house in order and dont worry about all those bogy man investors that are about to come tumbling down around us.
If the market turns its only going to impact on you if you have to sell if you dont have to sell it wont impact on you.
Foundation for PM.
Hi there,
I agree with most of the comments as well. Working in the property industry as valuer I have found that there are suburbs with far greater potential for capital growth, so 5% is rather conservative. It also depends what you intend on buying Strata, Torrens etc. I personally invest in shares but am looking to take the leap into property but where i have identified the best areas i cant afford. Bit of a dielema.
The first step for anyone getting into the property market is the hardest one, so yes first home buyers have to lower their expectations. It gets easier after that, so what I mean to say is 10 years ago I brought a house for 100K PPOR. Today that house is worth 250K, I'm a little older and a little wiser and my pay packet is a little fatter. So I decide I want to move to a better suburb and better house, new house costs me 500K. Not a problem as my first house is paid off and I can easily afford a 250K mortgage on my current wage. Fast forward 10 years, my house is worth 1 million, I want to sell my house to buy a better one in a better suburb. So a person who brought a house 10 years ago for 350k now has a house worth 700K and likes my house so they sell their house and refinance to buy my house. Iv'e just sold my house for 1 million but still owe 150K on it, but my wages have increased so I can easily afford to borrow 500K. So I go and find myself a little better home, fast forward 10 years I'll sell my home take the profits and down size to a smaller unit and live happily ever after. In the meantime Australia's population has increased exponentially as we are a lucky country, so there are plenty of people needing some where to live.
I know some people will go into great detail why my theory is flawed and that's OK as I believe in investing my hard earned cash into property and shares. It works for me and I'm not advising anyone to invest in anything, I'm just participating in a open forums on real-estate. See if you think property prices cant be sustained because of the debt levels the same must be said for shares, as companies rely on people buying their products to increase profits which lifts share prices. So you have a dilemma you don't buy property and you don't buy shares so you put your money into government bonds or a Internet bank account. and invest your super contributions into a conservative account. And if that's what you choose that's good but It's not what I choose.
I'll stick to property and shares thanks, and for my technical advise I'll read books by well educated people like Ed Chan, Micheal Yardney and Steve for foresight into the future.
All of the technical analysis doesn't calculate human emotion and the fact people want their own home and piece of dirt and will do anything to achieve this.
We can debate this for months but time will reveal the truth, 10 years from now lets see what price people are paying to own a bit of inner Brisbane?
) and a reserve bank that held interest rates too low for too long.
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