Category Archives: General Mortgage

Financial Planning and Mortgage Broking: A Different Approach to Regulation.

Financial Planning and Mortgage Broking: A Different Approach to Regulation.

Newsletter 2002

Financial Planning and Mortgage Broking: A Different Approach to Regulation.

The quality of advice given by some financial planners is ‘frighteningly poor’, according to a new joint survey by the Australian Consumers’ Association (ACA) and the Australian Securities and Investment Commission (ASIC).

It was the third such survey in eight years. Serious problems have been found each time, despite increasing regulation of the industry.

ASIC’s response conveyed its concerns. ‘The overall results of the survey show that many people aren’t getting the quality of advice they deserve. This is a wake-up call to the financial advisory industry that significant improvements are needed’, according to Peter Kell, the Commission’s Executive Director of Consumer Protection.

One of the major problems identified was planners recommending investments without justification, seemingly to earn commissions.

The ACA was blunter in its summary of the latest survey: ‘This ongoing failure to lift standards is disgraceful. Too many planners put their own interests ahead of those of their clients’.

‘The results are particularly worrying considering company principals (who may employ other planners) are currently applying for licenses under the new Financial Services Reform Act (FRSA). It promises enhanced consumer protection, but a large proportion of the advice in this survey would fail to meet some of its basic requirements.’

So despite increasing regulation of the financial planning industry, it seems that consumers are still not being protected. The answer? Everyone is calling for more regulation! But since we keep adding regulatory hoops, and the quality of advice remains poor does something seem amiss?

We think there should be regulation. But it would be different regulation. The fundamental issue in these markets is that financial ‘advisors’ and mortgage ‘brokers’ have conflicts of interest because they’re remunerated by the sellers of financial products – managed investments or loans as the case may be.

You can paper over it – you can legitimate this basic structure by imposing a whole lot of rules, a whole lot of compliance procedures but the basic incentives the businesses will face will continue to be the incentives of sales people. Indeed, as you can see from looking at their advertising, these industries are dominated by a ‘sales culture’.

The idea of regulating these industries to protect consumers actually legitimates the way in which financial advisors and mortgage brokers operate, often as sales people under the guise of being ‘advisors’. It also substantially increases costs.

I propose much simpler regulation – requiring all people who accept remuneration from financial services providers to call themselves salespeople and explain that, even if they take a similar commission from each service provider, there remain clear conflicts between their own interests and those of their clients. In addition a cheap and general ombudsman scheme should be available to address individual problems and to identify rogues who should be prevented from operating. I would add that consumers should make some small deposit to use the ombudsman– perhaps $20 or $50 – as you don’t need to practice in the industry for very long to realise that there are plenty of vexatious consumers out there. But that is a minor point.

In the meantime, there is more than one way of being ethical. Instead of hoodwinking clients into thinking we can be an unbiased source of advice, some of us are being up front about the way the market works and passing the generous commissions lenders pay us back to our clients – just like discount department stores that sell cheaper products.We simply couldn’t do that if elaborate compliance and audit procedures were imposed requiring us to be able to justify our ‘advice’.

Like most other brokers we try to find the best loan we have access to for our clients because we want their business and the market is a competitive place. But we advise our clients to keep looking for better deals – see newsletter 6. We’d rather compete for business than ‘advise’ the unwary that we’ll provide them with unbiased advice or that they could not possibly find a better loan than the one we suggest to them.

In a subsequent newsletter, we’ll provide a concrete example of how our advice is better than that provided by a computer program that has been audited as giving independent advice – just the kind of program against which mortgage brokers would justify their advice if their advice were ever regulated.

Better a simple solution that keeps everyone informed than more costly regulation that, far from preventing misleading behaviour, actually legitimates it.
Cheers,

AKA Nicholas Gruen

June 2002

Please note: The observations made here are general and indicative. Nicholas Gruen is not a qualified investment adviser. Further his comments are general and do not take into account your specific circumstances. Nor are they warranted as free from error in any respect whatsoever. You should not rely on any aspect of them without taking independent financial advice relating to your own specific circumstances. We suggest you obtain advice on a fee for service basis rather than from someone who earns either up-front or trailing commissions from investments they recommend. We would be happy to let you know of service providers who provide advice on this basis.

Mining Towns and Bad Advice

The following is an extract of an email I recently sent to a client who had been convinced by someone that an investment in Karratha was a sound idea…

As for developers and real estate agents they  have a clear interest in talking up the market.  But many so-called “property investment mentors” also have direct financial interest.  This is from an article in the Property Observer July last year titled “Port Hedland and Karratha “the best places to buy”? Don’t get roped into that one”  read the full article here http://bit.ly/1vAaAex.
Another more recent article on what is happening in other mining ‘boom’ areas http://bit.ly/1v7OLID  where he points out “The decline in these markets is not just about hard times in the iron ore and coal sectors. It’s also about over-building by developers and a failure to appreciate the full impact of the growing use of FIFO ( fly in fly out) workforces accommodated in temporary workers villages.”
We have many successful clients with strong property property portfolios and some of them did well out of the mining boom, buying ahead of the market.  We also have some clients who didn’t – this is a recent example I came across:
I foolishly I bought in Blackwater and Mackay when rents were crazy and out look was bright. Now rents in Blackwater have gone from $950pw, purchase price $495k to now $350pw and an agent told me today if I sold now I would expect $200k as there is zero interest in a property like mine. Mackay is a similar story, rent $700pw, PP $485k to $300pw and a $380k expected sale price. I am currently on a fixed rate for the next few years of 4.89%.
This person has little choice other than to sell their  family home in Sydney losing all of their  equity.
So my negative attitude to your Karratha strategy comes from my experience over the last 15 years.  Keep in mind that lenders also know about booms and bubbles – although they appear to have completely ignored that in the case of many mining areas.  However for a lender the ideal property is a 3 bedroom brick & tile house within 20 kms of the CBD or a large regional centre.  As you deviate from that either way, such as a one bedroom bet/sit or a $5 million harbour-side mansion the size of the market for these properties decline and that makes lenders nervous as when things go wrong they want to be able to sell easily and the bigger the market the easier the sale.  As a result lenders will lower the equity share on property that has a restricted market by as much as 50% and in many cases lenders will decline to accept a security.
Typically regional areas offer higher rental return over metropolitan areas however the cities ( Melbourne & Sydney ) offer better capital growth.  You have stated that you are looking for a positive geared strategy with good future income flow.  In my experience any ‘residential’ property with a return in excess of say 6.50% starts to ring alarm bells.  I am not saying they don’t exist but let’s look at some of the common scenarios:
  • serviced apartment or student accommodation – management or zoning restrictions limited market results in 60% LVR (loan valuation ratio) at best
  • studio apartment under 40 sq metres – again restricted market, LMI ( mortgage insurance) not available further restricting market expect 60% LVR
  • hobby farm > 5 ha – restricted market 60% LVR
  • retirement village – restricted market and management restrictions – unacceptable security
  • converted hotel/motel – unacceptable security
  • guest house / student housing where tenants share common areas – usually unacceptable
  • remote locations dependent on single industry – case by case
  • rural/ regional towns under 10,000 pop – case by case but typically 60% LVR
  • resorts / holiday letting – strictly speaking they are not ‘residential’ ie: people do not reside there, usually unacceptable
  • display homes – very restricted depending on agreement may get 70% LVR
  • property with rent guaranteed  – these are usually a managed arrangement or an incentive from the developer, will be assessed at market rent and equity probably discounted
While all of the above (and many others) offer good rental yield you have to keep in mind that the equity restrictions mean that you have to use more of your money and  this will ultimately reduce your ability to acquire more property.
While Melbourne struggles to make a 3% rental return, Sydney around 4% there are parts of Brisbane and I am sure other major centres where 6% on standard property is achievable. If you are looking for property that pays its way and makes a real profit, you will probably be forced to look at the higher risk options above.  If you are looking for property that can start to pay itself off, gradually becoming more genuinely positively geared over the longer term and capital growth is not your focus then larger regional centres may be your best option.

Is Rent Dead Money

Over the years I have heard the statement “rent is dead money” literally hundreds of times and on almost every occasion I have  tried  to explain why in my opinion this is not always true.  Finally a new report by the RBA confirms what I have always said – rent is no more dead than interest and other costs you have in owning a house unless capital growth is strong.

Over the past 18 months Sydney and Melbourne have had very high capital growth, none the less the annual rate of growth in property value since 1955 is just under 2.50%.  The RBA report suggests that at 2.40% growth an owner has to hold the property for around 8 years to be in front of a renter however there are suggestions that following the current bubble, growth may plateau at around 1.70% and at that rate it will take an owner almost 30 years to break even.

However there are times in the market such as the last 18 months  where growth of 15% to 18% means those who missed the boat are now even further away from their dreams.  Not only in terms of the additional $150,000 purchase price but the required $30,000 deposit to cover that additional contract price.

But keep in mind the Melbourne/Sydney bubble has been very much just that while the rest of the country has been barely simmering.  Even in Melbourne the growth has been quite dependent on locale.  My argument is usually more aimed at buyers who have limited savings, these are typically young couples or people who have experienced set-backs such as illness or divorce and the most important ingredients here are LMI ( lenders mortgage insurance) and stamp duty.  Borrowers with the bare minimum 5% deposit who live in states with no stamp duty concessions are really struggling to get into the market.   In most cases 5% is no where near sufficient – for example in NSW  a house in a regional area with a deposit of $17,500 on a  $350,000 house does not even begin to cover stamp duty $10,000 and LMI $12,000.

Repayments on a $345,000  ( 95% + LMI) loan at 5% interest will be $1850 per month or $426 per week,  however for $426 per week you could rent a much better house worth around $550,000.    Or if you look at the interest only component of $1440 per month you could still rent a house worth $430,000  and at 2.50% growth as the RBA confirm  it will take 8 years for the $350,000 house to be worth $430,000.  Over that 8 years you have paid exactly the same amount of interest as you would have paid rent plus rates, insurance, maintenance and all the other costs that go with home ownership.

Therefore my advice is that unless the market is taking off or about to take off  – and that is not easy to pick, then you are probably financially better off save that $410 a month which after 8 years will give you $40,000 more deposit and a much stronger position and therefore a better loan.  Having said all that “what price” the ability to change the curtains or hang a picture on the wall.

 

Change of Queensland Real Estate Rules

Under the new law that has been passed couple of days ago, real estate agents are no longer obliged to reveal their commission rates to their buyers. Furthermore, they are no longer obligated to follow an extreme commission limit.

The modifications made in the Property Occupations Act and its associated regulations will surely affect how buyers and sellers make a deal, since the agents are no longer required to reveal their fee to the prospective buyers.

With the latest changes, agents can now ask any amount as commission fee from the seller as the maximum commission limits have been dissolved. These changes will also affect how agents participate in an auction as they are no longer required to issue price guides.

The goal of these changes, according to Jarrod Bleijie, Queensland’s attorney general, is to get rid of red tape as the changes will also include stricter disclosure policy, elimination of warning statement written in the contract and longer agency agreements. He said, “Contracts can often do more harm than good, with many people either skimming over important information or in some cases not reading the finer detail at all”.

According to Jarrod’s statement, these changes will greatly protect Queenslanders in purchasing a house. When the process of buying a house becomes simpler, people living in Queensland who want to invest in a house will be secured with the changes as stated in the Act.

On the part of real estate agents, the changes are well-respected. In fact, the president of Real Estate Institute of Queensland, Anton Kardash, considered the changes, specifically the price guide ban, as a way to promote transparent relationship between the buyer and the seller. For him, it is a win-win situation for consumers as they will enjoy better transparency when they purchase a property at an auction.

However, the changes may also hurt the merchants, according to Tony Panos, who is a real estate coach. He told the Real Estate Business publication that buyers might be disappointed if they would not have a way to know whether or not such property is in their price range. “They would stay away from properties where they were given no idea at all of the selling price. So, I think it would be against the vendor’s best interests,” Tony commented.

Given previous allegations of developer support for the Campbell-Newman government one has to question who benefits most from these changes

Borrowers advised make additional repayments

With record low interest rates now is the most suitable time for Australian mortgage holders to repay their loans or make additional repayments.  Every dollar that you repay at the moment is substantially reducing the loan principal where as with higher interest rates a larger proportion of the repayment is lost to interest.

What’s  more by making additional repayments now you are conditioning yourself to be better prepared financially when interest rates do eventually rise.  Not only are you more used to making the higher repayments but in the case of hardship or unforeseen financial problems your advance payments provide you with a buffer – this can be either in the form of a repayment holiday or redraw those funds for other purposes.

So, now is an ideal time for Australians with a mortgage to pay off their debt as much as possible.