It's time to revisit the old question; “To fix, or not to fix?”. Recent rate moves from the Reserve Bank,  show that the current low “emergency” rates are coming to an end and will start heading upwards again. It might be time to start considering your options, and whether or not you're ready for any rises that might come.  It depends on how fast they'll rise and how big a rise you think you can handle but if you don't have much room to move in your budget, you won't want a nasty shock later on.

We reckon the time to fix is not when you think the market has bottomed because that's not so easy to pick, the time to fix is when you feel comfortable with the rate being offered and safe in the knowledge that for the fixed period at least, you can afford your mortgage repayments.  Here is an example of what rising rates can mean, and how they compare to fixing at the rates offered now.

Say you're on a $380000 loan on a variable rate of 5.21 per cent over 30 years. You'll currently be paying $2089 a month in repayments. On a 6.99 per cent 3 year fixed rate you'll be paying $2528 – a whole $439 more a month. This seems no contest, who'd want to pay all that in an era of historically low rates.

But say rates increase by two percent, so that the variable rate is now 7.21 per cent. You're now being set back $2583 a month, $594 more a month than today's variable rate. If you reckon you might struggle and think a 2 per cent rise might seem a little extreme, remember that 12 months ago a good competitive discounted variable rate was 8.74 per cent!  If we returned to those levels, you'd be put back a whopping $2987 a month, almost a thousand more a month than today's rates!  

Keep in mind that fixed rates normally come with a lot of restrictions* and in the event, unlikely as it might currently seem today that fixed rates come down, you could be up for very high exit costs to get out early. 

No-one, not even Governor Stevens, knows how fast rates will go up or by how much, but if you think you'd have troubles paying the fixed rates being offered now, you should consider whether your budget could handle the hit from an even higher variable rate in the future. If not, perhaps the security of a fixed rate is worth considering.

* Most lenders restrict principal repayments and redraw on fixed rate loans.  The Rock Building Society offers fixed rates with 100% offset accounts and or fixed rate lines of credit.

 The property market can look a little daunting to many home buyers and investors today. They know they want to “get a foothold”, but the prices are so high. So they and their friends, who are in the same boat, grumble and moan until...eureka! Each one of them alone can't get a foothold, but if they join forces....

It is becoming more common for groups of friends and investors to jointly purchase properties, and lenders are putting out a large range of products to cater for them. These products may allow you to buy property when you couldn't before. But there are important issues to consider, such as the effect on your borrowing power and possible legal entanglements..

Let's imagine two friends, Andrea and Peter. Each of them is renting, but they wish they were buying instead. Both of them have savings, but not enough for a deposit, and their incomes aren't quite big enough to cover a mortgage near the places they want to live and work. Andrea and Peter decide to pool their resources with a co-ownership product. Together they have enough for a deposit on a two bedroom apartment, and their combined income is enough to cover the loan repayments. They now own their piece of property.

Andrea and Peter are close friends, but they're not that close. They want to keep their finances separate. So they made sure they found a product that allows them to pay their loan automatically out of different bank accounts. They're in each other's house, but they don't need to be in each other's accounts. They also have different opinions on financial matters. Peter is pessimistic about where interest rates are going and wants a fixed interest rate. Andrea isn't concerned however, fortunately their loan can also cater for their different choices in matters like this. Peter can fix his part of the loan, and Andrea can leave her rate variable.

Co-ownership products provide a way for people to buy property who were previously locked out of the market, and they increasingly allow the partners to keep much of their independence and make choice according to their individual preferences. There are some very important issues to keep in mind however, and some important downsides.

The first, minor, issue, is that whilst both of them are buying their first home, they have to share a single First Home Owner's Grant. There's only one grant to a property purchase, and they'll never get it again. Much more importantly, Andrea and Peter may be getting a piece of property pie, but each of them is liable for the whole debt on the property. This can be a blow to their borrowing power in the future. Lenders will see the whole debt liability, but only part of an asset and a terrible income debt ratio.  Even if the property becomes an investment the entire loan is considered a liability while only half of the rental income is accepted.  As a result lenders will be much more wary of lending them money than they usually would be.

Now say that Peter finds the love of life and wants to get a house all of his own.  He can only use the equity he has in the half share  if he stays with the same lender and even then only with Andrea's permission and probably with her as a guarantor.   If he wants to go to another lender  he would have to convince Andrea to agree to a refinance or simply forget the equity he has.  Even so he may struggle to secure a new loan because of the existing debt against his name, so he wants to sell out his part of the property. But who is he going to sell it to? Andrea may not be willing or able to buy him out. They could try to find a replacement for him, but there's not much of a market for halves of apartments, and Andrea may not be comfortable in a financial relationship with someone else.

What if Andrea falls behind on her payments? Is their agreement prepared for this? Can Peter carry the debt, after all the bank still expects to be paid.   If these agreements go wrong - and over the life of a mortgage many unexpected things can happen - it is a recipe for litigation nightmares.

The products becoming available have agreements designed to cover many of the issues that can arise, such as defaulting or a partner wanting to sell out, but they can't account for every problem. It also needs to be well sorted out in advance. This requires rigorous legal advice and consultation with your broker. It may seem a hassle, and perhaps a strain on a relationship, but lawsuits are even worse - and a lot more expensive!

Co-ownership products may be a good option for you if you want to buy a home or invest, but consider all these issues before you get in. They provide a lot of opportunities that wouldn't otherwise be there, but a lot of potential problems as well.

Australian house prices don't look to be going down soon, but different areas have different experiences in the years to come. If you're looking to buy a home, you're going to want to buy where growth will be stronger, and try to steer away from the places where it will be weaker.

There are a gazillion different reasons why prices in one suburb will perform differently to others, but today I want to talk about unemployment.

Australia may be fortunate compared to our peers during this crisis, but we're still resigned to the prospect of rising unemployment. It's also a sad truth that this unemployment will be felt in some places more than others. Some areas have more people in sectors that get knocked around in recessions, like manufacturing or retail or have residents with less skills to sell. They also can have more people in part time and casual work, and are easier for companies to let go. Some already have higher unemployment, meaning job seekers are less likely to find work through social networks when many of their peers have no work.

In places like this, house prices are likely to suffer relative to more fortunate suburbs with stable industries and access to employment. There may be forced sales as laid off workers cannot meet their repayments, which can drive prices down. Potential home buyers already in the area are less likely to want or be able to take out a mortgage without job security and potential buyers from outside the area will be worried by the lack of opportunities.

Of course, having volatile employment industries also means that these suburbs may have higher price rises in the good times, but many, if not most of us, prefer a little stability in our assets.

You may think it would be quite easy too see what suburbs will suffer and avoid buying property there. They'd be the same places with the same intractable problems going back decades. Places “everybody knows” are bad news. The story has more twists than that though.

Researchers at the Urban Research Program at Griffith University and the Centre of Full Employment and Equity at the University of Newcastle have created the Employment Vulnerability Index. This index looks at thousands of different suburbs across the capital cities and also regional centres. Using census data to determine the characteristics of the suburbs, it shows which unfortunate places are likely to bear the brunt of unemployment.

There are a few things to take home from this. We do see that suburbs like Cabramatta in Sydney, Dandenong South in Melbourne and Loganlea in Brisbane are “red alert” risk for job loss. These suburbs have been associated with disadvantage before and we can see why they are likely to suffer again. There are lower levels of post-secondary education, and thus skills to sell. They're also in the manufacturing regions of their cities as we can see by the higher than average proportion of people in those industries. The Bonds experience has already shown what can happen with these jobs. But areas that have experienced strong growth before the crisis are also at risk. This is even if they are educated (e.g Ettalong Beach in NSW) or haven't before experienced disadvantage (such as Epping in Mebourne and Morayfield in Brisbane). Besides manufacturing, industries like retail and construction are also at risk in a recession (which explains the Government stimulus towards these areas), and anyplace where a lot of these workers live is likely to see more unemployment and lower house prices.

It only takes a quick look at the maps to these how these at risk suburbs tend to cluster in bands in the outer suburbs.

Like I said earlier, there are a gazillion reasons why prices perform differently in different suburbs, and unemployment is just one. The location of inner city suburbs like Haymarket in Sydney or Melbourne probably means that the properties will remain attractive despite resident's potential to lose jobs. Nonetheless, employment risks are a very important factor to keep in mind when considering how your housing investment may perform in the future.

Well we all want to know; where are house prices heading? As some wag once said, predictions are difficult, particularly about the future. But I’m starting to think of coming out from underneath my rock. I’ve always been a conservative property investor and so sold all my investment properties while prices were still rising. I didn’t make squillions – because I didn’t sell right at the top - but I got Peach going on the proceeds of my profits, so I’m not complaining. All the houses I bought starting in the mid 1990s made healthy profits.

I’ve been waiting out both the top of the boom and now the anxiety of the bust. But I’m starting to think the worst is over and if you choose your property well and you’re investing for the long term, it’s time to venture back in the market. Don’t expect super returns, but I’m hoping to make good solid returns by investing for the long term.

We’ve seen blood running in the streets in some overseas markets – like the U.S. and Spain and Ireland. Back home in Oz, we hit the top of the market sooner, and overall prices haven’t moved much in several years

Steve Keen, an unorthodox economist whom I respect, has been preaching doom and gloom for a long time now, but he looks like he'll need to lace up his hiking boots having lost his bet with a mate of mine Macquarie Bank economist Rory Robertson. Well, where have prices gone already this year? First we need an accurate measure. Until recently house price series were based on median prices. This meant that if more luxury houses were sold one month this could drive up the median price, even if those houses were actually being sold for less than they’d been bought. Likewise median prices might fall where flocks of first home buyers were buying cheaper places in the suburbs even if, in their ardour they were driving their prices up. The RP Data–Rismark Index avoids this by being a 'hedonic' index, which takes into account the features of the homes being sold, such as size and location, so different times and even different cities can be compared far more accurately. The Index for the first four months of this year showed prices rose by 2.8%. This has effectively wiped out the losses of last year. But what is behind this growth? If it's the extension to the First Home Buyer's Grant, could we be just staving off the decline with a mini-bubble? There are some good reasons to think not.

The RBA has had a great deal of space to reduce interest rates, and it has used it. As Rory Robertson points out, the rate cuts are worth $27000 over three years on a $300000 loan. That's a lot more than the $7000 boost, and a lot more than U.S. homebuyers received from much smaller cuts to rates by the US Federal Reserve – cuts that were not passed on by lenders as effectively as they were in Australia in any event. This has also emboldened buyers who were holding off whilst rates were rising. Importantly, the RBA had the advantage of seeing what happened overseas before it happened here, and had time to act. Property prices could fall if there simply isn't a need for the housing that exists. As Nouriel Roubini pointed out in the US, “When supply increases prices fall” and the US and Spain now have far more homes than families. The First Home Buyers Boost has probably created a pricing bubble in that end of the market while the recession and fears of unemployment will keep the market subdued, in Australia we have been under supplied with housing for several years and while the success of the first home buyers boost has taken some heat out of the rental market the long term outlook indicates strong rental demand. And for those who want to buy, our banks are well capitalised and still keen to lend money to all but the most highly geared borrowers. People are still wary and given the global machinations there seems good reason to be spooked! But there are powerful forces here keeping prices up. We may not be headed for another boom, but we don't look headed for a big bust. And the market is starting to respond in the way one would expect. The more than halving of the RBA’s cash rate, together with a feeling that at least in the financial markets the worst may be over, is starting to send property prices in a familiar direction. It might be time to get back on board.

I hope to have some exciting news for Peach clients interested in locating worthwhile investment property in the next few months. Until then, or at least until my next newsletter, best wishes to you and yours.

Often first home-buyers (even some second home-buyers!) are overwhelmed and daunted at the complexities of applying for a home loan from a bank or other lender. So if you've not had much experience in home lending, this could be a good place to start. In this overview, I provide borrowers with an outline of the lending process pretty much from the ground up - the way it works and why. Of course, the idea is that it should all make the borrowing experience a little easier.

A word about lenders

Just as you would be if you were lending your money to a total stranger, lenders are very cautious. Remember, even if your house soars in value, there's no big upside for your lender in backing you (except in Shared Equity - see below). They will only ever get their money back plus a competitive interest rate. Lenders never want to lose their money - but the tighter their margins, the less they can afford a bad loan and even less the bad publicity of a foreclosure. So that's why they err on the side of reducing their risk that loans won't be repaid. The way they minimise the risk is to impose strict lending criteria. 

SATISFYING LENDERS' CRITERIA

There are three main criteria that lenders require first-time loan applicants to meet. These are effectively three "hurdles" all of which must be jumped before a loan application can proceed.

1. To be satisfied that you can meet regular mortgage repayments, lenders want to know that your income stream is adequate. (A very rough guideline is that your income is seen as adequate if your repayments can be met from 35% of your income, but lenders will look at things more closely than this). If your lender is satisfied that you can afford the calculated repayment level, then you've crossed the first "hurdle" towards a successful loan application.

2. The second hurdle is to prove that your income level is secure. This can be demonstrated by a borrower's continuity of employment history. If you've recently changed to a similar job after a long stint in a previous position, that's fine. But if you're on probation or have undergone a major career change (from brain surgery to carpentry), lenders may want to wait a few months. If you're self-employed or on a contract, lenders take confidence in your future by looking at your past 2 to 3 years. Most lenders apply the rule of thumb of averaging the income you declared to the tax office over the past two financial years.

3. If the bank is confident that you can service the loan, there's still one more hurdle. They consider the unlikely situation of you becoming unemployed, injured or on long-term benefits. The lender needs to be satisfied in this worst-case scenario that they can sell your property for a sufficient amount to recover their loan. They obviously don't want to wait for 12 months for the market to improve and as such, they are usually comfortable with lending up to 80% of the value of a normal residential property. This is known as a loan-to-value ratio (LVR). It is possible to increase the borrowed proportion up to 95% LVR for an owner-occupier if the lender takes out lenders' mortgage insurance, at a cost of between 1% and 3% of the loan amount and paid for by you - see below for more on LMI.

4. There's actually a fourth criterion. Mortgage insurers want to know if you're prudent with money or whether you tend to spend everything you get. For that reason, they prefer all borrowers who wish to borrow more than 80% of the value of their property to have saved at least 3% of the value of their property purchasee.

Genuine savings is where you can provide supporting documents that confirm that you have accumulated a minimum of 5% of the purchase price (3% for some
lenders) by way of progressive and regular savings over a period of not less
than 3 months. Any lump sum deposits are excluded unless they can be
clearly shown via documentary evidence to come from the sale of an appreciating
asset (e.g. shares or real estate). Gifts from any source are excluded from
genuine savings (although if they sit in your savings account for 3 months they will probably go un-noticed). Whilst the FHOG remains as an acceptable source of borrower’s
contribution, it does not qualify as genuine savings.


Other exclusions from genuine savings:

• Advances on wages/commission from an employer (this may include bonuses);
  


• Inheritance
  


• Financing of a deposit (borrowed funds eg: credit card)
  


• Builder discount/finance ( some builders offer cash rebates)
  


• Vendor discount/finance
  


• Proceeds from sale of motor vehicles
  


• Windfall gains (eg:lottery or gambling)
  


• One-off government payments (e.g. baby bonus)

If genuine savings cannot be demonstrated as per the above, the LVR must be
usually less than 85% .

  - Return to top

WHY PEOPLE ARE DISQUALIFIED FROM LOANS

There are a number of common reasons why lenders decline loan applications from potential borrowers. Being aware of these 'causes of disqualification' before the application process can be valuable for applicants - remember every loan application appears on your CRA.

1. Lenders have learned that they must be guided by a borrower's track record, not by promises of an employment promotion or better business earnings. Usually, this makes sense. However, it can also be unfair on applicants such as those who have been out of the workforce to raise children. Even when employers provide evidence that a job will be held open for the borrower, lenders will often turn them down. Lenders will also often decline those on probation in a job. In each of these above cases, some lenders are more lenient than others, so it is important to consult with someone who knows the market well.

2. People are often disqualified from a loan even if they can afford it, as they cannot demonstrate a track record of saving. That is because the money they've been using for their home has been given or lent to them. Lenders and mortgage insurers prefer to see a proven record of thrift to demonstrate the ability for repayment.

3. The other main reason for a loan application being declined is due to a borrower's credit record. From the lender's perspective that's understandable - if you've defaulted on a past loan, what's to say you won't default on a new one? However, there are traps for everyone here - we've had a loan held up for a client (who had been a public servant for 25 years and was only seeking to borrow 56% of the property value) because of a disputed bill with a telephone company. He ended up paying the bill just to get his credit record clean so that the loan could proceed. Another borrower was defaulted because he'd lived in a shared house and had gone overseas thinking a bill was being looked after. So be careful. Small blemishes even if they're not your fault can make lenders shy away - and they stay on your credit record for 5 years. - Return to top

OPTIONS IF YOUR LOAN APPLICATION IS DECLINED

If a lender declines your application for a home loan, it is worth seeing a broker about your prospects of success with other lenders, or to explore other means of proceeding towards obtaining a home loan.

Also, see if you can see why the lender has declined your application. Can you meet their concerns?

Consider if any parents or family can help with assistance to service a loan. But only ask if you're comfortable in doing so and are confident that you're not exposing them to any risk.

Another option is to explore "non-conforming" lenders like Pepper, Bluestone and Liberty. However, they have higher interest rates and costs.

If your loan application is rejected, it may be best just to wait for a few months until you can better satisfy lenders' criteria. Having a little longer to build up savings and employment stability may lead to success in the loan application with your preferred lender the next time around. - Return to top

WHAT LENDERS SEE AS A GOOD BORROWER

Lenders see you as a perfect borrower if the following criteria are met:

• You can show a record of steady employment;


• If self-employed, you can show a tax declaration of sound income over the past two financial years;


• You are a permanent resident or citizen of Australia


• You have no blemishes on your credit record


• If this is your first home loan, you can show a good track record of saving - at least 3% of the property's value.


• Existing loans all current with no late payments - Return to top

TIPS ON IMPROVING YOUR CHANCES FOR LOAN APPROVAL

Your chances of obtaining a loan are maximised if you can meet the lenders' criteria as closely as possible. As each loan application you make is likely to be logged on your credit record, try to make your first application as strong as possible.

• If you think there's doubt about whether you can get a loan, see a broker before you apply for a loan to gauge your chance of success before any inquiry appears on your CRA;


• Wait a few months if necessary to improve your match with lenders' criteria;


• Be absolutely honest in your loan application - any discrepancies will soon show up, so be totally upfront with your broker or lender from the start;


• If you're a first time borrower and want to borrow more than 90% of the value of the property, you may have to demonstrate your savings record. Remember, it seems a bit silly, but lenders want to see a growing positive balance in your savings account and won't usually count what is also evidence of saving - declining credit card debt balances. So, although it might be less efficient to do so, delay paying off debts that can wait in order to build up your positive savings record;


• Make sure your credit rating is good by ensuring all bills are paid on time.  If in doubt, chase up the credit reporting agency Baycorp Advantage and get a copy of your credit record;


• If you are facing any credit problems, contact providers to try to come to an arrangement with them that keeps your credit record clean. - Return to top

LENDERS MORTGAGE INSURANCE (LMI)

There are two big traps in lenders mortgage insurance or LMI as it's known in the industry.  

The first is to think that it gives you protection against defaulting on your loan - for instance as a result of redundancy.  It doesn't!  It is, as it calls itself, lenders mortgage insurance and exists to protect the lender against your default.  If you do default and your mortgage has lenders mortgage insurance, then not only will the bank chase you for repayments, but the insurer may do so as well on its own and the bank's behalf.  A corollary of this is that the choice of insurer for LMI is not yours but the lender's.  (Mortgage Protection Insurance is a policy that covers you for your mortgage repayments if you are sick, disabled or unemployed.  Let us know if you are interested in getting this kind of insurance as we may be able to help.)

The second trap is that, where lenders require mortgage insurance - generally if your loan to valuation ratio exceeds 80% - it is common practice for the lender to issue an 'approval in principle' before LMI has been obtained. Accordingly where approval in principle has been given but LMI is subsequently declined, the approval in principle cannot proceed to unconditional approval and is then revoked.  So if you require LMI don't take the lender's 'approval in principle' as anything more than one hurdle on your way to unconditional approval.  Even if your valuation comes in OK, you can still be declined if LMI is declined.  So be aware of this trap.  

Note: There are only two major LMI providers in Australia. LMI agreements with each of them vary only very slightly from one lender to another but the conditions each provider requires do vary somewhat. So if you are knocked back by the LMI with one lender you may have a chance with another lender that uses the other provider.  As brokers, we are aware of which insurers each lender on our panel uses and so may be able to assist you decide which LMI provider, and so which lenders would consider your application most favourably.

The fee for Lenders' Mortgage Insurance is paid by the borrower as a once only fee at loan settlement and varies depending on the value of the property being purchased and the size of the borrower's deposit. This is a graduated scale increasing on both property value and percentage borrowed so you might pay 0.7% for an 83% LVR on a $300,000 value ie:$2100 whereas you could pay 2% or more on a 95% LVR at $500,000 ie:$10,000. LMI is more difficult to obtain and more expensive for loans of $500,000.

The insurers place various conditions on applications and among these are length of employment, income tests and deposit conditions. For example if your deposit is from the sale of a house, you will be expected to show evidence of this. If it is from savings, you will again be expected to establish that you have saved that amount (or at least 3% or 5% of loan amount depending on insurer) over a minimum three months. They also restrict maximum lending (LVR) into various locations. For example, regional centres are typically 90 to 95%, while smaller centres may be 85%, and inner city may be 65%. It is important to keep the LMI policy in mind, as this almost always over-rides the individual lender's policy. - Return to top

TYPES OF INTEREST RATES

Loans come in a variety of guises. However the loan types shouldn't be confused with the Interest type.  Interest types are;

• principal and interest (P&I) - here your loan payment covers the interest charge plus some of the original loan amount.  Thus reducing the loan balance over the life of the loan;  


• interest only (IO)  - whereby you agree to pay only the interest charge for a specified period, typically 5 years.  Most loans (except most lines of credit) revert to P&I after some period,


• variable home loans - whereby the interest rate charged moves up and down in line with certain indicators, typically the Reserve Bank Cash Rate.  So if the Cash Rate increases .25% then you can expect your home loan rate to increase by approximately the same amount .25% (though from time to time lenders do take changes in rates to disguise their own increase in margins - or highlight their reduction in margins.).  Some rates are based on other indicators and you should understand the implications of this;


• fixed rate loans - which lock you into a given rate for a specified period, typically between 1 & 5 years - though if you want longer periods (up to ten years) we can arrange them for you.  So even if the variable rate increases by 5% you are protected and pay the rate you agreed at the outset until the end of the fixed rate period.  However you are locked in, even if the variable rate decreases by 5% and in these situations it can be very expensive to 'break' your fixed loan.

So it is possible to have a mixture of the above eg: Fixed for 3 years with  Interest Only or 25 years variable with Principal & Interest and almost any combination even part fixed and part variable (sometime referred to as a split). - Return to top

TYPES OF LOANS

Competition in the market place has not only seen lower margins for lenders, but a greater diversity of features and additional benefits being offered to attract your business.  Superficially this would appear to be beneficial for you the borrower.  However the features, discounted rates and variations in fee structures often simply make it much more difficult to do direct comparisons between products.

Claims such "pay your loan off quicker" are common place and often they are quite incorrect, especially if you are paying higher interest rates or ongoing fees to obtain the so-called benefit.  For example, on a $100,000 home loan a $300 annual fee (typical to most professional packages) is  the equivalent of .30% in additional interest rate.  So a 6.70% rate with a $300 annual fee is actually 7.0% on a $100,000 loan.

A line of credit (LOC) is essentially a perpetual interest only loan - although by its very nature there is nothing to restrict you reducing the principal at any time either by lump sum or just monthly salary deposits. Thus if you have a line of credit for $300,000 on which you owe $250,000, you only pay interest on the $250,000 you have drawn. When linked to a cheque and credit card facility and with salary crediting, your line of credit provides the same kind of flexibility as an offset account. 

In fact it is generally more flexible. Provided that the line of credit allows you to capitalise interest, you don't even have to make repayments. Instead, when interest is charged to your account it is added to the balance of your loan. Thus for instance using the example above, if you need to pay $1,500 for interest on the $250,000, instead of being required to pay that amount into the loan, at the time that you would otherwise be required to pay interest, your balance simply becomes $251,500 for you to pay back when you like. But of course if your credit limit is $300,000 and you've already borrowed to that limit, the lender is going to want to see some payments into your account to service the interest.

As you can see, lines of credit are one of the most convenient forms of credit. They are also as effective and simpler than offset accounts. Often lenders will tell you that an offset account will save you thousands off your loan – because you're not charged interest on money you don’t need to borrow. But precisely the same thing is possible – usually more simply – using a line of credit. 

Remember some people have trouble not spending money when its there.  If that sounds like you, its best that you avoid a line of credit and submit yourself to the discipline of having to make regular payments of a size you have previously planned to make.  Also keep in mind that if the borrowing on your line of credit is for investment purposes, interest on it will, in the normal course of events be tax deductible. In this case, you should be wary of attaching your credit card to the line of credit as some of the borrowing will then no longer be for investment purposes.  This will complicate the calculation of your tax deductions for interest as some of the loan will remain investment related, but some will be related to personal expenditure. Where there's a mix of investment and non-investment borrowing it's usually preferable to have separate accounts for each kind of borrowing. 

An 'offset' account is a sophisticated way of 'fine tuning' your lending requirements to your earnings and your daily spending. In addition to your home loan, you have a transaction account with the same financial institution. You deposit your income into the transaction account and use it for all your daily expenses, usually through a linked card or cheque account. Any money in this account is offset against the amount owing on your home loan and you only pay interest on the outstanding balance. So say, for example, that you have a home loan of $250,000 and you have a balance of $10,000 in your transaction account, you only pay interest on $240,000. Interest is calculated on a daily basis. 

Offset accounts come in many guises and you should be wary of 'partial offsets' as opposed to 100% offsets. Partial as it's name implies, means that you don't get the full interest benefit and in some circumstances the benefit is less than what you would gain from a standard interest bearing transaction account. Even a 100% offset account can be a trap if it comes at a higher interest rate than what is otherwise available to you. See our first newsletter. 

Particularly where the expenditure on your offset account is personal and it is offset against an investment loan, there are specific taxation implications upon which we recommend you seek professional advice.

All-in-one accounts are usually a single home loan account that allows direct salary deposits and some withdrawal functions - these are often limited to a few ATM or transfers per month and a linked credit card account. The potential savings are similar to the above however be aware that some accounts are so limited you may need a standard transaction account - and fees if applicable must be taken into account when comparing products.

There are some basic loans being offered that provide free unlimited redraw and unlimited principal reductions. So theoretically you could pay your salary into the loan account and withdraw as you require the funds or by using your credit card for monthly expenses then make an end of month payment into your credit card. So a loan like this can act very much like an all-in-one account, although you have to consider possible credit card and transaction account costs.

Finally, remember that many of these accounts require you to exercise discipline in their use, if your long term ambition is to repay your loan principal. - Return to top


I hope this has been of assistance.

Property investment is one way to reduce assessable income through the range of tax deductions available to landlords. This year the ATO has flagged landlords among those it will be paying closer attention to at tax time.

Each year the Australian Taxation Offices announces a number of areas that they will be paying particular attention to at tax time. Included in their list for this year are investors, including investors with rental properties. The ATO tells us the reasons for their focus include the large number of new investors (the number of Australian tax payers owning rental properties has grown by 100,000 in the past 2 years to 1.6million) and the wide range of common mistakes made on claims.

What is the ATO looking for?

The ATO uses sophisticated software that identifies property investment claims that potentially contain patterns which suggest mistakes or deliberate deceptions in the tax returns. Tax payers identified in this process are then targeted for some form of follow up or audit. The characteristics of tax payer claims the ATO identifies as containing mistakes include:

• unusually high claims for rental deductions
• low rental income in relation to rental deductions
• high claims for interest expenses, and
• high claims for borrowing expenses.

The ATO lists some of the most common mistakes property investors make as:

• Claiming deductions for rental properties not genuinely available for rent.
• Not apportioning expense claims where the property is only available for rent part of the year, such as a holiday home.
• 
  
• Overstating interest claims on loans taken out to purchase, renovate or maintain a rental property.
• Claiming the full cost of a visit to inspect a property when it is combined with a private purpose, like a holiday.

Some tips

If you are looking for some deductions before the end of the financial year, at this stage you may be limited to repairs and maintenance, prepaid interest or insurance or body corporate charges.

Ensure that you differentiate between repairs & maintenance and construction & improvement costs. Repairs and maintenance can be claimed as a deduction in the year incurred, construction and improvement costs are classified as capital expenditure and depreciation expenses may be claimed over time. For example, replacing an entire fence would probably be considered to be capital expenditure, where as repairing a damaged section would be classified as repairs and maintenance.

Ensure the property you are claiming deductions for is a rental property – not your weekender. If you do use the property for some of the year and rent in out for the rest of the year, revenue and expenses must be apportioned between the two uses appropriately.

Make sure that interest on your property loan has been claimed correctly; e.g. if you have a loan that is for both personal and investment use, interest must be apportioned (or talk to Peach about restructuring your loan to make things simpler!).

The ATO plans to write to new entrants to the property market with some information on the dos and don’ts of investment property deductions to let them know where to obtain more information. The ATO also publishes a booklet called Rental properties providing a guide to tax obligations for property investors. The publication can be accessed through the ATO website at: http://www.ato.gov.au.

After a few years of very little growth – indeed some declines in some areas – Australian property prices are on the move again – in fact the best property price research suggests that Australian house prices grew by 13% last year.

Meanwhile the share market has tanked.

My own assessment of the likely prognosis for the Australian economy is the same as the Reserve Bank’s and the Federal Treasury: there’s enough growth coming out of the newly emerging economies like China India and Brazil to mean that the economy will continue to do relatively well. And, though we will probably see some more increases in interest rates, the current American slowdown will relieve pressures on the RBA to lift rates further.

That means I think the Australian share market is already quite substantially oversold.

But the combination of these circumstances means that it is important to ensure that you are in a position to access any equity you have in your home or investment properties. Some people may need that equity to avoid a margin call on shares. If you do have a margin loan, it would be crazy to risk a margin call forcing you to sell into a bear market if you have equity you can draw on in your property investments.

And if this isn’t a concern for you, I can say that I personally am getting set to purchase some property (having been out of the market except for my own house for about five years). If you’ve got any additional equity, being able to write a cheque for a few thousand dollars to secure a property immediately it presents itself in the market is a smart thing to do.

So give us a ring and have a chat about your circumstances, and see what your options are. Visit our website or ring us on 1300 13 75 86.

Your vote is your vote. But in response to some curiosity from both journalists and peach clients, I’ve decided to try to work through some issues in my own mind about which party might manage the economy better. At the moment the recent rise in interest rates has been the lightning rod issue of the economic debate. But economic management goes deeper. And better economic management is likely to give us better, more prosperous lives, whether that’s as a result of lower interest rates, or better services or lower taxes.

So here goes.

Howard should never have promised to “keep interest rates at record lows”. He said he didn’t – it only happened in his party’s ads. That’s a pretty shoddy excuse in any case – as if he doesn’t have control of and responsibility for the truth of his party’s ads. But it’s now been revealed to be untrue in any event. He actually used words like that on a radio program a few days before the 2004 election.

Still that’s what politicians do – on both sides of the political fence. They make promises that take risks with what can actually be delivered – as Paul Keating also did promising his infamous L.A.W. tax cuts.

A more interesting question is ‘would things be worse or better if the ALP had been in power?’. Or running the question forward ‘would an ALP Government manage the economy better than the Coalition in the future?’

I can think of one reason why they’d be worse and three reasons why they’d be better.

Because interest rates are used as the accelerator and brakes of the macro-economy, an economy with more spare capacity, an economy with more productive power is one with lower costs and so one with lower inflation and less need to tighten rates. The economy has been growing strongly and steadily now for 16 years.

That’s taken up a lot of slack in the economy – taking us quite close to full employment, and certainly to the brink of serious skill shortages. That means that as Rory Robertson of Macquarie Bank has said, “Fiscal policy and monetary policy look set to continue working in opposite directions”. Or in the words of the Secretary to the Treasury Ken Henry, policies that won’t grow the productive base of the economy will simply lead to money being redistributed - tax cuts that don’t generate productivity will simply be taken away by the Reserve Bank as higher interest rates to constrain the inflation that they’d otherwise produce.

I think the financial journalist Alan Kohler summarises the situation quite well in a recent column.

The reason I think Kevin Rudd and the ALP will be good for investors is not part of the election campaign, and probably won’t be: they are likely to be better managers of prosperity than John Howard.

Howard has squandered the booming budget surpluses of recent years on re-election rather than the national infrastructure. There have been huge transfers to middle class welfare designed to attract votes and belated, miserly, spending on national infrastructure.

Addressing the emerging problems, in skills and in infrastructure has been a more substantial part of the ALP agenda and rather an afterthought for the coalition.

That’s the short reason why I can think of more reasons the ALP would run the economy better than the current government. But there is one counter argument.

One reason why inflation and therefore interest rates would be worse under the ALP

Workchoices has been one of Labor’s ‘boo’ words in the election. I'm afraid I'm unmoved by all this unfairness it’s supposed to have unleashed. We have one of the highest minimum wages in the western world. That’s been maintained by the legislation. Workchoices has made it easier for firms to drive a harder bargain with workers on the terms of their employment, but not driven minimum wages lower – a reasonable compromise it seems to me when we’re still trying to reduce unemployment. Once we’re at full employment workers can decide what terms they’ll accept and if a firm won’t give it to them they can work for a firm that will. We’re already at that situation in many parts of Australia except for pretty low skilled workers.

That having been said, and for all the drama about how ‘radical’ Workchoices is and how it’s going in the dustbin, as right leaning economist Mark Wooden writes, the ALP’s IR policy is now fairly similar to the Liberals. Their ties to the union movement will nevertheless ensure that their policy will allow bosses somewhat less freedom than Workchoices and there are some worrying and unelaborated references to ‘multi-employer’ agreements that could enable ‘pattern bargaining’ in some industries which would be a large backward step.

Several reasons why the economy and rates would be worse under the Coalition

Firstly as Alan Kohler says above, the ALP would have spent more of the past revenue windfall on infrastructure which would be keeping the costs of living and working down.

Secondly that also goes for even more important infrastructure – skills and education. The ALP would have invested more in education and training which would have made our workforce more job ready as new jobs were created by the mining boom and the associated economic good times.

I have two more speculative thoughts – speculative because they’re based on what I think the ALP would have done in power, (based on how they acted last time) rather than on any promises they made in Opposition.

The media game these days gives such advantages to the incumbent government that virtually all successful Oppositions have been small targets. Howard became PM by being a small target before the 1996 election – and a conviction politician afterwards (though mostly on cultural rather than economic matters). Being ahead in the polls, like Howard was in 1996, Rudd is following the same ‘small target’ formula.

Government revenues have exceeded expectations by tens of billions of dollars a year for several years now, largely as a result of the mining boom. That’s led economists to worry about simply passing those dividends back to people as tax cuts. With an already overstretched economy they feed directly into inflation. Also permanent tax cuts based on what could be temporary revenue can be imprudent.

My guess is that an ALP Government would have cut taxes too. But it would have paid more attention to its advisors’ concerns. So in addition to direct tax cuts, it might have cut taxes by making payments directly into people’s superannuation accounts – which constraining its inflationary effect by locking the money away from immediate consumption.

And it would have continued to build compulsory super which would continue to take the pressure of interest rates. One of the reasons the New Zealanders have interest rates a percent and a half higher than ours is their lack of compulsory superannuation.

So that’s my professional opinion of who will run the economy better in the future.

Postscript: The bulk of the words above were written in the forth week of the campaign. But in the fifth week (thank God there are only a few more days to go) a substantial additional difference opened up between the parties – reflecting the last of my comments about the ALP. I had previously expected them to squeak in with less spending than their opponents, but only by a tiny margin. The difference now looks like being around $10 billion or one percent of annual GDP can be expected to have a genuine effect in keeping interest rates lower.

In our work with borrowers we come across a lot of ‘urban myths’ about borrowing – things which drive people’s behaviour which are fundamentally misinformed. So as the first in a series which I’ll put out in subsequent newsletters, here are some urban myths exposed.

Don’t mortgage your own home.

Perhaps the most frequent myth is the idea people have that if your own house isn’t mortgaged, it’s safe from any financial action. Wrong!

The law is that if you owe money to someone, they can come after you and sell any assets you own until they get their money. So if you have a house, it’s effectively on the line any time you enter a contract – for instance for dry cleaning or telephone services. Of course, most small debtors won’t go to the trouble of selling your home up – it’s not worth it to them for such a small debt.

Having said that, if you can keep your own house unencumbered that’s a nice thing to do, other things being equal. But given what I've said above, it’s throwing good money after bad if you need to bear additional costs to keep your own house free of a mortgage. People often have to pay mortgage insurance – no small amount of money – to keep their own house unencumbered.

Take the following example. The Smiths have an unmortgaged house worth $500,000 that they live in and want to purchase an investment property worth $300,000. They have $60,000 as a deposit for a house in Sydney. But buying the house without encumbering their own house will cost them more than $3,000 in mortgage insurance. But what if they can’t meet their bill? Say a terrorist act blows up their house, that the house cannot be insured against terrorist acts, that it’s now unrentable and they cannot meet their repayments. The lender can – and probably will – sell up not just their investment property. Since its value is well below what they owe, the lender can then – and probably will sell their home. Remember the law is that generally a debtor can sell your assets till your debt to them is fully repaid.

Now you could argue that not mortgaging the house could at least affect the order in which the assets were sold. Thus, not encumbering your own house improves the likelihood that your investment property would be sold first. As a legal observation, this is true enough. But it seems to me very likely that if the investment property would clearly yield enough money to repay the mortgage, a lender would happily allow you to sell that in place of your home: That is, it would let you behave as if your investment property was the one with the mortgage.

Why would it do so? Firstly because, provided that this can raise the money it needs, it’s no skin off the lender’s nose. Secondly there is in fact something in it for the lender. Lenders don’t like selling people’s homes because every now and again it ends them up on a TV current affairs program playing the role of evil villain. Part of the reason banks are conservative about people being able to service their loans (even when their loan to valuation ratio is very low) is that they hate those current affairs stories. Lenders hate throwing people out of their homes. Of course there is the chance that you run into a really unreasonable lender, but I’d be very loath to pay thousands of dollars of mortgage insurance to have so little effect on the final outcome.

In this example, in most cases the best approach would generally have been to mortgage the home and leave the investment property unencumbered – leaving it available for the raising of more finance if that was desired at some later time.

If you really do want to keep creditors’ hands off your family home then you need to consult an accountant and have the property title put in a different name to your own. Thus generally speaking (though there can be exceptions) a spouse owning a home can hold onto it even if her husband is bankrupted (and of course vice versa). And if you hold your own house in the name of a company or trust this may protect it also (though of course creditors may be able to access the asset through the company if you own shares in the company).

You shouldn't do any of these things without getting the advice of a professional you trust. Another option is ‘non- recourse’ lending where the lender has recourse to the security backing the loan – they can sell the house that is mortgaged – but their rights end upon doing so. You can get access to this kind of lending, which is standard in the United States because of government regulation. But you shouldn't be surprised to find that it costs more – because it’s higher risk for the lender.

I don’t know if you’ve noticed yet but starting just three or four years ago a New Zealand property developer has begun an international campaign that’s having quite an impact – and it’s something that you need to know about whether you just own your own home or you’re a property investor.

I ran into Hugh Paveletich – the New Zealand property developer in question – in my role as an economic consultant. After I expressed interest in a website he helped establish he put me on his ‘drip’, which is to say his e-mailing list. Rarely a day goes by without being ‘bcc’ed into an e-mail intended for the media and anyone else he can influence pretty much anywhere in the English speaking world – but particularly in the antipodes. I’ve since lunched with Hugh and his wife on one of his trips to Australia and he’s a nice fellow.

As Hugh looked at the New Zealand property market he thought how ridiculous it was that land cost so much when New Zealand had so much of it – per person that is (per sheep it’s a different story – but I digress!). Hugh got thinking about all those policies that go under the name of ‘smart growth’. They sound pretty well and good. Contain cities to certain limits so they don’t gobble up all the farms in the area in a massive urban sprawl. Increase density, limit spending on roads and increase spending on public transport so that it’s more viable. In fact when you look closely at these policies they come with heavy costs. I won’t go into detail on all of them here, but suffice it to say that I think Demographia has done us a service pointing to many of them.

Hugh and his partner in the US – Wendell Cox – produce figures on all the major cities in the English speaking world on their Demographia website and they recently released their third annual report into housing availability (and prices!) in the USA, the UK, Australia, New Zealand and Canada.

They argue that where house prices are high – like they are in our capital cities, they’re high not primarily because of increased demand for them, but because regulation – particularly the inadequate release of land for housing on our urban fringes – has starved the market of supply.

Australians might be surprised to learn that Sydney, Adelaide, Hobart. Perth and Melbourne made it onto Demographia’s list of least affordable cities. The report found that on average Australian houses cost 6.6 times annual household incomes. According to Demographia, anything more than 5.1 is ‘severely unaffordable.’

What lends striking credence to the Demographia view of the world is that cities of similar sizes have very different price levels and this is particularly where they regulate land differently. Take Austin Texas and Perth WA. Both cities are rapidly growing, and both have populations of 1.5 million. But whereas Perth’s multiple median has sharply risen over the past five years from 3.7 to 8.0, Austin’s multiple has actually fallen over past ten years from 3.3 to 3.1. This means houses in Austin are more affordable today than they were ten years ago.

The difference, Demographia contends, lies in Perth’s stringent land zoning regulations that monitor and restrain growth on the fringe. And the same conclusion is drawn for all 159 cities surveyed: ‘Where there is constraints on the supply of land for residential development housing inflation has occurred…Where there are no such constraints housing cost inflation has not occurred.’ Demographia’s answer to the crisis in housing affordability is to free up the regulations governing land release. When supply is balanced with demand, they argue, prices will fall.

Now if Demographia is correct, then all those first home buyers have something to get angry about – it’s politicians that are making that first home so difficult to buy – or at least its what politicians do which is regulate the release of land. And investors – well the Demographia message for them can be boiled down into one word – risk! If Demographia are right and they get their way and politicians ease up on land release on the outer fringe then maybe our house prices will start to fall from over 6 times average earnings back to around 3 where Demographia says they should be. But the consequences are scary: investors home owners will lose their shirt. Red ink from property investors will be running in the streets.

So what’s all this mean for your property investments – existing and future? Well like lots of other inputs into your thinking, this is just something to be kept in mind. The implications could be huge. But I doubt they’ll be all that great. I have little doubt that if Sydney or any of our capitals converted to Texas’s style of land tenure house prices would fall – perhaps a fair way. They don’t regulate land release on the fringe like we do. And they have fewer restrictions on redeveloping your block – about which more in a moment.

At least one right leaning think tank – the Institute of Public Affairs – has geared up for a campaign for greater deregulation of land use. They and the Housing Industry Association are sponsoring the Great Australian Dream campaign to secure greater land release. John Howard is jumping on the bandwagon but it’s not his area – it’s the states (strange how he never misses an opportunity to pass the buck to the states).

I expect all this activity will have some impact – indeed it already has in Victoria which has looked at ways of releasing more land notwithstanding its own previously announced plans to lock more of it up. But somehow I doubt that there’ll be a torrent of new land released. And Melbourne’s house prices are slowly heading up, not down.

Rory Robertson of Macquarie Bank thinks Demographia’s work is too one dimensional. He argues that Dermographia fails to factor in the significant and interactive roles played by low interest rates, negative gearing, the halving of the Capital Gains Tax, and immigration: ‘Record levels of immigration and population growth have been a key factor in putting upwards pressure on house prices’. In the past twenty years has seen immigration grow at a steady rate of 100, 0000, a year. That’s another million people who need houses.

Robertson points out that in its list of affordable cities all are North American cities, all were inland, and most had comparatively low populations. It is not news that most people would prefer to live in New York or Sydney rather than in Buffalo or Dubbo. The choice for Robertson is between ‘dull’ or ‘sexy’. Still I found Demographia’s comparisons between Austin and Perth and Houston and Sydney more pertinent. Yes, Perth and Sydney are on the water and so can’t expand as efficiently as inland cities – which can do it around all 360 degrees from the city centre. But can that really explain why Houston’s houses cost around 3 times annual earnings while Sydney’s are around three times that?

But will the release of land brings about a fall in inner city housing prices? Robertson doesn’t think so: ‘Releasing new housing land and building homes faster on our outer fringe is unlikely to produce significantly lower city average house process, ’ For ‘those who want to live in the inner city but can’t afford it shouldn’t hold their breath,’ land release is unlikely to be the quick fix they are waiting for.

And Demographia is pretty silent on what those real estate agents will tell you it’s all about – location location location. The divide is not just between desirable and less desirable cities, but within cities themselves. The desire to live closer to the centre is based on infrastructure as well as life style choices, but inner city aspirations, the lure of location, is also responsible for driving up prices. First home buyers often buy on the fringe and then when they became wealthier and/or become ‘empty nesters’, often ‘trade up’ to be nearer to the city. And as Robertson points out, any survey of median prices fails to distinguish between the value of inner city property and that on the fringe.

The American literature tells us that an important driving force of property prices is the difficulty of getting redevelopment permissions in inner city areas. This is an Achilles heel for Demographia. Because it is a political campaign as much as a research outfit, Demographia is keen to acquire allies in its fight. It seems supportive of the suburban lobby groups campaigning against redevelopment. Groups like Save-our-Suburbs often argue that they are resisting ‘forced densification,’ which occurs in the inner suburbs as part and parcel of the ‘smart growth’ philosophy. But a major force for densification (I’d guess it’s more important than any policy of ‘smart growth’) is increased demand for housing in inner city locations. The Save-our-Suburbs crew seem to me to be almost the antithesis of Demographia’s free market philosophy.

And they’ll be supporting all those restrictions on redeveloping your block if you own a house in Hamilton, or Double Bay or Toorak. So my expectation is that property prices of well located and serviced suburbs will continue to rise, and indeed that now is not a bad time to buy. But do keep an eye out for the issues that Demographia raises – both as a citizen and as someone who owns or is interested in real property. And watch out for land on the urban fringe. If you buy in, remember that some of it’s value comes from an ‘artificial scarcity’ which could be undermined with the onward march of free market ideas (where they’re convenient for their advocates that is).

If you want to reduce the amountof interest you pay on your home loan, one option is an "offset" facility.

The way that this works is that, in addition to your home loan, you have a transaction account with the same financial institution. You deposit your income into the transaction account and use it for all your day to day expenses. Any money in this account is offset against the amount owing on your home loan and you only pay interest on the outstanding balance. So say, for example, that you have a home loan of $150,000 and you have a balance of $5,000 in your transaction account, you only pay interest on $145,000. Interest is calculated on a daily basis. It sounds like a great idea, a way that you can pay off your mortgage early and still have access to all your funds.

There’s no doubt that, providing you’re not paying any fee for the offset facility, its better to have than not have. The only problem is that, unless you can get access to all the features at a discount price (as you can under professional packages) offset accounts are only available at higher interest rates than home loans without this feature. If you look at what that higher rate is costing you, then it usually turns out that on any sizeable home loan you pay more for the higher interest rate on the bulk of your home loan than you save on the slight reduction in the home loan balance that the offset facility allows you.

I’ve attached a calculation I did for someone that compares two products, a basic variable rate product and a home loan from one of the major banks. As the calculations show, in this person’s case the offset account reduced the home loan balance by about $3,000 (actually this assumption was pretty generous to the offset account). That amounts to an interest saving of $178.50 per year. By contrast in the first year of the home loan the simpler product would save nearly $1,000 in fees and charges leaving a healthy net saving of $818. This saving would rise over time if re-invested in the home loan.

The other great advantage of an offset account is that you can pay your home loan off faster than the repayment schedule demands when you want to and then get your money back later on. But there’s another way to do that - a redraw. If the offset is a Mercedes Benz, a redraw is a Holden Commodore.

Competition in banking has meant that, although ‘basic variable’ rate products used to be very inflexible, if you know where to look you can now have the most important flexibility features. The basic variable rate product which I mentioned to the client enabled him to pay his home loan off as fast as he liked without penalty and it also enabled him to ‘redraw’ any excess he’d paid off from his home loan.

It is more cumbersome than writing a cheque. It requires a fax to the bank and the payment of a small fee of between $0 and $50 depending on the amount redrawn and the institution. But it’s a perfect standby if the client wants to get his house painted, or add an extension to his house, or put a deposit down on another house sometime in the future. You can even write the cheque at the auction. And when you get home or back to work you can fax the money into your account! No-one knows you don’t have an offset account, except your lender and you.

Please note: These calculations are based on the best information provided to Peach in January and February 2002. They are provided as strictly indicative calculations. It is possible that rates for any of the costs charged differ from those provided in this calculation. This could be a result of human error, use of specific mortgage insurers other than those which may be encountered in a transaction , or changes in stamp duty and or other charges by governments of which Peach is unaware. Further some states may impose charges other than the ones outlined here. Generally these figures will be checked by your lender prior to approval and by your conveyancer prior to settlement. No responsibility is taken by Peach Home Loans for the accuracy of the figures provided.  Readers of this newsletter should not rely on any of its contents before checking first with Peach Home Loans or some other professional.  We deny to the extent possible by law all legal liability to any person who does not discuss with us their plans.   Borrowers should never assume that they qualify for a home loan will before receiving an unconditional loan offer from a reputable lender.

While the news looks bad for investors following the second rise in interest rates in recent months, there’s light at the end of the tunnel. Before I explain why, let me explain, once again, that my own investment philosophy is broadly and I might even admit crudely, contrarian. I believe that markets basically work pretty well, but that they go in cycles of optimism and pessimism and that one can make better than average returns by broadly betting against the market. 

So if you did nothing else but bought into markets after they’d enjoyed some sustained period of price falls or low growth and sold after they’d had a sustained period of high growth I reckon you’d do better than average and indeed better than a lot of funds which tell you about their expertise in picking investments (but which broadly follow and often underperform the relevant index).

When I can I supplement that basic contrarian instinct with some research – or some reading of others’ research – to find specific opportunities to benefit, specific investment themes that are consistent with my broad contrarian philosophy. Obviously if there are good reasons for expecting an area to do well, then I’ll buy there if I think it’s a good time to buy real estate more generally.

Some of the takeouts of a contrarian philosophy are that when others are selling that creates a chance to buy advantageously – and vice versa. I bought some property during the property boom and sold it during the boom. Like a lot of contrarians I sold too soon – but at least I made good money and was limiting my exposure. 

As I was selling the property, with the sharemarket having performed poorly I figured it would do fairly well (based on not much more than a contrarian perspective). Sure enough it did. But since it has outperformed for several years I’m lightened my exposure. I’ve put quite a bit into international shares via a fund manager I’m very impressed with – Platinum Capital.

I’ve recently started lightening my exposure more and winding back my gearing, and soon I may gear up some more. The evidence suggests that the time to wait to invest in residential property may be coming to an end. (Well the fact is that buying in WA over the last five years was a ‘no-brainer’ that I thought about but didn’t act on sadly. But as you’ll see below, now WA is not necessarily a better investment than elsewhere.)

Here’s a graph of how house prices have performed in the last few years.

As you can see, Sydney’s been pretty crook. But that’s why developers have slowed down their development plans there. And the result of a growing population and reduced development of dwellings is falling vacancy rates.

That’s led ANZ analysts to make this point regarding the NSW market.

With approvals currently trending at an annualised completions rate of 26,400 (compared to underlying requirement of 46,000 dwellings), shortages in rental accommodations and dwelling supply will intensify, providing a powerful catalyst for the next upturn in 2008. By that stage, we estimate the NSW housing market will have unprecedented levels of pent-up demand (equivalent to almost 10 months of production). We expect the current dire sentiment pervading the NSW housing market to improve over the next 12 to 18 months.

These words were written in July before the latest rate rise (though the analysts were expecting the rise that did occur.) Developers are thus operating pretty much countercyclically against the price cycle. They are providing more supply where dwelling prices induce them to – smoothing prices just like you’d expect in an economics textbook. In Perth with strong price rises building looks like outrunning supply putting a lid on price growth (Perth is now rivaling Sydney in unaffordability.) So prices may well come off there in the not too distant future.

For these reasons on the Eastern Seaboard, I think it’s starting to become a good time for renewed property investment, provided you’re in it for the long haul. Don’t expect the big price growth we saw in the late nineties and early naughties. That only comes around once in a long time, but with rental yields for decent investment properties at 5 per cent or so (usually lower in NSW) you only need to pick up a bit more than two per cent a year in price growth and you’re making money what with building depreciation allowances, negative gearing and concessional capital gains tax. Now price growth is most unlikely to be less than inflation over the longer term (which will be around 2.5%) and could easily be two or three percentage points above this – add another few percentage points per annum for well chosen property and you’ve got a very effective long term investment. Now you’ll notice these assumptions are pretty conservative. Even so, property becomes a good investment again!

Here’s ANZ’s snapshot of the next couple of years.

Until next time,