Is It True That Buying Property on Loan Is Always The Right Choice (Even in GFC)

enveloped on 24/10/2017 - 00:54
Last edited 24/10/2017 - 10:37 by 1 other user

On investing property, this year seem to be the worst, with Australia's house price (against rental or debt) ranking top 3 in the world. Many predicts a housing crash.

But I met another data programmer friend who made the argument that there is no reason not to invest in property on loan as long as the loan is not secondary. He calculated that if you don't mind where the house is, then you can easily find a house which, with interest-only loan covering 80% of the investment, generates positive cashflow since day one, even today in Australia.

Assuming cashflow to be zero (factoring in all expenses). Suppose interest-free for 9 years. It effectively means that one is paying 20% of the property with deposit, and betting the rest 80% will cost more at the end of 9-year term.

Given inflation, 80% of a property being worth more in 9 years is a sure bet. Even if you are in the most extremely wrong time and wrong place, that is, Q4 2006 in the U.S., you would still end up with 9.92% gain on house price ( U.S. house price by Q3 2015 against Q4 2006 )

Suppose the house costs $1m, bought with 80% loan. At the end of 9 years it would cost $1.092m, and you have $0.8m loan, making your equity 0.292m. The inflation adjusted value of your original 0.2m would be 0.232m, you end up 25% richer in real terms even if you were in the wrong time in the wrong place facing the housing crash of decades.

This is so counter-intuitive so I post it here for comments.

To simply the calculating factors like maintenance fee and rent vacancy rate, he used DHA's offering, like this example which guarantees continuous rental income for 9 years and a constant 13% management fee which covers all maintenance (replacing drier etc):
https://www.dha.gov.au/investing/buy-a-property/property-det…

And he calculated the monthly cashflow for 12 years (he actually assumed all of them to be zero in making the 25% richer point)

$ bc -l < monthly_cashflow.bc 
0   40.81547619047619047569
1   63.13178571428571428520
2   85.89442142857142857090
3   109.11230985714285714232
4   132.79455605428571428517
5   156.95044717537142857087
6   181.58945611887885714229
7   206.72124524125643428513
8   232.35567014608156297084
9   -640.93004131798369494855
10  -614.25998564700363106394
11  -587.05652886260396590700

The monthly cashflow is calculated from the following BC program, which has all the parameters he used, in case you want to find fault in estimation or calculation:

$ sed 's/^/    /' < monthly_cashflow.bc 
# function: mortgage payment (per term)
# r = interest rate for each term
# v = present value of the loan
# n = number of terms
# p(r,v,n) = payment in each term

define p(r,v,n) {return r*v/(1-(1+r)^-n)}

# function: income (per term)
# r = rate (water plus council rates)
# p = rental revenue in each term
# f = management fee, e.g. 0.165 means 16.5% of revenue
# i(p,r) = rental income in each term

define i(p,f,r) {return p*(1-f)-r}

# assumption: rent in real terms doesn't change.
# (i.e. not affected by housing crisis. refer by U.S. example:
# https://www.economist.com/blogs/dailychart/2011/11/global-ho…

# assumption: inflation rate is 2%
inf = 0.02
# assumption: investment loan rate
# https://www.naritas.com.au/widgets/rates-widget/?t=hl#invest.
lr = 0.0375
# assumption: loan consists of 80% investment
lp = 0.8
# assumption: interest-only period = 9 years
io = 9

# a case: an apartment
# https://www.dha.gov.au/investing/buy-a-property/property-det…

# present value of investment (a house) is 430,000 
pv = 430000
# weekly rent is $410 (= gross yield 4.18%)
wr = 370
# management fee is 13% of rent
fee = 0.13
# other annual costs (water rates, coouncil rates, strata levy)
acost = 606 + 1094 + 1695

for (i=0; i<12; i++) {
    income = i(wr/7*(365/12), fee, acost/12)
    # inflation adjustment
    income = income * (1+inf)^i
    if (i<io) {
        payment = pv*lp*lr/12
    } else {
        payment = p(lr/12, pv*lp, (30-io)*12)
    }
    print i, "\t"
    income - payment
}

Financial

Comments

airal3rt on 24/10/2017 - 00:58

If buying property was always the right choice, nobody would invest in the stock market etc. Any calculations made upon assumptions are worthless when the assumption is proven incorrect at a later date.
- enveloped on 24/10/2017 - 00:59
  
  This argument is very specific on using mortgage, so I updated title to reflect that. Banks loan money for property with a different standard than, say, loan for buying stocks.
  
  The best investment I had was in Bitcoin, beat all stock markets. But bank won't loan me money to buy Bitcoin. They would, however, loan for investment property.
  - try2bhelpful on 24/10/2017 - 07:59
    
    +1
    
    If bitcoins go pear shaped, which wouldn’t surprise me, there will be no assets to recover; that is why the bank won’t loan you money.
  - Peck on 25/10/2017 - 08:56
    
    Bitcoin is not an investment, it is a mode of gambling.
    Negative gearing without capital grown is not good. Buying into a market that has topped out is the worst time to buy!
    Have a look at Japan realestate prices. No wages growth in Aust. DeJaVue?
garetz on 24/10/2017 - 01:55

+2

Its always the right choice in a rising market, which means there hasnt been a property crash in sydney since the 80s. Most people dont understand that property prices arent driven by prosperity, but by cheap credit availability.

If interest rates would goto 10%, about 50% of mortgagees would default if not more. Property prices would drop like a stone, not cause of economic factors, but because people are overextended and do not allow a cushion for rate rises. We are definately at the top of the market, a crash is imminent. However even the GFC which should of happened 2-3 years before it did happen, was postponed due to many factors.

The gfc was a minor property correction, we only saw a fall of 5-10% of property prices at the time, which took 3 months to recover from. Most people today don't know what a property crash even looks like, since its been approx 30 years since the last one.

If a property crash comes here, it will cause a new great depression, it might even bankrupt the country. People dont really understand that Australias socalled "wealth" is based on property values, if they drop, then jobs will plummet, interest rates will skyrocket, our australian dollar will crash, our import prices will skyrocket, our exports will be so cheap that most our agriculture will be sold off to overseas interests. It's just a matter of time.
- enveloped on 24/10/2017 - 07:30
  
  Thank you for making the point of credit rate change, which wasn't factored in. The statement that property was worth buying even right before GFC was based on the U.S. property price fall to 66.1% in real terms (Q3 2006-Q1-2012), not the 5-10% price fall of Australia. The point made was even if property fall to its 66.1% you are going to be okay, but the calculation didn't factor in variable rate as you can see in the program.
mskeggs on 24/10/2017 - 06:42

+2

Rents are falling in Brisbane and Perth, for example.
How does a 4 month period unable to find tenants before you have to drop the rent $30 a week feed into your model?

Given inflation, 80% of a property being worth more in 9 years is a sure bet.

How do you figure this? Take a look at Ireland or Spain for recent examples, or Japan going back to the 1980s, where you can have paid an interest only loan for over 30 years and still be underwater.

By all means invest if you think buying expensive assets is the best course, but don't leave your assumptions unexamined.
- mskeggs on 24/10/2017 - 06:46
  
  And with DHA housing as an example. Take a look at Townsville property prices, one of the biggest DHA areas, and see how they have performed during the biggest real estate boom ever.
  - enveloped on 24/10/2017 - 07:32
    
    I'm confused why should I look at the example property's performance during boom - aren't we talking about impeding crash? Or there is a point to be made by comparing those with Spain/Japan before the crash?
    - mskeggs on 24/10/2017 - 07:52
      
      +2
      
      Townsville property has gone nowhere in the last 5 years or so.
      Spain and Ireland and Japan are all substantially below their peaks.
      
      You cannot expect inflation to bail you out (and remember higher inflation will lead to higher interest rates). At the end of the DHA contract, what happens if the rent you can achieve is 50% lower than they were paying, and the house has declined 10% in value? You still have 15 years or mortgage to pay, making up the monthly repayment and nobody wants to buy it for what you want to sell it for.
TheBilly on 24/10/2017 - 07:19

+1

Naturally the financial system is set to fail. You can't make something from nothing. Paper money is in a constant decline in value for example; I borrow $100 and have to pay it back with $10 interest - effectively I have to make the $100 and also another $10 which never existed in circulation. That $10 was created on my taking the $100 loan. Already the US economy is so much debt their entire gdp income can only cover the interest. So where people have it all wrong is they think there will be a property collapse…. There will be a financial system collapse, property is a by product, like jobs, war, poverty etc.
try2bhelpful on 24/10/2017 - 08:11

+2

Buying property in sought after places is generally worthwhile but there are a lot of reasons why it can be problematic. It is a big asset that needs to be sold in one chunk if you need the money, if the area you are buying into has a downturn, e.g. WA mining, your investment will be negative, if you incur major structural works this can be an issue. Some of the apartments being built at the moment have issues with mould, balconies leaking, dodgy cladding etc. you might also need to consider the management fees for a block of flats.

My view is buy a house as close to the cbd of a major city as you can. Get is inspected for major faults and ensure you have funds for the upkeep and some buffer in case of a downturn in the market.
[Deactivated] on 24/10/2017 - 10:27

+4

Australia’s housing market has reached a unique point in its history: household debt at a record high, interest rates at an all-time low.

http://www.abc.net.au/news/2017-08-21/how-interest-rate-rise…
Scroll to the bottom, under "How interest rate rises will affect your area" use the map and select a region of interest. Use the slider to see how mortgage stress would change if interest rates rise. Observe "% in stress" colours.
- one man clan on 24/10/2017 - 10:48
  
  That's a great article and interactive tool.
- peterpeterpumpkin on 24/10/2017 - 11:32
  
  +1
  
  One thing I've never understood is how people don't plan for the worst when they sign themselves up. I don't know if it's because I'm pessimistic or just surrounded by people with bad luck. Divorces, disabilities and disemployment - I've seen it all.
  
  I can't be the only person in Sydney that knows more than one person being forced to take $15,000+ paycuts in new jobs?
  - [Deactivated] on 24/10/2017 - 12:01
    
    …am I the only person in Sydney who had to borrow to buy a property when the interest rates were well into two digits?
    - enveloped on 24/10/2017 - 22:27
      
      Which year was that!
    - [Deactivated] on 24/10/2017 - 23:41
      
      +1
      
      @enveloped: 1990, bank home loan interest rate 17%.
  - lupiter on 24/10/2017 - 15:37
    
    I'm not in Sydney, but when I took out my loan the calculation wasn't "how much can I borrow?" but "how high can interest rates go while I can still pay this loan?" and "how much of a pay cut can I take and still pay this loan?". My bank's estimates seemed to be based on me living on bulk brown rice, spending my evenings sitting in my empty apartment staring at the wall, and walking everywhere.
- enveloped on 24/10/2017 - 23:51
  
  +1
  
  Had to admit that this is a very good interactive tool! I took it to an expert in the Sydney Property Buyers Expo who was paid to convince people that such bad scenario won't happen. I just want to hear what he may say.
  
  He said that interest rate is not like weather which may or may not be good. It is a man-made decision by the RBA who has a responsibility for not shooting their own foot. If 0.5% raise means 3/4 instead of 1/4 mortgaged home owners would be stressed, then it means interest rate won't raise by 0.5%. "The simple reason is, that if people have to use all their income to pay mortgage, they will cut consumption, eat bulk brown rice, spending the evening watching empty walls and walk everywhere, or default. All these are terrible for the economy, hence RBA can't let it happen."
  
  When I presented the case that rate had been two digit a few decades ago, he answered that it is not very insightful to predict future based on past experience. "Use some deduction, not only heuristic, since we live in a very different time. If you use your past experience how do you explain things like QE."
  
  I don't entirely subscribe his view - just learning different opinions and thought I may share it.
  - [Deactivated] on 25/10/2017 - 08:15
    
    "Experts" on a property buyers expo are not likely to make any prediction, or to give any advice which could discourage the buyers. As helpful as Captain Hindsight from Southpark.

Is It True That Buying Property on Loan Is Always The Right Choice (Even in GFC)

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