Should You Buy, Sell or Rent?
It’s not surprising with everything we’ve written about house prices in recent weeks, your editor has gotten plenty of emails asking for personal advice.
Unfortunately, I can’t give individual personal advice.
But what I can do is repeat what I’ve written here several times before.
If your finances aren’t stretched – and you believe you’ll keep your job – then unless you want to lock in a profit on your home, you may be better off not selling… even if it means seeing the value of your home fall.
On the other hand, if you’re paying out a high proportion of your income on mortgage repayments and you’re concerned about servicing the loan, then you should seriously consider selling up and getting out.
That could mean renting somewhere. Or if you think prices will fall, but you’re not entirely convinced, then you should at least think about moving to a smaller or cheaper home.
At least that way you’re reducing your debt level and you still get to stay in the property market – even though the value will fall.
Is it worth it?
If you’re an investor, there’s no getting around it. You’ve got to do the numbers.
Are you really making as much on that investment property as you think you are? Is it really worth financing a property for another ten years with an interest-only loan?
Look at the numbers. For most property investors it means sacrificing income now in favour of capital gains in the future.
If there aren’t any future capital gains then why are you sacrificing current income?
Not only that, but you also need to work out the comparative returns on other investments.
As I wrote on Monday, it’s amazing to even say it, but right now there’s a greater chance of losing money on a property investment than there is on small-cap mining stocks!
It shouldn’t be that way. But it is.
And there’s even a chance you’ll be better off sticking cash in the bank rather than going through the hassle of owning and maintaining an investment property.
I won’t go through all the numbers again, but you should read Monday’s Money Morning to give you some idea of the capital gains needed to make housing investment profitable.
And remember, the actual return on housing is worse because we didn’t include all the fees for buying and maintaining the property.
But at least it’ll give you a starting point.
Finally, as an investor you need to figure out future returns. It’s all very well to say, “In the long run property always goes up”. But who says?
For the most part property investors are looking at a short timeframe of ten or twenty years and assuming that’s representative of the long term.
Yes, share prices can fall
We could do the same thing by showing you a chart of the US S&P500 stock index between 1988 and 2000:
If that was all the data we gave you, and you knew nothing else about the stock market, I’m sure I could convince you that share prices always go up.
But you’re not dumb. And I’m not a crook. Because now I’ll show you the S&P500 from 1988 until today:
Now you can see the stock market doesn’t just go up. It goes down as well.
But if all anyone told you was that share prices only go up, and if the only period they’d shown you was a period when prices were rising, then you’d probably believe them. Right?
Let me put it this way: the next twenty years for house prices will look like the right-hand side of the above chart rather than the left-hand side – that is prices rising and falling, not just rising.
Look, the spruiking from the property guys is no different to the spruiking from the stockbrokers and fund managers of a few years ago.
Between 2003 and 2007 brokers told clients stock prices couldn’t fall due to the weight of money argument. It was the idea that with all the money pouring into super funds every day, month and year, it would provide a permanent floor under stock prices.
In other words, there would always be buyers of stock, regardless of what the economy was doing.
Not surprisingly, it turned out to be complete nonsense. Yet the weight of money argument isn’t so different from the population growth argument made by property spruikers.
They claim that with all the new people coming to Australia, it provides a floor under house prices.
What both arguments ignore is the human element. The mainstream and spruikers always view the market and market behaviour as though it’s a uniform reaction. But it’s not. The market – any market – is a collection of individuals acting in their own self-interest.
In the case of the stockmarket it’s individuals managing their own portfolio of shares… some are beginners taking a $500 punt here or there, others are investment “whales” punting $1 million a time…
And then there’s a whole bunch in between.
In addition you’ve got the fund managers. They’re investing for two reasons. One is to try and make money – or not lose money – for their clients. But they have another motive too: that’s to make their own money by charging fees or commissions.
If they make bad investment decisions, there’s a chance they won’t earn as much.
That means, you can have as much money coming into the market as you like, but it doesn’t negate individual actions. It’s those individual actions that cause prices to change.
I’ve used the example before, if no-one sells a share the price won’t go down. But there’s no cartel of share owners on the market. That means if owners believe others will sell then they’ll try to get out first. That can force the price down.
It’s the same on the buy side. If prospective buyers think other buyers will pay more for a share, then a buyer will be keen to get in quickly… that can force the price up.
Sellers bring out more sellers
Property investing is no different. I’ll repeat that… property investing is no different. For the past twenty to thirty years, prospective buyers and current owners have rightly predicted that people will pay more for property and so prices keep going up.
The more they’ve risen, the more owners and buyers believe prices will rise further.
But now the market has turned. Buyers don’t believe prices will always go up. That means sellers are starting to bail out. The proof of that is in the huge increase in houses up for sale.
The knock-on effect will be especially hard for investors who rely solely on price appreciation. They’ll now have to figure out if they can finance a property that’s returning a negative income yield and zero (at best) price growth.
Odds are they can’t.
And if owner-occupier buyers see the market flattening and then falling, what’s the rush for them to buy? There isn’t. Not until they figure that prices have fallen to a level where it’s worth buying.
But what about the shortage of homes and land? That’s simply not true. Falling prices will increase supply as developers fall over each other to sell their land at a cheaper price to other developers.
And sellers will decrease their asking price as they fall over each other to sell before prices fall further.
Just like in any other market.
The disappearing shortage
That’s when the lies about a housing shortage are revealed. Funnily enough, spruikers in California thought there was a housing shortage too. Over a year ago we printed an excerpt from an online community newspaper from 2006.
Here’s the quote:
“The Californian Building Industry Association (CBIA) continues to express alarm over what it calls an ongoing housing crisis in Southern California. Alan Nevin, the association’s chief economist, projected in a 2006 CBIA Housing Forecast that only 185,000 to 205,000 building permits will be granted this year, far short of the 240,000 new homes needed each year.”
“Southern California has been experiencing a massive population boom in recent years and it’s believed that 6 million new residents will be living in the region by 2020. The population increase, coupled with the housing shortage, has the CBIA worried that it will be increasingly difficult for first-time homebuyers to find a moderately priced unit.”
The supply picture in California today? Well, according to a recent report in the Christian Science Monitor:
“By the CoreLogic analysis, the states with the largest ‘supply’ of distressed properties (measured in months it would take to sell them) are New Jersey, Illinois, Maryland, Florida, Delawere, Georgia, Connecticut, Alabama, California, Washington, and Michigan.”
Oh dear. So much for a housing shortage. Just as houses “appeared” from nowhere to flood the market in California, houses will “appear” from nowhere in Melbourne, Sydney, Brisbane, Adelaide and Perth too.
Anyway, back to the point. As an owner-occupier, the really important thing – before you do anything – is to rethink how you view your home. You need to forget about it as an investment. You need to just think about it as a place to live.
Once you’ve done that, you’ll soon figure out whether it’s worth paying a few thousand dollars a month in mortgage repayments for a house that may not increase in value.
Then you can decide whether to switch to a smaller home with smaller repayments or rent… either one will be dead money. The only important thing is how much it’s going to cost you.
Or to put it another way – just as an example – do you pay $3,000 a month on mortgage repayments on a big house; $2,000 a month on mortgage repayments on a smaller house; or $1,500 a month on rent.
If after doing the numbers, you figure out renting is the cheapest option then that’s the point you work from. You then need to decide if paying an extra $500 a month to have a mortgage is worth it.
If not, then don’t buy.
Treat your house like a car!
Your editor takes the same view with cars. I know it’s different, but you’ll get the point when I explain it…
Each day we drive about 40km from home in Frankston to the office in St Kilda. We then drive home each evening.
And that’s it.
So, all your editor needs is a car that can make that trip each day. That’s why we bought the cheapest thing we could find.
Now, of course we’d like to drive a fancy car. Who wouldn’t? But the point is, any car more expensive than our current car would be a luxury. The Hyundai Getz cost us about twelve grand, but it does the job.
If we upgraded to a car that cost thirty grand, it would mean we’re spending $18,000 more than the minimum cost of driving between Frankston and St Kilda.
So, we need to figure out if that’s a cost we’re prepared to pay. For the moment it’s not. We don’t need to impress anyone by turning up in a fancy car. And we’re yet to be convinced that the extra comfort of a more expensive car is worth the extra cost.
The same goes for housing. Do you really need the four bedroom home when a three bedroom home is cheaper?
Do you really need four “living” areas, when two or three would be fine?
If you answer yes to the above, that’s fine. And if you’re prepared to pay a higher price and higher mortgage repayments, that’s fine too.
But remember that anything above basic shelter is a consumption or luxury item. So it comes down to how much house you want to “consume”. And like with anything you consume, you shouldn’t expect to profit from it.
Does that make sense?
The Aussie housing market is going down the gurgler right now. And we’re seeing more evidence of it by the day. Housing is going back to what it’s supposed to be – being a home and not a money-making investment.
Trouble is, it’s going to make a whole bunch of people poor along the way.
For Money Morning Australia