Why you probably shouldn’t buy your first home just yet
By: Stephen Colman
Tags: Banking, Feature, Finance, Property

Rarely does a day go by when we are not bombarded by a media report of house prices doubling, or young people being locked out of the market permanently. This is creating a sense of urgency and fear that if we miss out now these opportunities will never again be repeated. Couple this with the absurd belief that renting is somehow evidence you have failed, people are doing just about anything to “get on the property ladder NOW”.

Long term housing price trends

Is appears no sum is too high to gain entry, with mortgage repayments now exceeding 7 times annual income. To compare, a decade ago this was closer to 4 times annual income. The resulting effect is mortgages that take decades longer to repay than our parents endured, and a high degree of susceptibility to the impact of rising interest rates. To achieve this we now need to forgo lifestyle choices like starting a family in lieu of getting “ahead on the home”. Doesn’t sound like much of a dream to me.

“But buying a property is the only way to get ahead”

It would be disingenuous to suggest that homeowners have done “all right” out of the property market during the last couple of years. In the past 4 years — against the backdrop of the GFC — shares (both domestic and international) have tanked, bond yields have fallen, and fixed interest and cash investments has barely beaten inflation. Australian residential property prices, however, have managed to improve by a whopping 12.5 per cent annualised.

To put this in context, if you picked up a nice two-bedder in Brunswick for around $400,000 in 2006, you’d now be sitting on a property valued closed to $600,000. Invested the same amount in the share market? Well you’d be just about back to where you started right four years ago.

No one will debate what fantastic gains these have been for property investors; but what about the benefits for owner-occupiers? For those of us who want to live in the homes we buy, it’s a bit of a zero-sum game. Great, my house is now worth 50% more than when I purchased, but so are all the other houses in my street. Suddenly raising property prices don’t mean we’re any richer, they just mean housing is less affordable for those who don’t currently own.

“So I’ve got to buy now, or I’ll never be able to?! “

Hold on there sparky. Property has experienced a dramatic rise in recent times, but can this be sustainable?

Let’s take that figure of 9.5 per cent and extrapolate it a little. Our modest 2-bedder off Sydney Rd would now costs $600,000 if we were to buy it again. If this trend continues, house prices will double roughly every 7 years. Suddenly today’s 25 year olds are hitting their 30’s, and find entry into the property markets starts a $1m+.

Even with above average income growth, the average home now takes 11 years of full time income to pay the mortgage. There is not a western economy on earth that can support this level of commitment.

“So what’s going to happen then?”

When times are good, it’s easy to maintain a positive bias that times will always be good. Negative data is swept under the carpet and we rationalise current behavior as the norm, even when we can see it is anything but normal. I feel we are in a period right now that people will look back on and say “how could be have been so naïve?”

Australia’s property market is built on extremely shaky foundations of high investment, low interest rates, and expectations of continued capital growth. It is only going to take one of these to crumble for the entire market to fall.

This is an unpopular suggestion, but not a fringe view. Government understands the dramatic circumstances of a correction, or even slowing growth. Recall the recently high level of stimulus in the form of the doubling of the First Home Owners grant following the GFC. If the housing system were to fail at that time the effects would have reverberated through every facet of the economy. The government acted, and they acted large.

Out banking sector too is acutely aware or the risk. Try to get a loan as a first homebuyer today. Lending practices are be reigned in tightly, with deposits increased and strengthen due diligence. The banks have factored in a correction and are safe guarding themselves from default.

So if growth isn’t sustainable, how bad is it going to get?

There are two schools of thought on that one. In the best case, we will see prices dip, and then stagnate. In this scenario we may see the economy slow following an economic event such as weakening in China, or/and an increase in unemployment. The reserve bank will drop interest rates, but this alone will not be able to stablise prices. Speculation will decrease and investors will start to look for alternative assets to stick their money. Rents will increase, as remaining investors chase income over capital growth, but by how much will be a function of market demand.

In the worst case, we will see the type of carnage experienced in the US and the UK over the last few years. Prices will drop by 20 per cent, which might sounds great, but you probably won’t have a job to be able to afford the repayments if you did want to buy a place. The knock on effect across the entire property landscape will be dramatic as investors desperately try to sell property additional to their personal housing needs at whatever price they can get.

How do you prepare yourself for this?

I truly feel this isn’t an “if” but a “when”. This is the time to be building a suitable capital base that can act as your war chest when the panic hits. You will not be able to secure a mortgage with a 10 per cent deposit when the decline happens. Already banks want to see 15–20 per cent of the purchase price upfront and strong future repayment capacity. As soon as they start to get a bit more jittery they will tighten conditions significantly. If you want to capitalise on falling values by buying your primary place of residence (and maybe an investment property if you feel conditions will improve) during the downturn, then you need to start thinking more about holding 30–40 per cent of the purchase value of the property you are hoping to buy. This will provide you security in both the knowledge that you are someone the banks will want to lend money to, but also that you have a buffer against rising interest rates when they start to bite on the upswing.

There may be a lot of attractive reasons to start thinking about buying property now, but don’t let yourself be guided by the past. Research, understand, prepare, and only then dip your toes into what will probably be the single biggest financial decision of your life.