Report July 2012
DIRE PREDICTIONS
REIT president Adrian Kelly said yesterday the market had bottomed out. The Mercury, May 3 2011
It should come as no surprise real estate agents are as equally adept at predicting the future as economists, stock brokers and weathermen. The only difference between listening to these four groups is level of financial pain you’ll endure if you act on their advice and one of their predictions subsequently goes off a cliff.
Out of those four, taking the advice of a real estate agent is the one most likely to significantly impact your finances negatively, especially if you’re buying on the wrong side of a boom.
While the last point entirely depends on circumstances, this is an industry where you can still make the most significant purchase of your life using as little as 5% of your own equity. If real estate goes down or into ‘negative growth’ as industry spokesmen have now termed it, you can quickly slip into a money sink hole. The fact it can’t immediately be seen it on a balance sheet is irrelevant, but of continuing benefit to the real estate industry as it continues to search for uninformed buyers in falling markets.
Remember, we’ve been told for the whole of this century by industry spokespeople that real estate, on average, doubles every 7-10 years, despite the fact a calculator and sixty seconds shows this it be a fallacy. The fact that this has now seeped into our consciousness should come as no surprise, it’s parroted through all forms of media by real estate ‘experts’ whose expert status comes from their position selling real estate.
THOSE MOST AT RISK
Those most liable to going off the cliff are first home buyers. They’re often the most financially naive, the most financially vulnerable and often implored by their parents to take the plunge ‘before they miss out’ – lest they be condemned to the doom of being known as renters for life. Unfortunately, they’re counselled by their parents, who are often no less financially naive, having mistaken their own fortune in a rising real estate market as a sign of financial genius – a fact that swells the saliva glands of every lurking real estate agent.
After Adrian Kelly told readers of The Mercury in May 2011, that the market had bottomed, you might be eager to know what happened next. However, I’ll hold those figures for a moment and show you what Mr Kelly was saying nearly a year later in April 2012, which gives a clue as to how accurate his prediction of a bottom in the real estate market was.
TASMANIA’S first home owner grant should be doubled to $14,000 to boost the state’s sluggish economy, real-estate advocates say. Real Estate Institute of Tasmania president Adrian Kelly says upping the grant even if only for 60 days would have a huge impact on boosting the ailing real-estate industry and the wider economy. The Mercury, April 30, 2012.
The spokesperson of a real estate body publicly begging the government for stimulus is a clear indicator there was no floor under Hobart house prices.
At the beginning of June 2012, RP Data released their May 2012 Home Value Index showing Hobart dwelling values were down 8.91% year-on-year. Not to alarm anyone from Hobart, but Hobart’s dwelling values have been declining at a faster rate from peak than in the US when their housing bubble burst. On the release of these figures, and showing the hide of a rhinoceros, Adrian Kelly was again quoted in The Mercury, where he dusted off the classic real estate call to action, “now is a fantastic time to buy”.
SAFE AS HOUSES
Given Mr Kelly’s previous prediction and the stakes involved with such a significant purchase, it’s worth seeing what might have happened to a first home buyer who believed Mr Kelly’s May 2011 suggestion that the market had bottomed out. At this point in time, Tasmania’s housing finance figures had fallen to levels not seen since the late 1990’s, Hobart’s listings had increased every month since June 2010 and Tasmanian real estate transactions had fallen 18% across 2010.
With various median prices available from various data providers suggesting Hobart medians from $320,000 to $350,000, we’ll choose a figure of $300,000 to work off, given it’s a first home buyer who’d probably be spending less than the median. Assuming a first home buyer with a 10% deposit, the first home buyer will need a loan of $270,000.
Assuming $11,000 for closing costs in Tasmania at this price, they’ll receive $7,000 for the First Home Owner’s Grant, but the remaining $4000 will need to be capitalised on the loan. Likewise, as they don’t have a 20% deposit, they’ll need lenders mortgage insurance – $3200 for a mid range LMI quote, again this will need to be capitalised on the loan.
As it stands, the first home buyer would have required a loan of $277,200. And at the time of Mr Kelly’s prediction, first home buyer 12 month teaser rates were around 6.20%. This makes for a monthly repayment of $1822.
Assuming a 25 year mortgage, after 12 months on the teaser rate the principle would be down to $272,706, while paying out $17,070 in interest. The bad news? After an 8.9% fall in Hobart house prices, year on year, that first home buyer’s house is now worth $273,300 and the first home buyer is left with only $594 equity in their house.
That’s after ploughing $53,218 into the house. And we haven’t even considered council rates and water charges yet, which would be around $2200. A grand total of $55,418 spent over 12 months and the first home buyer is close to negative equity. Another year of continued declines and the buyer is certain to owe more than the house is worth.
For the buyer there are several further indignities. Firstly, that teaser rate now ends and their monthly mortgage payment goes up by $112. Secondly, had they chose to rent they’d still have their $30,000 deposit and assuming the average Hobart house rent of $320 per week (according to Australian Property Monitors APM), they would have saved $8,778. Assuming the average Hobart unit rent of $258 per week (APM), they would have saved $12,002.
Using the best case scenario, by waiting 12 months they potentially have a 40% higher deposit, combine this with the fall in prices and their loan requirements have fallen by 15%.
THE FUTURE
The real estate industry’s favourite comparison is real estate vs. the share market. Here they can talk of risks and volatility while pointing to the daily gyrations of the share market. They’re well backed by the media who put stories of 2% share market declines on the front page, while 2% share market gains are inconspicuously relegated to page 45.
The risks of real estate, however, remain well hidden because real estate declines happen in slow motion. Falls are relentlessly denied by the industry, until the point where they’re finally acknowledged, if only so they can claim, as Adrian Kelly did, that the bottom is in and the recovery is underway.
Every year since the housing bubble burst in the United States, the US real estate industry has continued to announce housing recoveries. These recoveries are always backed by cherry picked or unquantifiable data and always they prove false because the market continues to fall.
Yet if we want to discuss risk we should take the example of our first home buyer, an example that could have been mimicked across several Australian real estate markets. Purchasing a dwelling for shelter or investment in Australia at the moment still requires a sizable amount of equity, a sizable amount of debt, or a combination of both. Regardless of the makeup, that debt and/or equity is placed into a single asset with limited liquidity and high transaction costs.
While we’re not in the business of making predictions, those approaching real estate should be aware of the change in the real estate market. Household debt levels in Australia are still hovering near record highs; real estate listings in Australia are elevated; housing finance figures are consistently much lower than in the boom years and the beginning of Australia’s last real estate correction was abruptly ended in 2008 by the government doubling the first home owner’s grant. This move only served to further increase prices and debt levels.
Helen Kempton, “Locals Wary Over House Sales,” The Mercury, May 3, 2011
Linda Smith, “Double Home Grant Call,” The Mercury, April 30 2012
Nick Clark, “Housing Prices On the Slide,” The Mercury, June 5, 2012
Mancell Financial Group is an Authorised Representative No. 226266 and Credit Representative No. 403187 of FYG Planners Pty Ltd, AFSL/ACL No. 224543. ABN 29 009 541 253 This information is general in nature and readers should seek professional advice specific to their circumstances. Think you need a lawyer for a superannuation claim? Think again!
