Invest in property!

Followed by the sound of a head banging against a wall... Repeatedly.

This is a topic that comes to a head with my significant other every so often. We've worked very hard to pay off our substantial loan in Australia even faster than I was estimating, just over 6 years to be exact.  But she looks at what others had done in the past, and are continuing to do, relating to investing in property, and she challenges me to explain why we aren't doing the same.

I run through the numbers, again and again, reading up on negative gearing, tax incentives, etc. expecting to convince myself that there is something there that I haven't seen and it *just* *doesn't* *add* *up*.

It seems everyone is into negative gearing. Deduct losses from your taxable income. This comes from your highest tax bracket, so if you made $200k, 20k of deductions would be $9000 worth of tax that would otherwise be given to the ATO, and now can be allocated to an investment property's capital growth. Got it! But wait a sec, I'm still out of pocket $11k for the year. The 9k isn't invested in the property, it merely lessened the amount I had to sink into it.

Having spent some time looking at the property market, none of it adds up unless you're willing to really gamble on new developments out in the middle of nowhere, or can secure a criminally sweet deal in today's market. The reality is that property prices in Australia are just too damned high, even if you look at areas that have been depressed as of late.

Lets take the Sunshine Coast for example. Lovely place, I like spending time up there and wouldn't mind retiring there some day. Property there has taken a savaging after booming through 2005-2009. It's taken a 20% loss since the peak. One area is an interest to us, Caloundra as it's big enough to have the amenities we desire, but not a glitter-strip attracting schoolies and hoons. There is a LOT for sale up there, even considering these are record low interest rates.

And there is the kicker. These are some of the lowest interest rates on record, and these properties are still incapable of being positive geared without significant investment.

An average 2 bedroom apartment in a relatively new building (2000's) will set you back $400-450k. Often these are in short-term stay sub-leasing arrangements. It doesn't look that bad from a price point of view, however there are other factors to consider:
Rental yield: Long-term rental rates for units like the above range from $410-440/week, and from what I can see, units are taking 4+weeks in-between tenants so you have to factor that cost in. Putting them in short term stay rental pools is an option if you find a good building, but even then the occupancy for last year was at best 85%, at worst 65%.  Frankly, there is an oversupply of units.

Body Corp: I couldn't believe some of the body corp fees I was seeing in these units. $6000p.a. for effectively a studio apartment, with an additional $2000p.a. for rates. That is $153/wk off any rent return right there. Oddly enough I was receiving quotes in this ballpark for 2 bedroom apartments as well. Probably explains why 16 units within that single building were up for sale.

So lets work some numbers on a nice apartment: $430k after all sales fees etc. with body corp and rates adding up to $8000 and a rental rate of $430/wk. In an investment interest only loan at 5.2% that is a weekly repayment of $429. Add to that your rates/b.c. ($153) and management fees (9% of rent: $39) that comes to a total of $191/wk out of pocket. Ok, obviously we need some capital in the property to get that down. Most advice I've seen is to aim for a 70% loan. I mean that makes some sense because if the property was any easier to positive gear then why would people rent? (they can afford the mortgage provided they can be bothered to save the 20% deposit)  30% of that is $129k. Crap, well I don't have that kind of cash sitting around. (And *no* you cannot "use" equity against that, you can only borrow against it.) I've got $80k that I can put against it now, so what does that look like... It drops the interest charge to $349/wk for a total difference of $111 out of pocket. Let's work with that.

$111/wk is $5,772 a year. As I made more than $180k last year I can deduct the top tax bracket from that. So it would be $3,175 out of pocket provided that unit was rented 12 months. This doesn't include any cost for maintenance or other incidentals like contents insurance if it's furnished. (if that's even worth having or just absorbing those costs as well)  Now I can probably deduct a bit more based on depreciation but let us use this as a bench mark.

$3,175 a year is certainly affordable, but is it a good investment?  Right now my total investment in the property is sitting at $83,157. $80k is tied up in an offset account not even earning me interest. If I left 80k in my savings account I'd have approximately $81,225 after tax, if I invested it or put it in Superannuation that figure would be significantly higher, but for this example that brings our total investment for this year to $84,380. I'm still $111/wk out of pocket, and if I'm lucky and rent demand is strong I can expect to perhaps raise rents by $10/year, but at that rate it would take 10 years so each year I need to allocate more cash. By next year I should have enough savings easily for that 30% target. ($129k) That with the rent increase drops the out of pocket down to $54/wk.
So the next year's out of pocket is $1,544 after tax deductions. Moving in the right direction but my realized cost after the 2nd year is $129,000 + $1,225 (first years lost interest) + $3,175 (first year losses after tax) + ($3,590 2nd year lost interest) + $1,544 (2nd year losses after tax) A total of $138,534 tied up in this investment so far. And I'm still negative gearing it. Any improvement I get from rental yield is being negatively geared by the loss of earnings I should be making on funds I need to reserve for this investment. But I'm going to get that back when I sell the property, right?

Fast forward 20 years when we're ready to sell this investment gem.  Oh wait! There was a time bomb lurking in that equation, did you see it?  INTEREST RATES. We are sitting on record low rates right now, and probably will be for the next year. However, the average rate is closer to 8%. When they start to climb, they will climb back up to 8% in a matter of a few years. (.75% and 1% hits are not that uncommon)  What does affordability look like going into a 3rd year at 8% instead of 5.2%.
Remember that $54/week out of pocket? at 8% that would be $215/week!  To get that back to $54/week we need to find another $105,000 to put in our offset account. A total of $234,000 tied up in this property! To positive gear the property will take $270,000. Want to see 9%? $272/week out of pocket.  Does that still look "affordable"?

Now fast forward 20 years, and let's sell that property. What kind of capital growth can we expect? Double every 10 years? You're simply kidding yourself. Property prices can only out-pace inflation for so long unless you truly believe in an Australian dream where two families combine their assets to afford that 4 bedroom home. All you need to look at is the ratio between median income to median house price to see that the balloon is fully stretched. If house price growth doesn't drop relative to inflation then people simple cannot - afford - to - live - here. So who exactly will be purchasing your unit? Why would you live in an Australian city if you could get a home in virtually any other city in the world for less? If inflation drives salaries up, interest rates will rise and that affordability crisis will set in. Nope, if you cross your fingers, the property market will be able to maintain close to inflation until you retire, and maybe you see a bit of a surge opportunity to sell. Inflation averages at around 3%. If house prices can keep pace, that would mean your $440,000 unit would be worth in the ballpark of $800,000 in 2034. If you believe in a figure closer to 6% (What property spruikers love to quote based on short-term annualized figures), you're dreaming. Why? If a person/family earning $80k today struggles to buy a $400k home, do you think in 2034 when they're earning $144,500 they're going to be able to afford a home worth $1.28M?? (That is $710k in today's dollars) You show me a family on $80k comfortably affording a $710k house, then I'll concede that 6% p.a. property growth is even remotely possible.

So you're selling a unit for around $800k. Hopefully capital gains tax laws haven't changed too much by then, deduct selling fees, your total realized investment in the property through its life, and don't forget any renovation costs incurred through the life of the property. (Depreciated) And what are you left with? Now convert that figure to a per annum figure. My own estimates say by time of sale I would have invested over $500,000 in my offset account, plus lost interest, plus cost of renovations. Making $300k over 20 years is pretty crap, given the amount of money invested.

Remember that $80,000 we started off with? Put in a meager savings account that alone would earn $36,000 after tax and we've sacrificed a lot more than that in the life of this mortgage. The irony is that as interest rates increase, the investment property costs us more, while savings earn more. (At 6% that figure is $102,000) Superannuation averages 5-7% long-term with considerable tax benefits, but there's no guarantee the government won't screw over retirees within the next 20 years, plus there's always the risk of super exposure to shares and property.

Lump sum, I think a *lot* of people are kidding themselves, or being completely conned into investing in property unless they are securing extremely good bargains that can be positive geared easily today. Unfortunately, quite a few I've talked to are currently negative gearing over $100/wk today. Affordable today, yes, but in two to three years as interest rates start to recover? Sorry, but if you're in that boat be prepared for the tooth & nail fight for the life rafts when it starts taking on water. The S.o.B's conning you into buying property today will be circling like sharks to buy off those properties at 2002 prices as mortagee possessions and distressed sales reach plague proportions.