Profits. It’s the word made new again for this decade. If the late Nineties held ‘com au’ as the chic buzzword, the share market punishment of ‘no profits com au’s’ has seen a flight back to old economy shares. Or even property investments! For most of us though, whether you invest in internet or mining stocks is pretty much a non-question. The average Australian punter is flat out meeting their mortgage payments, or worse, their landlord’s mortgage payments. There was a time once however, as recently as the 1980s, when just paying off the family homemade some very good profits. Mike Doonesbury, the author of the comic strip by the same name, quipped then that he felt like staying home while the house worked for him. Could these times be returning? Or more pointedly, can smart profits be made by the ‘wannabe’ homeowner chasing the right house in the next hot suburb. Can owning your own home be a top financial investment?
The Professional Investment View
The average professional investor tends to argue that owning residential property loses your potential profits. Their argument is based on averages (and a little bit of bias). Historically the share market has performed much better than property investment, at least over the past decade (by some reckoning as high as 20% yield, but commonly 12%). However, in the 70s residential property investment was profitable because the baby boomers wanted their own home as they settled down to make their own families. The 80s market also was partly fuelled by these same boomers upgrading their houses for their expanding families. Nowadays, however, speculative profits on the baby boomer phenomenon are more likely to be taken in investing in retirement funds and maybe later funeral business shares! Property investment currently has more like a 6-7% yield, (but you follow some smart ‘profits path’ tips you can beat averages).
So this ‘professional” argument believes that the idea of owning your own home is the best investment that you could make, is actually based on a historical anomaly that is unlikely to return again in the future. Their advice is ‘rent your own home and invest the money saved in the stock market’.
That is fine if you wear a suit on the weekends and are financially disciplined. But remember Australians have one of the highest rates of credit card debt in the world. Home mortgages may be seen as a burden, but at least they force us to be putting money aside each fortnight for our future. Also, and here is a cultural bias, Australian’s like to own their own home. It is the “Great Australian Dream, isn’t it?” We like to slouch around our fully paid off pad, our own little kingdom. And we don’t like rental inspections or the perceived master/servant relationship of being a renter. Tastes are in fact changing with the generations, with young people more and more like the flexibility of renting. But still, the majority of Australians aspire to be an “owner”.
Then there is “customisation”. Your home is your “own space,” something that is very personal, and drastic renovations to this space are not usually a tenant’s option. The smart owner renovator should also be able to make these customisations at least return their money on resale, another way of “saving more for retirement” perhaps. Putting in a new kitchen and adding a bathroom tend to pay their way; average returns of 90% of the renovation costs tend to be recouped on the sale price. That’s good news if you would really like to be living with a modern kitchen and have an en-suite to your bedroom. You get to enjoy these benefits for the years of your property ownership yet haven’t wasted your money in the resale value. If you plan wisely, you can also be taking profits on such renovations. For instance, if you choose only minor kitchen upgrades, such cosmetic repairs typically repay over 110% in the resale value.
On the financial side, it should be remembered that yield averages are there to be beaten. The residential property investment return figures are to some extent skewed by too many amateur investors. The majority just buy a place (their own home) because “it felt right.” The punters on the stock market tend to be a lot more systematic, buying to set criteria (such as PE ratios and the like). So if you too set yourself step by step criteria, you should beat the odds, and clean up when you finally sell your own home!
The Path to taking Profits from your Home
Have you ever been envious of someone you know, who lucked the property investment jackpot? Who just because they couldn’t afford that nice house in the suburbs back when they were young, now have a tidy retirement package brought to them by the sale of what-was-once considered an inner-city ‘slum terrace’. Can you, later in life, repeat their success? Well yes you can, but the rule is don’t rush (and be systematic). There are pitfalls with property investment, not as many perhaps as with the stock market where you can lose all, but it is easy to fail to realise true profits.
- Caution. Pause to review your lifestyle and investment goals. It is a major life decision to use your home as an investment as you are going to have to live in your home for at least ten years. (Yes, this long period is recommended to see those big profits because of the large costs of real estate transactions.) You shouldn’t rush because you really need to get to know your own strengths and limitations. If, when being honest with yourself, you really would like a bit of a hobby farm away from the rat race, then ‘investing’ in your own home is not for you. If you are not within 10kms of the GPO of a capital city, then you are highly unlikely to get a good return on your residential investment. You won’t have that all-important ‘position, position, position’. So being financially smart would be to rent that small acreage and save what you would have spent extra, (say on an inner-city residential investment mortgage), in something like an indexed mutual fund. You will need financial discipline to keep saving every fortnight though!
- Research (and use your calculator). You can never do too much reading. Subscribe to something like ‘Australian Property Investor’ and even a more general investment magazine such as ‘Business Review Weekly’ (to keep your investment mind open to shares or alternatives). Buy a bunch of property investment books; most of them tend to be a lot less junky than the standard motivational/self-help-get-rich-quick fare. One nice thing about property investment is that it is a sober area that tends to attract the long-term conservative investor. What this suggests is that you probably won’t get the chance of getting rich quick as you might invest in the next ‘com au’ that goes public. But if you do your research, what you buy is very unlikely to be a ‘rip off’.
- POSITION. Hey, we have to return to this one as it is so important! Your investment research will bear this out, but where you buy is the key to almost everything. Spot the modern equivalent of what was once a sleepy little convict colonial area called Pitt Street or Toorak.
- History. What type of property will appreciate most over the long term, apartments or freestanding houses? How will the First Home Owners scheme affect sales of the type of homes that are typically attractive to young buyers? To provide the best answers you should make extrapolations from the history of real estate profits. Getting the correct answer to these sorts of questions could win you the ‘property investors bingo’. Baby boomers were only part of the 1980s property boom: the introduction of Capital Gains Tax, changes to negative gearing laws twice within the decade, and of course, rising inflation and interest rates, sent sales prices through the roof. (But only in select areas; that ‘position’ again!) apartments and profits
- Timing. ‘When you buy’ runs a close second to ‘position’. It has been mentioned that buying your own home as an investment is less timing critical than professional property investment, but you still don’t want to buy in a boom and sell in a slump. The easy way to insure against this is to avoid over-hyped booming suburbs and to buy an area with strong position fundamentals. Perhaps the more relevant timing criteria for the owner-occupier is:
Do older homes make better resale profits than the ‘freshly’ built?
Homes become dated. Yet that’s not a bad thing for taking profits. Around the twenty to thirty-year-old mark (or as young as fifteen years old on some modern cheap constructions) the fit-out of a home comes up for replacement. The plumbing, the hot water system the air-conditioning/heating and even the roof may well be at the end of their useful life. Conversely, just after a major overhaul when such mechanical systems have been replaced, is a great time to buy. The reason being that such structural repairs rarely add significantly to the home’s resale value (a sad indictment of human focus on appearance over substance). But replacing such utilities sure can be expensive to finance yourself, so be careful not to buy just before their expiry date!
Also to consider, from the investment point of view a second-hand home can be a much safer bet because you know what you are getting in terms of the area. New estate areas and their just-new-homes don’t have an established track record of appreciation with which to chart your future profits. Importantly, because these older homes were built on that thing they are not making any more of, that is well-positioned land, they are often the better investment pick. These areas have also had time to develop architectural charm in area diversity, a little bit of which is vital for resale profits. (Too much diversity, however, where you have 50’s houses rubbing against Victorian terraces in the same street, can dampen property values). Established areas can be ranked more reliably in terms of their conveniences of shops and transport, amenities, which will have to be present if you are to make good profits on the resale.
Lastly, there is no GST may make these second-hand homes a better investment bet than building a new home.
The trick is to check that the second-hand home you buy has no major defects or repairs pending. Yet also you need to be critical of the older home’s structural limitations, such as smaller kitchen size and storage spaces, checking they are at least able to be upgraded cheaply to the current generation’s needs. Furthermore, an older home will rarely fit the current market taste. From an investment point of view, this can be the one clear advantage of a new building. If the modern taste is for minimalist open-plan housing with a stainless steel kitchen, then as a property speculator you can take profits by building to suit this fashion trend. But as the owner-occupier you are not acting as a pure speculator, as you are buying your own home to live in for as long as you please, and when you sell to hopefully take profits. By then you can be sure that whatever ‘-ism’ that was in then, is now out! Ask yourself; do you really think the next decade’s homebuyer won’t be cringing at impractically white (minimalist), empty feeling (open plan) and cold (stainless) homes much as we laugh at orange laminex nowadays.
- overcapitalising. This is the biggest sin of people who think that their own home is their best investment. The famous example is the family pool, which might cost ten thousand to install yet actually turns away buyers that don’t want the endless maintenance, or who prefer gardening to swim. In short, avoid spending money on your home unless you really need to or if it is a prestigious area which will pay a premium for enhanced features.
- Maintenance. Spending you shouldn’t avoid, lest you wish to see your profits decay.
- Me, my family and my dog. The final point necessary to repeat is that your own home is primarily for you. Residential real estate profits are typically not driven by the buying habits of the average Australian family. Only those select buyers able to afford to pay a premium will buy ‘position and quality’. You need to think carefully about your own needs before choosing your dream home on investment grounds. Moving from the suburbs to an inner-city terrace could be a very profitable financial decision. But your dog won’t love you for it.