Wednesday, July 25, 2007

Housing Simulation for Canberra

I plugged the actual numbers for our own situation into my housing simulator. These include a 7% mortgage rate current in Australia, Snork Maiden's salary, and our current net worth. I'm assuming a 10% downpayment, a house price of $A500k and rent of $A400 per week. Buying would cost us all of Snork Maiden's salary at first vs. about 40% on rent. It would only make sense if prices appreciated at 7% per year indefinitely. Maybe prices have historically risen at that rate in the recent past, but can they continue to do so? The average Canberra house would cost $A3.8million in 30 years time and rent would be $2800 a week. Adjusted for inflation at 3% these are $A1.6million and $A1200 per week in today's money. In the long-run real GDP per capita growth has averaged 2% p.a. So we can't really expect wages to increase faster than that. How long can house-prices and rent rise at twice that rate?

4 comments: said...

Yes, it's always hard to tell with real estate, but you'd be amazed how prices can continue to grow IN THE RIGHT LOCATION. For example, in '83 I bought a rental property for $82K in Sydney's Western suburbs. I could have bought a house on the more expensive northern suburbs (where I lived with my parents) but the prices there were higher - around $150K. My theory, like yours, was that there was a limit to how much people could afford to pay for a house, so I thought the cheaper houses had more long-term growth propects. In the property slump of the mid-80s the house I'd bought slumped to $75K before recovering. I ended up selling it after 10 years for slightly less than I paid for it.

In the latest boom the price for such a house went up to $240K and has now dropped back to around $180K. Meanwhile, the houses that cost $150K on the north shore now average around $750K! The thing to remember with real estate is that the "average" wage earner will just be forced to buy cheaper houses further from desireable locations as prices go up - but over time there will be more and more rich people competing for property in the most "desireable" suburbs where supply is restricted - eg. close to beaches or, in the case of Canberra, close to the city centre or other centres of employment. If you look for a residential suburb close to planned future business growth, and pick a solid house in a pleasant quiet street close to shops, schools and public transport you should see pretty good real price gains over the 7-10 year real estate cycle. But the returns in the long run aren't likely to exceed stock index returns, so the only reason you may end up ahead buying vs. renting is because people tend to gear up to 80%-90% LVR when buying property, and don't usually gear their stock investments very much.

ps. The interest rate on a home equity loan for investing in stocks is at an interest rate about 1.5%-2% less than a margin loan. This makes it very close to the best rates available to wholesale commercial borrowers such as geared share funds. But the main benefit is via tax savings if you do make use of negative gearing. A conservative 50% LVR on an index stock fund makes sense if you
a) borrow at home loan rate, say 7.25%
b) invest in index stock fund (eg. listed ETF such as CDF) which yields a small franked dividend of say 2.5% yield.
c) hold for medium-long term, say 10 years+, and get average total return of around 8%-10%, say 6.5% capital gain.

This will mean the negative gearing is saving you income tax at around 40%, and at the end you pay capital gains tax at the rate of only 20%. Do a model to compare the effects.

It's still not quite as effective as salary sacrifice into a SMSF, investing in a stock index fund until retirement age, and realising gains during the pension stage of the SMSF when the gains tax rate is 0%. But with a SMSF investment you don't have access to you money before preservation age.

mOOm said...

That is a very good point that top end real estate could appreciate in the long-run faster than per capita GDP growth. We are looking to rent in inner North Canberra which is the most expensive area after Yarralumla and Red Hill. One twist in the Canberra situation is that the land is leased from the government. I wonder whether that has an effect on long-term price growth compared to normal locations where you actually own the land? Structures are depreciating assets the real long-term growth in real estate is from land value in good locations.

Adventures In Money Making said...

excellent points by enough wealth.

i was under the impression that Australia housing market is in a bubble. is that true?

mOOm said...

I think it is a bubble if I need 7% price appreciation a year indefinitely to break even versus a stock investment :) That's pretty much the definition of a bubble - if an investment only makes sense assuming rates of earnings growth or capital gains that are a lot above theoretically or historically expected values then that investment or market is overvalued.