is property still booming?

  1. bbm
    2,264 Posts.
    In my opinion...NO

    My reasons why I think the property boom is over and that a lengthy period of little or no growth (high probability of a correction also) is upon us is as follows:

    (Note that I have a heavy bias toward the Melbourne market)

    1. Prices are inflated.
    2. Yields are running at 3-4%.
    3. Vacancy rates are at all time high's of 4.5-5%.
    4. Auction numbers are down.
    5. Auction clearance rates are in the high 60's to low 70's at the best of times.
    6. Properties not sold at auction are on the market for several months.
    8. Attendances at auctions are low.
    9. Bidding is restricted to only a few people, if any.
    10. We are in a rising interest rate environment.
    11. As Nickoo mentioned last week, where is the money going to come from to fuel property appreciation. Wages will not increase enough for this to occur.
    12. (The most important) Household debt is at an all time high. In the late 80's the ratio of home loan repayments to average weekly earnings was 34%. Today it is running at 37%. Including personal and credit card debt this figure could be as high as 50-60%. Remember also that interest rates were 18% back then, so the absolute interest rate number makes no difference on commitment levels. It's simple, people are just borrowing more.

    At a minimum, for property to become more attractive, yields must be running at greater then 6% and vacancy rates less than 2.5%. For this to occur it could take many years.

    People will say that "This is all rubbish and doesn't mean anything. We have seen property prices double in the last few years and so it will continue, interest rates are low and people are taking their money out of the share market and putting it in to property".

    Oh really? From 1990 to 1996 property appreciated at 1% per annum. So who says that it can't happen again, even for the next 10 years?

    I won't mention anything about real estate agents, the media and the government because I have shed my views on this many times before.

    So what happens in a period of slow or negative growth?

    Here is an example of the current state of play in Melbourne if you decide to invest in a property now for the next 10 years:

    Purchase price: $335000 (current median)
    Stamp duty and fees: $20000
    Cost base: $355000
    Deposit: $33500 (10%)
    (so your total cash in hand, or cash outlay is $53500)
    Loan at 90%: $301500
    At 6.5% interest rate for 25 years: Repayments of $2036/month.
    Total interest paid (after 10 years): $176556
    Total repayments (after 10 years): $244290
    Balance owing (after 10 years): $233766
    Rental income (4% yield which includes vacancy period): $13400/year
    Rental income (after 10 years including rental increases): $156000
    Agents fees, council rates, insurance, water service charge, maintenance, and mortgage insurance (after 10 years): $44500

    With your income minus your expenses (+interest), your groos loss is $65056, giving you $30576 back from tax (top marginal rate).

    Total outgoings (expenses + principle repayments) is $288790.

    Cost to keep property = Total outgoings - Income - Tax refund = $102214.

    Therefore it costs you $197 per week to service the property.

    Property value after 10 years.
    At 5% appreciation per annum: $545679
    At 4% appreciation per annum: $495881
    At 3% appreciation per annum: $450211

    If you were to sell the property in ten years this is what you will have in cash (minus CGT and outstanding loan balance).

    At 5% appreciation: $264913
    At 4% appreciation: $226894
    At 3% appreciation: $192642

    Now remember the cost to service the property? $197 per week. If you were to use your original cash outlay of $53500 and put it in to a savings account earning 5% interest + $197 per week for 10 years, you will have $188789.

    What does this all mean?
    It means that your property will have to appreciate at a minimum of 3% per annum for a worthwhile investment.

    What if interest rates rise?
    Consider an interest rate of 7.5%. Selling the property in 10 years will provide you with cash in hand to the following effect:

    At 5% appreciation: $258236
    At 4% appreciation: $220220
    At 3% appreciation: $185968

    Your cost to service the property is $215 per week. Once again using your initial outlay + $215 per week in a savings account earning 6% will provide you with $206273.

    So what does this mean?
    Your property will need to appreciate by a minimum of 4% per annum for a worthwhile investment.

    Doing the figures for an interest rate of 8.5% means your property must appreciate by a minimum of 5% per annum for a worthwhile investment.

    So there we have it, it's not going to be all smooth sailing as some people think, considering that the bank seems to be a good place to park your cash if thinking of investing in property.

    To achieve a minimum of 3% appreciation over the next 10 years I personally think will be a little difficult considering the many factors that are at play for this to occur.

    One must also remember that contrary to what people think, it does cost you money (even after rent and tax refunds) to keep the property. Quite expensive also at the moment. Don't just look at capital gain, look at service cost also.

    Well, that's my view. I hope I haven't bored too many people.

    Comments welcome.

    Have a nice weekend.
    BBM

 
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