Question Mark

Today’s Reserve Bank decision to raise interest rates by 25 basis points, to 5.75%, is set to widen the gap between the upper and lower ends of the home buying markets '” and Sydneysiders are the most likely to feel the pinch.

The top end of the market has been running hot for some months now as home owners channel funds from record sharemarket returns into property.

I don’t expect today’s decision will change this. When you can afford to put this kind of money into property, an increase of 0.25% in your interest bill is little cause for concern.

Buyers at the lower end of the market won’t fare so well. Even at the best of times, these purchasers often have to borrow heavily to enter the market, making them particularly sensitive to interest rate rises.

Ever since the last property cycle peaked at a level that locked many of them out of the market, home buyers have been waitin’, wishin’ and hopin’ for the market to adjust sufficiently to ease the affordability squeeze. This situation has been most severe in Sydney, where house prices increased at an exponential rate and moved way out of line with the rest of the nation.

Although the Sydney market has indeed gone through an adjustment in the past few years (including a drop of 5% in the median house value during 2005), today’s rate rise cancels out at least some of the benefits of the adjustment for home buyers who have been hoping to enter the lower end of the market.

Buyers at this level may opt to stay out of the market rather than take on potentially unsustainable debt. This might cause house prices to drop yet further '” or at the very least, stay put '” for the remainder of 2006.

Those buyers at the lower end of the market in Melbourne and Brisbane will also be affected, although not quite to the same extent as their Harbour City counterparts, because affordability was better to begin with.

Across the Nullarbor, where the mining boom is creating a different set of conditions, a single rate rise is unlikely to have much of an impact on home buyer activity. I believe it would take several consecutive rate rises or a slow down in the resources sector to decelerate the property market gains of the past 18 months.

For investors Australia-wide, the outlook is different again. Even though investors tend to participate at the same level of the market as first homebuyers, an increase of 0.25% in their interest repayments should have a minimal effect on their net cash flow and ability to hold the investment. This is because:

• The rate rise is fully tax deductible. For example, a 0.25% rise represents a 0.13% rise for an investor on the top marginal tax rate.
• The rise forces first home buyers out of the market and back into the rental market. Increased rental demand forces up rental returns. I expect that rental returns will continue to firm up over the remainder of 2006, and probably into 2007.

CGT AND THE PARENTS’ HOUSE

Twelve years ago I bought a block of land in a leafy suburb 18 kilometres from Melbourne’s CBD and built a house as a gift for my parents. The house was paid off within a few years. I lived with them until I got married four years later. My parents have remained in the house ever since.

The house is registered in my name because my parents were unable to borrow back then. I have never regarded this house as an investment property. I don't charge my parents rent and have never claimed any tax benefits.

We are moving to an inner suburb later this year and would like my parents to come with us. Ideally, I would like to sell the house they are living in and buy a unit in their name near where we are moving to. What's the capital gains tax implication if I do sell the house?

Because you lived in the house for the first four years of ownership, the capital growth achieved over this time will be capital gains tax exempt. Therefore, the worst-case scenario is that you may have to pay CGT on the capital gain achieved from the time you moved out.

You will need to get a qualified valuer to give you a valuation for what the property would have been worth at the time you moved out. When property is sold, the capital growth for CGT purposes is calculated as the sale price less the valuation price. Given that you held the property for more than 12 months, you will be entitled to a 50% discount on this figure.

Your best-case scenario '” though it’s a pretty long shot '” is to obtain a ruling from the tax office exempting you from CGT liability. This would mean signing a statutory declaration detailing exactly what your intention was when you purchased the property, and what your intention is to do with the money when you sell the house.

I suggest you consult your account and or a property lawyer to discuss your options further. The money you pay for specialised advice may be well worth it in the long run.

SUITE DEAL

I would appreciate your opinion on an advertisement I’ve seen for buying suites in a hotel. The ad promises a 10-year lease with 7% net rental return. What do you think of this kind of investment '” what are the pros and cons?

I see three key problems with buying this type of property.

First, hotel suites have the same characteristics as other types of commercial property: the capital value is driven primarily by the rental return. If the return in dollar terms stays the same for the next 10 years, the capital value will not increase.

Second, rental guarantees are limited to the success of the company offering them. When you buy into this kind of arrangement, you are essentially an unsecured creditor. If the hotel does not achieve the occupancy rate it needs to cover your return, then you won’t get the promised rental return. In other words, the hotel is passing its occupancy rate risk on to you.

Third, many people who buy hotel suites borrow the full amount of the purchase price. This is not a good idea because all the income will go towards paying the interest. Add this to the fact that the property will achieve little capital growth, and you won’t be any better off than you were before you bought it.

I suggest there are better places to put your money.

RAIL CONCERN

We are thinking of moving to an inner suburb in Melbourne. We've found a house that fits all our criteria, except for the fact that it backs on to a railway line. We don't mind the noise ourselves, but we are a bit concerned with the asking price and capital gains potential.

Are there any statistics to suggest lower capital gains for property built close to train lines? Should these properties sell more cheaply than comparable properties further away? If so, by how much?

There are no statistics I am aware of that would prove categorically that properties near railway lines should sell for less and/or achieve less capital growth than comparable properties in quieter areas, but my experience is that this is nearly always the case.

If you buy near a railway line '” or for that matter a main road, industrial estate or other noisy area '” you are purchasing a compromised asset that will expose you to considerable risk.

Residential properties in noisy areas have less demand than those in quieter areas, so the vendor is probably finding it difficult to attract potential buyers. This means you may be able to negotiate a competitive purchase price.

However, if you buy it cheap, you’ll probably also sell it cheap. The less demand for a property, the poorer the capital growth rate. In some cases, demand may be so low that your asking price is forced down until you meet the market’s expectations.

I suggest you explore properties in areas with stronger demand. Even if you pay more initially, the capital growth should more than compensate for this.

MORE MONEY FOR MOTHER

My mother is 76 years old and owns a house worth about $500,000. Our father died some years ago, reducing the pension she received. She’s now finding it quite difficult to make ends meet.

Ideally she would like to get her hands on an extra $10,000 per year to give her a better quality of life '” maybe go on a holiday, as she is quite active still. People have suggested she get her hands on some money via the equity in her home. Is it possible for her to do this?

Your mother can access equity in her property through a reverse mortgage, products that are designed for people who own their home but have little income for living expenses.

The loan is secured against the borrower’s home and repayments are deferred until the borrower dies, the property is sold, or the borrower is no longer living in the house (whichever occurs first).

The amount that can be borrowed under a reverse mortgage depends on the age of the borrower. The older they are, the more they can borrow as a percentage of the property’s value. As a guide, someone your mother’s age may be able to borrow up to 20% of the property’s value, although this varies between lenders.

Interest rates for reverse mortgages are about 1% higher than the standard variable rate. The interest compounds over the life of the loan.

The decision to draw on equity in the family home shouldn’t be taken lightly at a stage in life when your mother doesn’t have sufficient income to pay off the loan. It’s important that she, and anyone who may be responsible for the debt if her circumstances change, understands the full ramifications before signing on the dotted line.

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

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