Wednesday, February 9, 2011

Melbourne's Costly Hobby


If the property value goes up every seven or eight years and it doubles, which I understand, I agree – how many years do you have to hold the property for the property to make enough cashflow… to cover your mortgage, your rates, your water and all your outgoings?  Ladies and gentleman it’s sixteen years.  So the property can double in seven years, it can double in eight years but for you to walk away from your job it takes sixteen years… before it makes enough money for you to stop going to your job to support it… so what happens is we find people go ‘I’m worth a fortune’, and they are.  But they still have to go to the job every day at 6.30 in the morning because they’ve still got to put money into the fortune!”
That’s probably the most sense we’ve heard from a property “guru” in years.
Money Morning reader Pat brought it to our attention.  The words come from property financing whizz Rick Otton.
The fact is, most property investors are in the same financial position as the doddery old English Lords of the manor… asset rich, cash poor, and debt heavy.  The Lords have to sell off the family silver to stay liquid.
And property investors have to work harder than before to pay for what is no more than an expensive hobby.
Investments shouldn’t cost you money, they should make you money… that’s why they’re called investments.  If something is consistently giving you a negative return then it’s either a bad investment… or it’s not an investment at all.
The fact is, if you keep pouring in more cash into than you get in return you may as well take up trainspotting or stamp collecting.  At least you’d probably get some enjoyment from it rather than getting yourself deeper into debt with the bank.
Of course, we dispute the argument that properties double in value every seven years.  Simply because the numbers don’t support the claim.
I know you’ve probably seen the charts and numbers that “prove” it, but they don’t.  What you see is a neat number trick.
What the numbers actually show is that property prices have typically doubled every seven to ten years, but only since the mid-1970s.  Over the previous seventy years house price growth was broadly flat.  There were periods of price rises and periods of price falls.
“Ah,” you may say, “But if you take an average house price from 1900 and double it every seven years you’ll get to today’s average house price.”  That’s the other number trick the spruikers like to use.
Sure you do, but all the growth has been in the last thirty-odd years.  Averaging out a number over two distinctly different periods doesn’t provide a fair reflection on the true price action.
It would be like taking the price action of the Nasdaq market from 1998 to 2001 and saying stock prices always move up like that.  You and I know that would be misleading.
But what’s more important is Rick’s comment that it takes sixteen years for a property to be cashflow positive.  Just remember that’s sixteen years in which the house has supposedly doubled in value twice.
Yet it’s not until the seventeenth year that the property investor is able to walk away with a net profit!
Now think about what the payback will be when property values don’t double every seven years.  How long will you need to hold a property for it to be cashflow positive?  Twenty years?  Thirty years?  Seventy years?
I don’t know about you, but seventy years seems like a long time to wait in order to make a $1 profit on a several-hundred-thousand-dollar investment.
I know the stockmarket has been pretty crummy recently.  But at least the buying, financing and holding costs are low by comparison. 
And that wasn’t the only tip-off we got from a reader this week.
It was a tip-off that contains a bombshell backing our call for a house price crash – a house price crash that’s already started based on what we’ve seen of the housing market – even though the official indices claim prices haveplateeeeeaued.
What does it tell us?  Well, if we thought we’d put the stake through the heart of the housing shortage myth, housing index firm Residex has hammered the stake through to the table.
According to its numbers, far from there being a housing shortage, Melbourne has a surplus of 18,000 properties!  That’s right, surplus… not a shortage.  And that doesn’t take into account the huge land release promised by the previous Victorian state government.
If that wasn’t bad enough for the Melbourne market, get this… Melbourne also boasts the lowest rental yield of any Australian city at just 3.3%.
That’s the gross yield of course.
If it takes the average investor sixteen years to be cashflow positive on a property, and Melbourne has below average rental yields, just think how long it could take Melbourne property investors to be cashflow positive.
You’d clearly need the staying power of Methuselah to get any kind of financial benefit from buying a Melbourne rental property!
Boy, is the Melbourne housing market set to plummet once buyers figure out there’s no rush to buy into this over-priced market.
By our back-of-the-envelope reckoning, the Melbourne median price needs to drop about $150,000 (about 30%) just for the rental yield to reach the national average of 4.35%.
And, as you know, when markets fall they never fall to the average, they always overshoot.
Looks like we may have underestimated with our forecast of a 40% drop… who’s to say it couldn’t be a whole lot worse.
Not that the rest of the country is safe.  Another Money Morning reader sent us this email:
“I thought you might be interested to learn about Mandurah in Western Australia in respect of the so called “housing shortage” we have (that argument has been a bit quiet recently).
“…It has been interesting to see that the hundreds of apartments that had been completed when I was here last year are still vacant. I have had a walk around tonight to get a better gauge to see how many lights and flickering televisions could be spotted and my calculations are that maximum 25% of these waterside apartments have people living inside them. There are “for lease” and “for sale” signs everywhere as well as a couple of developments that have stopped half way through!
“Developers and bankers must be hurting big time sitting on these expensive and impressive looking buildings and bleeding heavily while waiting for gullible buyers!
“Moral of the story is that I would be steering clear of WA companies involved in construction related activities.”
As it happens, Residex calculates that Perth has a housing surplus of 6,000.
Our advice for today?
If you’re a property investor (but not necessarily an owner-occupier) then sell Melbourne and sell Perth… unless you’re planning on living to the age of 969… because that’s how long it’ll take to be cashflow positive on your so-called investment.

Regards,

Kris Sayce
for Money Morning Australia 

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