by Scott Pape - December 10th 2011
RIGHT now across the country, home prices are falling.
Spring – the traditional selling season – has sprung, and many agents didn’t earn enough commission to feed their BMW lease payments.
But it’s worse if you’re one of their clients – an owner of one of the 388,000 homes unsold as of November (up about 16% from the previous year, according to SQM Research).
More homes unsold means more choice for buyers, meaning sellers will eventually drop their prices – as we’re experiencing right now.
So where next for property prices?
To answer this we need to look at two interconnected drivers of property prices: confidence and banks.
In New York six months ago I walked past a bank advertising ten-year fixed-rate home loans for just 2 per cent. I thought it was a misprint, so I doubled back and had another look. It wasn’t.
Property (like Deal or No Deal) is a confidence game. When it’s hot, it’s hot – and when it’s shot, it’s shot. Case in point: despite incredibly low rates, property prices have been falling in the US for five years straight. Lowering interest rates has simply reinforced the perception that things really are buggered.
Right now – even in Australia – we’re worried, and with good reason. The European crisis is really a banking crisis, and it threatens to ramp up the interest rates the banks pay for their borrowings (and they borrow about 40 cents out of each $1 they loan out to us on mortgages). Our high level of household debt puts us in a tough position if the Australian banks ramp up their rates.
That’ll hurt a lot of homeowners, but it won’t cause a housing crash. People will do almost anything to keep their home – and the banks know it, which is why they’ll get away with it.
What will cause a crash is if the banks blink and become more cautious in their lending.
Here’s how it works:
Let’s say that blond kid with the cheesy grin and the Ray-Martin-inspired mop from Australia’s Got Talent decides to use his $50,000 prize money as a house deposit.
If the bank is willing to lend him 95 per cent of the value of the property (the ‘loan to valuation ratio’ or ‘LVR’), he can buy a $1 million mansion ($50,000 plus $950,000). But if his bank decides it’ll only lend him 87 per cent, he can only spend $385,000 ($50,000 plus $335,000). It sounds crazy, I know – but you can see from the graph that the potential buying price drops very quickly once the LVR falls below 95%.
That’s how the banks control the housing market.
This exact scenario happened in the UK and caused markets to crash. And it’s the reason all Wayne Swan’s huffing and puffing is just for the cameras – the banks have him over a barrel. (Wayne likes riding in big white cars with little flags on the bonnet – all politicians do. And falling house prices means no more white cars with little flags.)
That’s also why forecasting anything is a mug’s game – the outcomes depend on the decisions of a bunch of politicians from a bunch of countries. There’s no script for what happens next (although Europe’s reads like Fawlty Towers).
My hunch – and it is just a hunch – is that this will not end well. And in times of general uncertainty is pays to have personal clarity, or else you’ll get swept away by the headlines.
But how do you get clarity? Well, that all depends on where you’re standing at the auction.
If you’re looking to buy
It’s been said that a newly married couple spends the first five years of their marriage trying to (financially) replicate what it took their parents thirty years to achieve.
New home. New furniture. New car. New gizmos. It ends up ruining a lot of marriages, and a lot of lives. I meet them all the time – they’re stretched and stressed.
Someone should have told them, “Hey, it’s okay to take your time. So long as you’re saving really hard, it’s smart to rent for a while.”
I’m in the same boat myself at the moment, because I’m making the move back to the country. (I always knew I would when I was ‘older and more settled’. Well, strike me old and settled.) And I’ve decided to rent before I buy.
Why?
First, it’s much cheaper in the short term. Renting, on average, costs 5% of the value of the home per year and includes all upkeep and most outgoings. Owning costs 7 per cent for the mortgage plus maintenance and ongoing costs.
Second, renting offers fantastic flexibility. If my tree change turns to disaster, I can Tarzan out of there in 12 months’ time. No selling costs. No lengthy delays.
Third, even though I already own my own home, I don’t want to get in to a heap of debt by buying another property.
I passionately believe you should eventually own your own home. But there’s no rush. Right now, a smart strategy is to conserve your cash by renting so you can be ready to seize the opportunities that come from a falling market.
If your home isn’t selling
“From peak to trough we are seeing prices down about 10% in most of the capital cities … but for many vendors it feels like more than that”, property researcher Louis Christopher told me this week.
That’s a polite way of saying that many sellers have unrealistically high prices on their homes to begin with and have been caught out by a falling market. It’s a common problem that costs sellers tens of thousands – sometimes hundreds of thousands – of dollars.
Real estate consumer advocate Neil Jenman says that if your home isn’t selling it’s one of two things: “You’ve got the wrong agent or you’ve got the wrong price.”
Both can be solved. Here’s how.
Firstly, keep away from agents who want you to spend more money on pictures, premium website listings, or advertising. It generally won’t help sell your home (though it may feed their BMW). Instead, shadow-shop your agent. Get a friend to pose as a potential buyer for your property. Do they sell it well?
Secondly, once you find a competent agent, look at your price. If your home sits on the market, it gets stale – buyers think there’s something wrong with property or that the price is too high.
So either take it off the market for a few years or, if you have to sell, work out the lowest sale price you can afford and get the money in your bank. Don’t dither. Make a decision.
“To be smart in a depressed market, you’ve got to be tough on yourself. If you’re not tough on yourself to start with, then the market is going to be a lot tougher on you later on,” says Neil Jenman.
Just look at the way the Big Four banks have behaved this week, all in the name of protecting their bottom line. It’s time for us to do the same.
Tread Your Own Path!
Photo: http://www.flickr.com/photos/kruggg6/449912317/
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7 comments
I guess for some of us in our 30s, there is the sensation that if we don’t “get into the market” now, we’re going to be left behind. I think your article does address some of those concerns… I think what you’re hinting at is that wage increases will somehow keep up with real estate prices or that lending rates and drops in house prices will offer opportunities down the line from time to time. It’s tough when everyone is settling into “their own place” and one seems like an outsider looking in… But it is pertinent to note servicing a mortgage is not all fun and games.
SR dont rush it else you will end up like your friends, living in their dream home but so deep in debt that they are really in trouble, but wont admit it.
I have a friend who is about to discover that they shouldnt have bought their mortgage…she is pregnant and to date her entire wage has gone on the mortgage. They are going to drop 1.5 incomes for 6 months. Then they will have the expense of $100+ per day of childcare or a long term drop to just his if she stays at home after maternity leave. His wage is the same as hers so it doesnt add up. They have no savings as they have done as Scott said, achieved in 3 years what it took their parents 30 years to achieve…they have 2 newish cars (but neither are suitable for a baby carriage so will need to get another car), a newish house full of newish furniture…but they are going to struggle despite being on salaries above the national average.
You need to weigh up the decision. As Scott pointed out it is cheaper to rent then buy the equivalent place. You have the choice of 1) Buying your dream place and struggling 2) Renting your dream place and not struggling as much 3) Buying a place that isnt your dream but that you can easily afford or 4) Rent a cheaper place and save up a bigger deposit.
I got into my mortgage (first one ever) at age 37 and chose option 3, the place I can afford but isnt my dream. Because I chose the place I could afford I am paying it off quickly but not giving up the fun things in life to do so (2 months in Europe last yr, a trip to the US scheduled and paid for for next year). This way you can have your cake and eat it too.
Be brave and tread your own path.
We bought our house during the boom when we were terrified of being ‘left behind’ as well… suffice it to say that although the house is now worth about 100K more than what we bought it for, if we’d been banking the difference between our rent and our mortgage we would have been better off renting. You pay a lot in interest in the first five years of a mortgage… if you are saving at a good rate, you won’t get left behind.
Having said all that, I have never regretted buying our home. It was tough at first, but after paying off a bit extra every month, and getting a couple of pay rises, we’re quite comfortably well-off with it now. But we know a lot of people who are struggling.
That is a good graph and shows exactly how we got into this mess.
Wake up and smell the coffee australia… You’re economy is totally over heated. Your property prices way too high and mark my words, there will be a correction… How can a one bed near Hornsby cost $450,000… Ridiculous unless the average wage is 100k… Look at what happened in us and Ireland .. Same propaganda from the elites about getting in so u don’t miss out.. Avoid property… It will be 40% cheaper by 2016
+1
A good point but only a minor consideration to the banks in the scheme of things. LVR has less to do with the pool of funds available for residential housing than serviceability.
In Scott’s example above, not only would our singing star have needed a $50k deposit, but $80,500 (The after tax equivalent of a $115k salary) each year to repay the $950k loan over 25 years.