Why I am not a young homeowner right now

 

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Owning a home has always been the great Australian dream. A picture perfect home surrounded by a white picket fence, backyard large enough to entertain friends and host BBQs, and a cosy fireplace to snuggle up during those cold winter nights.

Late last year I decided I was ready to be one of Australia’s dream chasers. I wanted to finally enter the market and become a young homeowner.

A few factors that influenced my decision:

  • Desire to have a home to call my own.
  • I was financially stable now so I could afford a house mortgage.
  • All my friends were becoming young homeowners.
  • Fear of missing out on a rising property market.

And so in my typical anal-self I embarked on a lengthy mission to analyse my decision from all angles.

My due diligence process quickly made me realise that my initial decision to purchase was driven purely by emotions, not by facts and practicality. And buying a house via emotions was a sure-fire way to paying over the odds.

So I stepped back, sought counsel from my thrifty self, dived deeper into the hard facts and worked on the numbers instead. Luckily I had done that because it soon became clear that buying a home in this market wasn’t the right choice for me.

My research led me to the following conclusions:

  1. I think house prices are going down because of a property bubble. I don’t want to be buying a house now, and then have the value drop 30%. I’d rather wait for property prices to fall to lower levels before buying.
  2. The government is warning that house prices are rising too fast and it HAS TO STOP, further stating that they are prepared to introduce policy changes to make that happen. That is a warning sign, and further supports my #1 argument that prices will continue to rise like before, and likely come down.
  3. House prices are sky high right now and therefore unaffordable. To buy a place in this market I’d have to take out an oversized mortgage, leading to mortgage stress, i.e. more than 30% of my monthly income goes to paying off the mortgage. Do I really want to put that kind of pressure on myself? No I don’t.
  4. Any mortgage repayments that I commit to now will likely increase in the future via interest rate increases. That means more mortgage stress, and more problems!
  5. Renting is NOT the dead money scenario that many people refer to. Far from that.

Let’s get right into the details to find out why I remain happy to be out of the market.

Property prices in bubble territory and will likely ‘pop’

Chart showing how high Australia house prices have risen in the past 2 years

Let the charts sink in for a moment and notice how Sydney and Melbourne prices have risen in a hurry for the past 3 years. Because of the meteoric rise, I personally don’t think there will be much steam left in the tank for prices to keep going up at this rapid rate. Not only will rapid price rises be unlikely, I fear for the possibility of a catastrophic price drop.

In funds management I am regularly reminded of Bob Farrel’s investment rule #2, that is excess price rise in one direction will almost certainly lead to an opposite excessive drop in the other direction.

A good analogy: What happens when you take a rubber band and stretch it to its limit one way, and release it? It snaps sharply back the other way right?

In market terms, a snap back happens when prices come back to normal levels, returning to how things should be.

A chart showing the snap back of Shanghai Composite index following an excessive price rise

Performance chart of the Shanghai stock exchange between 1991 and 2015

This is a chart of the Shanghai stock exchange where normal market movements can be seen between 1991 to 2006. In 2007 when the market experienced excessive stock price rises, a snap back promptly occurred in 2008 and brought prices back back down to normal levels.

Another period of normalcy between 2009 and 2014 before another excessive price rise started to occur in late 2014. Again, a snap back occurred in 2015 and the most recent Shanghai stock market crash is still ongoing as I write this.

My worry is that the housing market is no different from the share market; both distinct in nature but driven by the very same investor psyche. Exuberance that drove the excessive price rise in the Chinese stock market is happening right now in the property market; Sydney prices are up 23% this year with Melbourne close behind being up 16%. Auction clearance rates are at all time highs with complacent buyers believing that property markets only go up, and never down.

Exuberance breeds property bubbles, and that’s dangerous. When the exuberance wears off, I expect house prices to come crashing back down to normal levels, just like what is happening in the Chinese stock markets.

The Reserve Bank of Australia (RBA) wants to stop price rises

Almost on a daily basis there are articles written on the overpriced and overheated property market. “A bubble is forming!”, read headlines. The RBA has mentioned the need to cool the market down and has started to put controls in place to contain out-of-control prices within Australia.

Such a move by an important authoritative government body will likely mean that property prices will stagnate going forward. What is worst is that these controls could possibly lead to fall in property prices.

The RBA has released research clearly showing that investor money have been the driving force of meteoric price rise. And that’s exactly where they have set their sights on.

Chart showing record levels of Investor loans being taken out Chart showing Investor loans on housing reaching record highs

Some examples of just exactly how the RBA is making it tougher for the property investors; banks are stricter on their lending criteria to investors, FIRB clamping down on illegal home purchases by foreigners investors, changes to the Significant Investors Visa Scheme.

There’s also very active chatter on the possibility of negative gearing being removed as a tax incentive for investors.

Property investors were the rocket fuel that propelled house prices, so without them it’s hard to see how prices can keep rising.

And that’s why I think prices will stagnate, and fall in the near future.

Living beyond my means and over-mortgaging on a house

With prices at these crazy levels, affordability is a real problem and the only way to becoming a young homeowner is to leverage-up-to-the-eyeballs. So I ask myself this “Do I really want to commit myself to a 30 year old mortgage that I probably can’t afford and rob myself of the opportunity to actually live life?”.

Not to mention all those sleepless nights constantly worrying about keeping up with unaffordable mortgage payments.

We all want to be happy in life don’t we? Part of being happy is having the control over our own lives to choose to do what makes us happy.

Having a LARGE and UNAFFORDABLE mortgage hands over control to the lending bank. It is effectively like being in a financial jail, shackled by the obligation to pay a monthly interest rate.

A majority of young investors fall into the trap of taking out a big home mortgage they can’t afford because house prices are just so b***dy expensive! Having an unaffordable mortgage however is living above means, and it’s something that should be avoided at all cost because it will get you into trouble over the long run.

Interest rates will go up from here on

Chart showing that Australian Interest rates were once as high as 17%

The official RBA interest rate for Australia has been dropping since December 2010 and is currently at historically low levels of 2%.

With rates very close to 0%, there’s very little room left for any more cuts. What happens if rates start going up?

Who is to say that is not going to happen in the very near future?

The current 2% interest rate environment have enabled many Australians to obtain large mortgage loans but what many working age individuals don’t realise is that interest rates have not been this low in the past; as recent as 1990 interest rates were at a sky high of 17.50%.

Putting the interest rate effect into perspective :

  • Mortgage loan of $512,000 at 2% p.a. interest rate = annual payment of $10,240
  • Mortgage loan of $512,000 at 10% p.a. interest rate = annual payment of $51,200
  • Mortgage loan of $512,000 at 17.50% p.a. interest rate = annual payment of $89,600

At 2% interest rates, mortgage repayments are deceivingly affordable. As the simple calculation shows, an environment of increasing rates can quickly make things very uncomfortable; a jump from 2% to 17.50% translate to $79,360 extra in annual interest payments.

A very uncomfortable rise indeed.

Once affordability becomes too big of a problem, the only way out of the situation is being a forced-seller of the family home which will lead to prices dropping as people exit the property market.

Not a very optimistic outlook indeed.

Rent is dead money – fact or just an outdated perception?

When I speak to the older generation about the idea of renting, I usually get a “are you crazy?” look from them shortly before the lecture on how paying rent money is dead money.

Paying rent money means helping the home owner pay for holding cost and helping them to own a home. So why help others pay for a home when you could use the money to buy a home yourself?- 'Old-style' home owner

It all sounds very logical in theory but when I put facts to numbers, being a homeowner doesn’t look that lucrative after all. I found out that renting was actually cheaper than buying, and by a fair margin too!

In my scenarios I’ve chosen my preferred suburb of South Yarra, obtained house pricing from realestate, have my maximum LVR capped at 80%, settled on a standard mortgage variable rate of 4.55% from a big bank, and included standard homeowner costs;

Scenario 1 which shows how expensive it Scenario 2

This example illustrates that I am no worst off financially if I rent. As a matter of fact, I ‘save’ $18,180.40 a year by renting. I also have the benefits of 1) not having to worry about an oversized mortgage hanging over my head, 2) the option of moving every year to experience a new surrounding if I ever chose to do so, 3) living in my preferred suburb and home without overpaying to buy it, 4) passing all maintenance requests onto property owner.

I’ve also concluded that renting is not dead money. Yes paying rent is helping a homeowner pay their mortgage, but if I was a owner-occupier myself, I’d be paying interest to the bank which is very similar to paying rent. I consider that dead money as well as it doesn’t bring me closer to out-rightly owning my own home.

Rather telling isn’t it?

Emotion vs Practicality

From a practical point of view I’ve worked out that the property market is not a smart place to put my money in right now.

But emotionally I still yearn for a house to call my own.

Sometimes there are decisions in life that just isn’t practical, and I feel that buying a house is just one perfect example.

I’ll be jumping into the property market as soon as I get a hint that house prices have stabilized and is unlikely to fall.

But for now, that moment has yet to come, and that’s why I am not a young homeowner now.

Are you convinced of my argument that sitting on the sidelines for the moment is the best thing to do? Let me know in the comments below!

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Comments

  1. JC says

    Also, in your analysis of mortgage vs renting there is the opportunity cost of investing the 18k in something else. Balanced off with the high leverage you can get with the mortgage (as long as rental yield, if it is an investment property, + effective capital gains after cgt + tax offset is greater than the interest rate). One would have to do the math with several assumptions to figure out what is right for them.

    • says

      Good point JC! As with all forward looking number-related scenarios, there are assumptions that we need to consider in detail to figure out the best way going forward. I’ve pointed out the qualitative factors, but indeed the quantitative factors are equally as important when deciding between mortgage vs renting.

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