In my previous article on this topic I discussed how some inner urban professionals are finding new solutions to the home ownership problem. It requires a new type of thinking, following years of inaction by our governments and regulators in response to the housing demands caused by ongoing high levels of immigration, and the need for housing as close as possible to areas of employment.
Those with the means to save a large deposit have been left with a question to resolve that was not confronting previous generations. For decades the assumption was that savings would go towards the purchase of a first home. Governments facilitated this process through timely land releases, first home buyer assistance programs such as first home owner's grants (FHOG) and stamp duty concessions.
Then the economic rationalists got involved. More and more the regulation of the housing sector was left to the "invisible hand" of the market. The market has continued to work for its participants: property developers, lenders, property investors, real estate agents and mortgage brokers to name a few. And the market continues to work, but for whom?
We have learned that leaving things to the market does not necessarily generate the social outcomes we are looking for. The current housing price boom is leaving behind a generation of aspiring first home buyers, most of whom fall under that ubiquitous tag "Gen Y" (as if that whole generation is in identical circumstances anyway!). They may not realise it but this generation of aspiring investors is on the threshold of redefining the Australian relationship with real property. Presented with a new challenge they will find new solutions.
Many have adopted the solution of their parents' generation. Enabled in some cases by parental deposit support (the new FHOG available only to the more affluent), and low interest rates they are borrowing ever and ever increasing amounts to purchase an expensive home to live in close to their work, schools and social networks. The outcome will be an extended period of high debt management through a succession of economic cycles, changes in employment, technological change, health events and other challenges to be thrown before them.
Clearly, this is an approach pregnant with risk.
New Times - New Solutions
There is an alternative, which many are now being forced to consider: that is to enter the market as investors. This has several advantages:
- it enables the transaction to be scaleable in accordance with the borrower's means
- it enables the investor to access the tax advantages available to investors from day 1.
- it reduces (but does not eliminate) the cash flow risk associated with the property transaction
To demonstrate consider the two examples below. The first scenario is the traditional solution, of buying where you want to live. The second is based on renting where you want to live, and investing in property you can afford, and where you believe you can obtain the best return on investment.
In my analysis I have worked through two scenarios based on prospective borrowers with an identical financial starting point; viz
- Deposit saved: $200,000
- Family income: $160,000
- Family unit: couple with 2 children
Scenario 1 - Owner Occupier
Family 1 decides to stretch their resources to buy a home in which to live near their place of work. This home costs $1.1 M and they need to borrow $973,000 to complete the purchase (inclusive of stamp duty, legal fees, loan mortgage insurance and government fees).
Scenario 2 - Investor
Family 2 decides to buy a property which they see as a smaller scale investment with good potential returns over time. This home costs $750,000 and they need to borrow $600,000 to complete the purchase (inclusive of stamp duty, legal fees, and government fees). They continue to rent in a home near their place of work (which, if they had purchased it would have cost $1.1M)
The cash flows associated with both scenarios are summarised in Table 1. They show that the investor is $2,108 per month, or 21% of their net employment income ahead in cash flow. Put another way if this surplus cash flow were directed towards debt reduction the loan could be repaid in 13 years, rather than 30 years.
Clearly those property buyers who opt for scenario 2 can exercise their wish to invest in the property market with a much lower level of cash flow risk than those who enter as owner occupiers. They will be much better prepared for cash flow crises that may come along such as the birth of another child, periods of involuntary unemployment, interest rate increases and unscheduled large expenses such as property repairs or replacement of motor vehicles. Further they can take the opportunity to build equity in their property much more quickly by directing their surplus cash flow towards debt reduction.
There are of course many more factors involved in making an appropriate property purchase decision. Each scenario has different capital gains tax consequences, and there are additional risks associated with managing an investment property as opposed to a family home. There is also an essential psychological and practical difference between owning the home where you live and continuing to rent.
The question is: are these soft benefits worth the additional financial risk? Over to you Gen Y - it is up to you to redefine or reaffirm the great Australian dream!
Disclaimer: This article is intended to provide general news and information only. While every care has been taken to ensure the accuracy of the information it contains, neither Loanscape nor its employees can be held liable for any inaccuracies, errors or omission. All information is current as at publication release and the publisher takes no responsibility for any factors that may change thereafter. Readers are advised to contact their financial adviser, broker or accountant before making any investment decisions and should not rely on this article as a substitute for professional advice.