Is property still a good investment?
Can I get a tax deduction from buying a property?
One of the most common questions we get asked 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 property value 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 2021 median price for houses was $750,000, and for units, it was $605,000. So, even in a Covid-affected year, prices 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, early childhood education, and better health arrangements have also made it 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
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 greatly impacts 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 cashflow 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 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 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 the loan amount is.
The banks also know that, in many cases, a loan is renegotiated or paid out within 5 – 7 years, reducing their risk factor significantly. Higher prices and ‘affordability’ reduce their risks even further as a result.
3. Interest rates
Tying in 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 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? And through the rest of 2022, they will climb higher, aren’t they?
Yes, the Reserve Bank has flagged a series of rate rises, and in the 3 months from May to July 2022, there have been increases each month. This has taken the Cash rate target from 0.1% to 1.35%. This is still historically low and is not expected to continue to rise beyond the next 2 years.
It is predicted that the cash rate will rise to around 3 – 4% by the end of 2023, and then – assuming inflation drops back to around 2.5 – 3.5% also, that rates may start to ease again.
Fixed interest rates have risen and are now sitting around 5 – 6% for terms up to 5 years with the major lenders.
Variable rates are still around 2 – 3%, and assuming they rise in line with the Reserve Bank rate, they would probably rise to around 5 – 6% p.a. by early 2024.
What does this mean in real $ terms? On a $500,000 loan over 20 years, if the interest rate rises from 2.5% to 5% (i.e. double the interest rate), the monthly loan repayment would rise from $2,649.51 to $3,299.78. An increase of around $650 per month. But the after-tax costs (@ 34% for incomes to $120,000) would be an increase of around $350 per month. This is why interest rate increases may not be as big a ‘lag’ on property purchases as many predict.
So will we see double-digit interest rates again? Well, nothing is certain, but it is highly unlikely. We would probably need to see double-digit inflation for a year or more to see interest rates rise that high.
And the banks – in assessing a borrower’s capacity to pay a loan – will always add a premium to the interest rate being used. They currently work on the basis of around a 5 – 6% interest rate to calculate your capacity to pay. In calculating your ability to fund an investment property, it is suggested that you budget based on this level of interest payment.
So, in time, interest rates may rise further. 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 “tomorrow’s dollars” – and inflation is likely to have pushed the price of property up further as well.
4. Population growth and demographic changes.
There is a generational shift in the demographic makeup of the Australian population.
This change arises from many factors, with immigration only being one aspect. While that has been limited in the ‘closed border’ situation of the last 2 – 3 years, it is likely to change as we move into a ‘post-pandemic’ world.
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 save living costs). Sharing a flat in uni, becomes sharing a home, and then becomes sharing an investment property.
At the other end of the marital relationship, where marriages have broken apart, each relationship member 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.
This has led to an increase in the number of one and two-bedroom dwellings 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 work and social requirements. The quarter-acre block is being replaced by a fully functional townhouse with group amenities and social connections.
And more and more of the developments being built have shared recreational, social and work-related facilities, enabling people to live, work and play within their own ‘hub’ without having to set foot outside their building.
So, based on this, with the increasing ability of people to afford home loans, 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 and lockdown have ‘driven home’ is that people do not have to ‘commute’ as often to a worksite. 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 viewer a mountainside, or even a swimming pool and rooftop garden, 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 – is 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 (in population, demand and value), and the opportunity to invest in this growth can be taken with proper research and due diligence.
5. Intergenerational wealth management and transfer.
What is that, you say?
Putting it another way – “the bank of Mum and Dad”.
As the ‘baby-boomer’ generation moves into retirement – and beyond – there is a progressive transfer of wealth occurring from parents to children.
In some cases, this transfer of wealth happens not just when the parents pass away, but instead, it occurs as the parents use the equity in their homes or other property to borrow and provide funds to their children to help them ‘get a leg up’ in the property market.
In some cases, the parents hold the properties, with the transfer of title happening through the execution of their wills (thereby avoiding stamp duty and capital gains tax at the date of transfer). In other cases, the title is held jointly by parents and children, enabling a simple transfer at a later date – or a co-investment situation that allows the parents to also benefit in a future sale of the property (Having put up the deposit and guaranteed the borrowing, using the equity in their own homes as security, allowing their children to qualify for loans more easily as a result).
These arrangements have maintained a higher level of property demand and have allowed some younger people to get a start in the property market. I expect that this will progressively increase over the coming decade.
For others, the receipt of their parents’ estate occurs when they have already bought a home, and the additional funds enable them to pay down debt and . or build up their investment portfolio, knowing that they have the funds and equity in hand to build up an investment portfolio.
So, where to from here?
There are some good opportunities in the market and the 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.
As an example, a 2 bedroom apartment in Inner Melbourne, selling for $635,000, could cost you as little $25 per week, after tax benefits and refunds, to acquire. And over a 10 year period, the capital growth could exceed 50% of the initial purchase price, with no cash outlay up front (assuming sufficient equity available on your existing property)
The ongoing, regular capital growth possible from a solid medium to long-term investment plan can give you the opportunity to fund a comfortable retirement, and help you pay off your own home loan sooner. We can show you how this is possible.
We have a team of associates that can help with many aspects of this investment strategy, from 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.
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