The past few weeks have seen banks tighten up lending conditions for property investors – either charging higher interest rates or imposing lower loan to valuation ratios or both. There is even talk of lenders managing their exposure by focussing on postcodes. This is all in response to increasing pressure from the banking regulator APRA (the Australian Prudential Regulation Authority) demanding that the 10% cap on property investor lending growth that it announced last December be adhered to.
Way back in the early 1980s it was pretty obvious that the medium term (five year) return potential from investing was pretty solid. The RBA’s “cash rate” was averaging around 14%, 3 year bank term deposit rates were around 12%, 10 year bond yields were around 13.5%, property yields were running around 8-9% (both commercial and residential) and dividend yields on shares were around 6.5% in Australia and 5% globally. Such yields meant that investments were already providing very high cash income and for growth assets like property or shares only modest capital growth was necessary to generate pretty good returns. Well at least the return potential was obviously attractive in nominal terms as back then inflation was running around 9% and the big fear was it would break higher. As it turns out most assets had spectacular returns in the 1980s and 1990s. This can be seen in returns for superannuation funds which averaged 14.1% in nominal terms and 9.4% in real terms between 1982 and 1999 (after taxes and fees).
The last few weeks have seen the investment scene hit another rough patch: US shares have had a fall of less than 2%, but for Japanese shares it was 4%, Australian shares 6%, Eurozone shares 7% and Chinese shares 9%. This note takes a look at the key drivers, whether it’s a correction or something more serious and some of the key threats and risks investors should keep an eye on.
As widely expected, the Reserve Bank of Australia has cut the official cash rate to 2% from 2.25%. This has taken the official cash rate to its lowest level ever and will push mortgage rates down to levels not seen since the mid-1950s. The latest rate cut if fully passed on to mortgage holders should save a borrower with a $300,000 mortgage about $12 a week or $625 a year.
It is now six years since the global financial crisis ended. From their 2009 lows US shares are up 212%, global shares are up 159% and Australian shares are up 91% (held back by higher interest rates, the commodity collapse & the high $A).
The case for the RBA resuming interest rate cuts this year has been fairly clear: commodity prices have fallen more than expected; the $A has remained relatively high; while residential construction and consumer spending are okay the outlook for business investment has deteriorated pointing to overall growth remaining sub-par; and inflation is low. This has seen the cash rate fall to 2.25%. While the RBA left rates on hold at its April meeting, it retains an easing bias pointing to further cuts ahead.
However, the main argument against further rate cuts has been that the housing market is too hot and further rate cuts risk pushing home prices to more unsustainable levels resulting in a more damaging eventual collapse. But how real is this concern?
What is risk? Surely that is a stupid question as everyone knows what risk is when it comes to investing. Investopedia (www.investopedia.com) defines risk as “the chance that an investment’s actual return will be different than expected”. It’s actually quite a complex concept because it could mean different things to different people depending on their circumstances and tolerance to it. And it can be highly perverse often being very different to what backward looking statistical measures and common sense might suggest. But it’s worth thinking about because it can impact how you invest.
Through 2013-14 it seemed the Australian economy was starting to transition away from a reliance on mining investment to more broad based growth.Unfortunately this transition has wavered a bit recently and growth has remained below trend. Fortunately, the RBA has recognised the problem and resumed cutting interest rates. This note looks at the outlook for growth and rates and what it means for profits and investors.
In this article, reader Melissa Huang asks Dr Shane Oliver about the pros and cons of buying off-the-plan property.
As house prices continue to rise, is it a good idea to buy an off-the-plan property for capital growth?
When it comes to investing in property or any investment for that matter, there’s no such thing as a free lunch. So the key is to go in with your eyes wide open.
Three reasons to buy off the plan…
There can be benefits in buying off-the-plan property if you do your homework and you’re not buying at the top of the market. If you’re a first-home buyer it’s not a bad way to get into the market. And if you’re an investor it’s not a bad way to start building a portfolio, particularly if you can pick up the property at a discount.
1. You may pick up a bargain
In order to get a loan from the bank, developers often have to show there is interest in the property. And they also like to get a degree of certainty before they start putting the development up. So they will try to sell a certain number of properties off the plan.
This means you may be able to get a good price and you usually only need to pay a small deposit, like 10% or so.1 And depending on your lender, you may not need to pay a deposit if you agree to guarantee the property against other assets.
2. You may benefit from being a first-home buyer
The benefits of buying off the plan vary state by state and can depend on whether you’re a first-home buyer or not.
For example, there are stamp duty concessions in most states and if you’re a first-home buyer, you may also get a grant because it’s a new development.
3. You may get other incentives
Some developers may provide short-term rental guarantees to attract buyers. And you may be able to customise the property to your needs by choosing:
fixtures and fittings
new appliances like dryers, stove tops and ovens.
…and three reasons to think again
When you buy off the plan, you are taking on more risk than if you buy an established or completed building.
1. You may get an unpleasant surprise
You can’t inspect an off-the-plan property… and things can change.
If something goes wrong while the building is going up—like interest rates rising or banks cutting back on financing—it can create financial problems. It’s not unheard of for developers to fall over when the market crashes. The building may eventually be completed many years later or it may never get off the ground.
So you should make sure the developer:
has sound financing
doesn’t have too much short-term debt
has a good track record.
But there are no guarantees. Developers have gone bust in the past and people have lost their deposits with no building to show for it.
And even assuming the development is completed, the property:
may not be quite what you think it was going to be—and it could be hard to get the developer to fix any defects
may be harder to rent than you think, despite seemingly attractive short-term rental guarantees.
2. You may be able to get a better return elsewhere
When you buy an established dwelling, you may pay more up front but you’re potentially earning rent from day one.
But when you buy off the plan, your deposit usually won’t earn any rental income for the construction period.
Even when you’re earning rent, the net rental yield can be less than you might imagine once you factor in your costs. Right now, the typical net rental yield is around 1–2% (Source: Real Estate Institute of Australia and AMP Capital).
And don’t forget that, like other investments (aside from holding cash in the bank), you’re likely to be liable for capital gains tax when you sell the investment property, assuming you’re making a profit.
3. You may see your property fall in value
If you’re buying off the plan now and the building isn’t completed until a few years later, there’s a risk the property will be worth less than you agreed to pay for it.
Home prices are rising now, as can be seen in the chart below, for many reasons including low interest rates and greater buyer confidence, as well as high demand relative to supply.
While they are likely to continue to rise for the next six to nine months, there will come a time (probably next year) when the Reserve Bank will start to raise interest rates. If that happens, it will act as a dampener on the property market.
Over the past few years there have been two significant downturns when home prices fell on average between 5% and 10%—just after the GFC and through 2011–2012 (Source: Real Estate Institute of Australia and AMP Capital ). And more risky developments would have experienced greater falls.
It’s important to get advice before buying off the plan. Tailored Lifetime Solutions dedicated Lending Specialist and our team of financial planners are here to help. Call our office on (03) 9851 0300 to arrange a meeting.
1 A 10% deposit is usually required to secure the property in the development before it is completed, and the balance or at least 20% of the property’s value as equity is required at completion, as lenders’ mortgage insurance will usually apply to loans with a loan to value (LVR) ratio of greater than 80%.
Investing can be profitable as well as fun, but it can also be unnerving and unprofitable if you don’t understand markets and don’t have the right mindset. The basics of successful investing are timeless and some experts have a knack of encapsulating these in a way that’s insightful. A year ago I wrote on 21 investment quotes I find useful, here are some more.
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