Is Property Still a Good Investment?
As we approach Tax time again – it’s only four weeks away now! – the questions around tax deductions for this year and beyond start coming in thick and fast.
And one of the most common questions is – can I get a tax deduction from buying a property?
Of course, the answer is yes – provided that it is an investment (not something you are living in yourself) and the costs of the property – interest and running costs – are higher than the rental received.
I have been keeping track of the median value of property in Melbourne over the years, and the following graph shows how it has moved over the years. This is based on the June median value across all dwellings (houses and apartments/units) from 1970 to 2020. It takes out the month by month variation and keeps to a consistent position – outside of the ‘spring and autumn rush’ for each year.
While there was a drop in the 2019 year, Covid in itself does not appear to have had as big an impact on prices as many thought. The December median price for houses was $750,000, and for units, it was $605,000. So, even in a Covid affected year, prices have continued to rise.
But, as I am often asked – is property still a good investment? I mean, how can prices keep increasing?
There are many elements to this issue, so let me try to go through some of them for you.
Over the last 40 years, we have seen substantial rises in property prices, and many will say that ‘it cannot go on like this’. As I see it, the key factors for the ongoing increases in prices are as follows:
1. Household incomes have increased.
Beyond the simple fact of steady increases in annual salary for most people (even if the increases have been very modest over the last few years), the increase in the female workforce participation over the last five decades has meant that most households have seen an overall increase in total income levels available.
Increased childcare and early childhood education, and better health arrangements, have also meant that it has been easier for most couples to have both members in the workforce simultaneously, leading to more disposable income, savings and debt reduction capacity.
This has also meant that there is ‘more money on hand’ to cover loan repayments, making higher loan balances more affordable.
Data from the Australian Institute of Family Studies in 2020 suggests that: “Changes to employment patterns, including a larger female workforce, have resulted in significant increases to household income, with the 2017/18 financial year average weekly household income at $2,242 before tax, up from $1,361 in 1995/96.”
That’s an increase of 65% in just over 20 years. As a result, it is likely that household incomes have increased by 85% or more since 1980.
2. Loan terms have changed
Over the last 20 years, the standard loan term has increased from 20 years to 25 and now 30. This may not seem like much of a benefit when you consider the extra interest payments, but it has a big impact on affordability and how much people can borrow.
Let’s say you are looking at purchasing a property and seeking a $500,000 loan. The bank offers you a loan over 20 years at 3% p.a.
The cost for a Principal and interest loan on this basis would be $2,772.99 per month.
Now, if we stretch that loan out to 30 years – what is the monthly payment?
It is $2,108.02 per month – a saving of over $600 per month.
But what if we go the other way and say – well, I can afford $2,773 per month. How much could I borrow with a 30-year loan?
The answer is $657,724 – $157,000 or 31% more!
So, for the ‘same’ monthly savings/investment, the scope to purchase a higher value property (or to bid to a higher amount at an auction) is suddenly realised.
Having worked with many finance brokers, spoken to many bank managers, and seen the assessment processes that the bank uses in calculating loan approvals, this element is very much in the picture. i.e. the banks don’t look only at the total amount that you are looking to borrow. They look instead at how much of your income it will take to repay the loan every month. If the monthly payment is below a certain % of your total income, and other factors agree, they will approve the loan – no matter how big it is.
The banks also know that, in many cases, a loan is renegotiated, or paid out with 5 – 7 years, so their risk factor is reduced significantly. Higher prices and ‘affordability’ reduce their risks even further as a result.
3. Interest rates have dropped
And with the second point, this is the big change in the market over the last 20 or so years.
The website infochoice says: “Interest rates on home loans hit 10.38 per cent p.a. in July 1974 and stayed at around that level until September 1980.”
Let’s do the maths on the same 20-year loan as per above, but with a 10.4% interest rate instead of 3%.
A 20-year loan costing $2,772.99 per month would only get you a total of $279,628. Compared to the $657,724 shown above for 30 years, or $500,000 for 25 years.
Falling interest rates have more than doubled the borrowing capacity over this time.
But you say, surely interest rates cannot stay this low?
In time, you may be correct. Assuming that the economy ever gets back to what it was like ‘in the good old days’ before Covid, interest rates will – almost certainly – increase. But if they have been pushed up, then it is because inflation has increased as well, meaning that what is borrowed in “today’s dollars” will cost less to repay in ‘tomorrows dollars’ – and inflation is likely to have pushed the price of property up further as well.
A good indicator in most cases is the fixed rates on offer for 3 to 5 year terms (Very few banks offer anything longer here in Australia). Currently, many of these fixed-rate terms are lower than the standard variable rate on offer. While this is partly due to ‘special covid arrangements’ the Reserve Bank put in place to assist the banks, it is a key measure to watch to see the direction of interest rates in the short to medium term. It is only my opinion, but I don’t believe we will see any significant change in interest rates for at least three years. Inflation would need to reach over 5% for two or more years before the Reserve Bank decided to pull the reigns in tighter.
4. Population growth and demographic changes.
There is where I see a generational shift in the demographic make-up of the Australian population.
This change arises from many factors, with immigration only being one aspect (and that is limited in the current ‘closed border’ situation).
While point 1 highlighted the impact of the ‘two income’ family arising out of the increasing female workforce participation, it also has had the impact of far more ‘solo’ income households, and the ‘professional couple’ groups – friends who are not in an intimate relationship, but who live – and invest – together, to step into the property market (or simply to save on living costs and increase scope for saving and investing). Sharing a flat in uni, becomes sharing a home, becomes sharing an investment property.
At the other end of the marital relationship, where marriages have broken apart, each member of the couple often needs to acquire their own residence. One household becomes two, each with “extra space for the kids” and a shared work or study space as well. I know I have assisted a few clients with such a transition, to understand the growing impact this has on property demand. And the need to ‘re-establish roots’ is hugely important in this area.
This has led to an increase in the number of one and two-bedroom dwellings being required in the inner suburban and city areas and an increase in the ‘townhouse’ type dwelling in the inner and middle rings of Melbourne. i.e. affordable, compact but with facilities, near to work and social requirements. The quarter-acre block is being replaced by a fully functional townhouse that has group amenities and social connection.
There is also a large amount of ‘generational transfer of wealth’ happening, and at a later age than for previous generations, where our parents and grandparents are passing on in their 80s and 90s – instead of their 50s and 60s, as was often the case in pre-war generations. This has meant that the inherited wealth is often larger – as it has had the benefit of time to grow – and it is going to children who are more ‘set’ in their financials plans, and are able to use more of the inheritance for investment, rather than for covering living costs.
So, where to from here?
So, based on the above, you can see that the increasing ability of people to afford home loans means that there is an increased ability to ‘invest’ in property – be it for their own living requirements or investment purposes.
The ongoing ability to claim rental property losses as deductions against other taxable income – and then have the profits made from the sale of the investments taxed at a discounted rate – makes the residential property an attractive form of investment.
What Covid has somewhat ‘driven home’ is that people do not have to ‘commute’ as much to work. More and more of their employment can be done ‘from home’, leading to a significant shift in demand for property from the ‘inner circle’ to both the middle suburbs or increasing the ‘tree change/sea change’ element for many people. After all, if you are stuck in front of a laptop most of the day, wouldn’t it be nicer to look out over an ocean view than the Jolimont railyards? Or to know that the surf is only ten minutes away when you finish work?
As a result, much of the demand – for both purchase and rental – are occurring in ‘planned developments’ where lifestyle and living facilities are being included from the start or are centred around areas that have well-established facilities, such as schools, hospitals, transport links, and local employment opportunities.
Various locations are ‘targeted’ for growth, resulting from the Victorian Government’s Melbourne 2030 plan, with its emphasis on Principal and Major Activity Centres, identifying the likely growth areas within the metropolitan region due to increased infrastructure, employment, and transport connections. Some areas will grow faster than others, and the opportunity to invest in this growth can be taken with proper research and due diligence.
There are some good opportunities in the market and scope to invest for medium-term growth and short-term tax benefits. With marginal tax rates of 34 to 49%, the total cashflow investment required to fund a property investment can be ‘tax effective’ and, over time, provide a solid base for your investment portfolio.
We have a team of associates that can help with many aspects of this investment, from investment property selection to bank finance and legal support. We can analyse the choices and show you how the tax savings can assist in funding the investment and how to optimise your choices.
For more information or to discuss your tax position or investment opportunities, please contact us on 0409788399 or info@fiscalartisans.com.au
