22 May Why investing in property does not make sense
Michael Pascoe, finance and economics commentator tells us why, in his opinion, investing in property doesn’t add up. He doesn’t say don’t do it but he points out why many investors go wrong.
Kevin: Joining me now is Michael Pascoe, finance and economics commentator, over 40 years’ experience in all forms of media.
It’s a pleasure to have you on the show, Michael, and thank you for your time.
Michael: My pleasure.
Kevin: You’ve written an article that was called “Why Investing in Property Doesn’t Add Up.” Could you tell us a bit more about that piece and what it means for Australians who are looking to invest in property?
Michael: There are a couple of things to it. First of all, it’s obviously a very general piece, because there isn’t one Australian property market; there are about 10,000 of them at least. But on the averages now, there has been such a surge in prices that you’re obviously not going to see that same soaring capital appreciation, obviously, until we digest a pretty big lift over the last few years.
The other side of it is supply has responded to demand, there has been a lot more building. That’s showing up and investors have certainly been active, meaning there’s more rental property around, meaning some rents are beginning to fall, other rents aren’t rising, and if the gross rental return isn’t flash, then the net rental return is even worse.
Kevin: When you build that on top of the credit squeeze that we had to have, with the banks toughening up on lending and so on, we’re probably going to see a lot of those units that are being built and apartments being built being left vacant or not being able to be sold, too. Will that add to that problem, or is that part of it?
Michael: I’m not so sure about that end of it. I think before you get to that situation… I presume you’re talking about properties that have been sold off the plan and then people can’t get finance.
Kevin: Yes, I am.
Michael: That’s a problem that the market will digest, but I think it’s a fairly short-term problem. The longer term is if you look in very rough figures, if you assume that prices on average are only going to rise by about the inflation rate for the next few years – and some people would call that an optimistic view; I think it’s not unreasonable. So let’s say prices go up by 2% a year. When you buy an investment property, depending upon what state you buy it in and how much it is, you’re paying as much as 5% stamp duty, so you’re not going to break even on your stamp duty for two and a half years. On top of that, you have land tax. Again, depends on where you are and how big your holdings are, but that has another bite of it.
My suspicion is that investors very rarely are honest and accurate in their assessment of costs of owning property. They might look at the gross yield and think, “Well, yes, that’s that. Well, we’ll be able to get around it, and we’ll still be making 2.5% or 3%.” I think a lot of investors in property, by the time they factor in all their costs, might be lucky to make 2%.
Now, you throw those numbers into the mix and it means an investor buying today, if they’re fortunate and buying the average property, they’re really not going to be ahead for three years. And that’s if they buy a property that’s still appreciating, and there are pockets clearly around the country where they’re not appreciating.
So it really is a challenge. The easy money seems to have been made in residential real estate. It comes along once every decade or so. Prices go through the roof. Like every boom, everyone piles in, and the people who pile in last to any boom tend not to do so well.
Kevin: You mentioned in the piece – that I thought was very good, too – that there are exceptions to this, and you just acknowledged that yourself, that there will be different parts of Australia that will still improve. What about properties where you can actually add a twist, add an extra bedroom to give you a better rental return, Michael?
Michael: That’s clearly where the professionals come into it, as opposed to the mug amateurs who just get burnt. That ability to pick a property that does have potential other people don’t see, the occasional bargain buy, the occasional stress sale that can do well, that makes the exception.
I’m talking very broad averages. By nature of those broad averages, there are some that are doing well. If you look nationally, the consensus view from people who watch property seems to be that Brisbane is going to fare better for a while yet, that the party is pretty much over or close to being over in Perth and Melbourne, and of course, the party is going backwards in Perth.
One interesting thing that I’ve come across in the last week or so from a finance broker and also from the comments made by the Reserve Bank’s Financial Stability Review is that it seems to be upside in Adelaide. Now, poor old Adelaide doesn’t get much of a look in and tends not to fly as high as any other state but also tends not to fall as low. I’m told that a couple of major banks are still happy to lend to developers for units in the Adelaide CBD when they’re not happy to lend for units in the CBD of the East Coast cities.
Kevin: That’s interesting. Just on another point, should property investors be focused more on long term, and if so, how long term?
Michael: Property investors have to be focused on the long term, because except when there’s a crazy boom on when you can buy and flip something fairly quickly – except for that once in a decade period – I would think looking at property in anything less than ten years, you’re fooling yourself. Part of the return that comes there is really for savings anyway if you do have to service the debt.
APRA and the banks have probably done investors a favor on a couple of fronts. I think they’ve forced a pull on the market, they’ve made people look a bit harder on what’s happening, and given what is happening with the returns, that’s a good thing. They’re also really encouraging banks who in turn encourage their clients not to do interest-only but to actually start knocking off some of the loan, and that should be a very helpful factor over the next several years.
Kevin: Jonathan Tepper, a researcher and economist from the UK, has loudly predicted that the Australian market is going to crash spectacularly within the next 12 months. He’s predicting 20 to 50%. What are your thoughts on that?
Michael: Oh, spare me. He’s another one, the latest in a long line of doomsday callers. I go back a fair way. I remember Steve Keen, when he came out with his famous prediction, and you have that klutz, the American who turns up here every couple of years with a new book he’s trying to sell.
Kevin: When he’s a got a book; yes, that’s right.
Michael: They make the same predictions. Nothing is impossible in the financial world, as we all know, but to have a serious housing crash in Australia, you would need to have a serious rise in unemployment. If you look at how Australians behaved during the 1990–91 recession when we had double-digit unemployment, the last thing they let go of is their real estate. We eat dog food before we sell the family home. So to get the sort of mass sales you would require to seriously crash prices, you’d have to paint me a scenario where we have a major rise in unemployment, and there is nothing on the horizon that you can say is likely to lead to that.
One of the things you never have to worry about is missing bad news. There will always be someone who wants to tell you bad news; it takes a bit of effort to go and find a more balanced picture. And the more balanced picture is that the Australian economy is close to pulling off an incredible transition from its resources boom into something more sustainable. We haven’t done it yet, but it’s looking like we could do it, and we have a situation where we have jobs continuing to rise, we still have good population growth, and as long as you have more employment and more people, it’s hard to see how you could have a really major property crash.
Also, unlike the lending institutions in Europe and the US, our banks haven’t lost the plot. We are fortunate to have APRA pull them up, as APRA had to pull them up last year and this year. So I just can’t see why that’s the probable outcome, because you get the odd clown who looks at charts from the other side of the world and does a taxi driver survey in western Sydney and extrapolates that to the nation. It doesn’t make sense.
Kevin: And more importantly, has a book to sell.
Michael: That tends to be the case.
Kevin: Michael, it’s fantastic talking to you. Thank you so much for giving us your time today.
Michael: A pleasure.