Question Mark

The Reserve Bank has offered new signs of encouragement to the property market. In its quarterly Statement on Monetary Policy released last week, the bank quoted data from Australian Property Monitors showing that prices fell by 5.2% in the September quarter of 2005, and a further 5.1% in the December quarter.

By contrast, Melbourne rose by 2% and Brisbane by 2.6% in the December quarter.

“The price falls that have occurred in Sydney, together with stable or increasing prices in other capitals, have brought price relativities between Sydney and the other capitals back to the pre-boom levels of the early to mid-1990s,” the bank says.

Sydney is the biggest residential market in the country. It’s the first to boom, and the first to slow down. It has the highest land values, so property will always be more expensive than other capital cities. However, during the last boom, Sydney prices moved even further away, forcing many home buyers to look interstate.

Price falls in the second half of 2005 were essential to bring Sydney closer to the rest of the pack, and encourage home buyers to buy locally. The evidence provided by the Reserve Bank should enable the Sydney market to firm up and, eventually, begin to move up again.

The property market lull of the past couple of years has also improved affordability. The bank says that, with ongoing wage growth but little change in average nationwide house prices, house price-to-income ratios are falling.

Nationwide vacancy rates were 2.5% in the September quarter, compared with 3.3% a year earlier.

All these factors indicate that the planets are once again aligning across the nation’s biggest housing markets. I believe they are on track to consolidate during 2006, with real movement from 2007.

YOUR PLACE OR OURS?

My girlfriend and I are thinking about buying a home to live in. Neither of us has bought before. As I see it we could either buy jointly, or one of us can buy and the other pays rent to the purchaser.

If we buy together, will we both have to take full responsibility for the mortgage? Can we both claim the first home owner’s grant if we buy together? Would we still be able to use equity in the property to make other investments later? What would be the effect on our borrowing power?

If we chose the owner/tenant option, would the tax office consider it an investment property or a primary residence? Could I claim 50% of the property as investment if I have a tenant?

• Option One: Buying together: I’m not sure of your current living arrangements. However, for the purposes of answering your question, I will assume that you and your girlfriend are already living together.

Once you’ve lived together for an extended period of time, the law regards you in the same way as a married couple. This means it won’t recognise an owner/tenant relationship.

If you buy together, you will both be responsible for the mortgage. If one person is unable to meet their share of the loan commitments, the other becomes liable for the total.

You will still be able to use built up equity to purchase other investments. Lenders consider bricks and mortar to be the strongest form of security. You can borrow more against property than other assets such as shares or managed funds.

In addition, your primary residence is one of the best ways of building equity, because your loan will most likely be a principal and interest loan. Repaying some of the principal will boost the amount of equity you achieve through natural capital growth.

If you purchase together, you will only be eligible for one first home owner grant.

• Option Two: Buying in one person’s name: Buying and having the loan in one name would allow the other person to borrow up to their full capacity later without the encumbrance of a pre-existing loan commitment.

FIRST HOME

I am a single guy in my early thirties and I live in Adelaide. I have never owned a property and would like to make my first purchase. At this stage I am working long hours and earning good money. I’m relatively ambitious and I expect my income will continue to grow over the next 20 years as my career progresses.

I’ve been to a lender who says I can borrow up to $350,000. I don’t know whether to buy a home to live in or an investment property. What do you think?

Unless you already have significant savings, your first home is unlikely to be your “dream home”. However, by enabling you to build equity over time, it can be an excellent stepping stone to bigger and better things down the track.

I suggest you look for a home that will meet your lifestyle needs for the next few years, as well as having sound capital growth potential to help you build equity quickly.

To give you some general guidelines, capital growth is higher in the inner suburbs than the outer suburbs, higher in quiet streets than main roads, and (if you’re buying a unit) higher in smaller blocks than larger ones. In the inner suburbs of Adelaide, $350,000 would buy you a good quality unit or a small house.

If and when you do settle down, you’ll be in a position to convert your first home into a “true” investment property, rent it out and generate an additional source of income. Alternatively, you could sell the property and use the proceeds to help fund the purchase of another home.

THE GREAT SUBDIVIDE

My husband and I live in the Melbourne suburb of Glen Iris. We paid off the house some time ago and our 23-year-old son will be moving out of the house in the next 12 months. So pretty soon we’ll be free!

Our home was built in the 1920s and needs renovating. We’ve noticed many blocks in the neighbourhood where the owners have demolished the original houses, subdivided the land and built two townhouses. Speaking to these people, it seems that they sell one townhouse and keep the other one to live in.

Our block of land is about 800 square metres. The council has indicated it will give us the relevant permits to subdivide. We have approached a builder who estimates it will cost about $450,000 to build each town house, a total of $900,000. Do you think we should just sell the property and move on or should we subdivide and build two units?

In theory, subdividing your land and building two townhouses sounds like a great idea. The reality can be somewhat less attractive. The project will involve considerable costs, not all of which are associated with the construction itself.

You need to allow about five weeks for the sales campaign, two months between selling and settlement, and a further 18 months between demolition and completion.

You’ll need somewhere else to live during this period, and renting a home of comparable size in a similar location could cost about $25,000. Agent’s fees and advertising to sell the new property may set you back another $25,000.

Assuming you don’t have access to other funds, you’ll have to borrow money to develop the land. Believe me, builders’ costs can and DO blow out, so I suggest you add at least 10% on to the builder’s quote just to be safe. Interest bills on the resulting loan of $1 million could be as high as $80,000–100,000.

You’ll need to sell the second townhouse for more than $1 million to become debt free. You’d need to do a fair bit of homework to make sure this kind of price tag is achievable for the style and location of property.

Moreover, any gains you make on the sale of the second property could be subject to capital gains tax, because that portion of the property is being used for investment purposes.

I suggest a much simpler solution would be to sell your current home and buy another one that better suits your lifestyle.

THE 'LOW DOC' OPTION

I’m applying for a loan to buy an investment property. I have recently set up a business so I can’t yet provide a full year’s financials. The business is generating an income and my expected rental income of $250 a week should be greater than the interest-only loan repayments on the loan, which should be less than $1000 a month.

However, the lenders I’ve approached won’t give me the amount I need based on this fact alone. Should I try other lenders, or am I likely to get the same response?

I’m sorry to say that you’re likely to get the same response if you try other lenders. Firstly, most lenders will only take 75–80% of your rental income into account when working out how much you can borrow. This is to cater for periods when your property may be untenanted.

Second, lenders generally factor in holding expenses such as insurance, council rates, and repairs. Third, they often do the calculations with a notional interest rate that’s higher than the current rate '” to build in a buffer if interest rates rise.

Fourth, lenders only regard your investment property as part of your financial situation. Factors such as dependants, credit card limits and personal loans (among other things) can affect how much you can borrow.

What’s more, even though you’re earning an income from your business, this does not change the fact that the business is new and you’re unable to provide a full year’s financials.

I suggest you either wait until you have completed a full year’s trading, or look into a “low-doc loan” which doesn’t require proof of income. (Note that, to compensate the lender for the increased risk, low doc loans may have higher interest rates.)

Mark Armstrong is Director of Property Planning Australia www.propertyplanning.com.au, an integrated property advisory and mortgage sourcing service. He also writes for Australian Property Investor magazine www.apimagazine.com.au.

You can email any questions regarding property to Mark Armstrong right here, by clicking questionmark@eurekareport.com.au