Thursday, May 28, 2015

Rent vs Buy: An Adelaide "Cost Comparison" Revisted

One of the very early articles I wrote on this site compared the cost of buying a home with renting one in Adelaide (Rent vs Buy: An Australian "Cost Comparison"). Earlier that year I'd sold a property I owned in Adelaide (returned to renting), I put my money where my mouth is and at the time it made more sense from a financial (and personal) perspective to forgo the security of owning (or more accurately "paying off") my own home.

Almost 5 years later I am still renting the same property, the lower cost of which (less than the mortgage I had) has been an enabler to put away some extra savings and investment. In the meantime property prices have basically gone nowhere (fell around 8-10% over 2010 to 2012 and have since rebounded back to 2010 levels) and interest rates have dropped.

The comparison I did previously using figures in Adelaide, at the time most other Australian capitals were quite comparable (i.e. yields around 4-4.5% for houses), but today Sydney and Melbourne are in a league of their own. The figures I lay out below make owning look quite attractive, but that same argument probably doesn't hold true in Sydney and Melbourne where prices have gone gangbusters and yields are woeful.

I have revisited the figures from the original article and compared them with today.

Rent vs Buy - The Figures

Property: $500k House

Rent (2010): $25,000pa / 52 = $480pw
Rent (2015): $26,520pa / 52 = $510pw

(Residex shows yields have slightly improved for Adelaide over the past 5 years)

Buy (2010):
$500k + $24,000 (stamp duty and transfer fee#) x 7.25% = $37,990
1% of property value for maintenance and insurance = $5000
Council and water rates = $2000
Total = $44,990 / 52 = $865pw (interest only)

Buy (2015):
$500k + $25,000 (stamp duty and transfer fee#) x 4.15% (3 years fixed) = $21,787
1% of property value for maintenance and insurance = $5000
Council and water rates = $2200
Total = $28,987 / 52 = $557pw (interest only)

# Adelaide based figures, this would differ between states

As I pointed out last time, this still doesn't account for all costs of ownership (or for that matter renting), but you can see that there has been a squeeze in the gap between the two. In 2010 the cost difference was $385 per week, in 2015 that has narrowed to $47 per week, mainly as a result of falling interest rates and a small increase in rents. The above example shows a 6.25% jump in rents, in my personal situation I have seen a 13% rise in 5 years (which reflects the local market, different areas in Adelaide may have seen higher or lower). Over the last 5 years I have also seen my income rise which would make servicing the gap easier.

In Adelaide a $500,000 house would actually buy you something quite nice, a modern 3 bedroom house around 10km from the city, maybe even closer or a small house in the city if that is a preference. If you are prepared to look at modest homes you can buy something more dated, 15-20km out from the city, for around $300,000. Assuming a 10% (+ costs) deposit (leaving a $270,000 loan) and 3 year fixed interest rate of 4.15%, the principal and interest repayments would be around $300 per week. Rent for the same house might set you back $320-340 per week. Suddenly a home in Adelaide is looking quite obtainable, maybe even for a household on a single income.

Now I'm not saying Adelaide is cheap, it's still expensive on a global or historical comparison (if we look back at the property to income ratios of the mid 1990s), but it is definitely obtainable for those who've had the capacity to save a reasonable deposit (circa 10-20%).

There are still some risks to the Adelaide property market, as I outlined a couple of years ago (What's next for Adelaide property prices?) the economic conditions are not positive in the state, we already have one of the highest unemployment rates in the country and things may be set to get worse before they get better as the car manufacturing industry shutters. Further to this Adelaide property is at risk of being affected by recent changes to investor lending (that is likely to tighten further), falling wage growth and a crackdown on foreign investment (some of which was well described in a recent article by Callam Pickering). These factors are likely to continue weighing on Adelaide prices, but in my view with prices being the same level as they were 5 years ago, the risk of a substantial correction (i.e. 15%+ nominal) is unlikely barring a complete meltdown of our banking system or huge spike in interest rates (neither of which I consider to be likely).

FT describes an asset bubble like this:
When the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, making a sudden collapse likely - at which point the bubble "bursts".
Those referring to all Australian cities as being in a bubble (I do agree Sydney and Melbourne potentially are) are either wrong or have come up with their own definition of the term. Perhaps they think it's likely we see a return to the historical price to income values we had in the mid 1990s (or earlier) and that we've been in a long lasting bubble since that time. I think that is an unlikely scenario (returning to ratios from 20+ years ago) given the political and financial system we have today.

On a personal note I recently started looking at property in Adelaide (to buy) for the first time in 5 years (looking at PPOR and/or investment) and I expect to purchase (perhaps more than once) in the next 12 to 24 months. Price growth may be slow to begin with and won't rule out some negative growth (what a term! e.g. falling prices) in the short term, but there are some reasonable yields out there now and the time to buy will be while sentiment remains poor.

And if GFC 2.0 comes knocking on Australia's door and smashes the price of all Australian property in half... well at least I'll still have my Gold ;)



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Tuesday, May 5, 2015

Martin Armstrong on Australia's Bank Deposit Tax

Yesterday I spotted an article by Martin Armstrong (Australia First to Introduce a Compulsory Tax on Money Itself) that I think is misleading (no surprise that Zero Hedge was quick to republish it).

Before delving into Armstrong's claims, let us take a look at what he is presumably talking about (I say presumably because his article rant is light on facts & details about the subject at hand).

From the AFR, a tax on bank deposits:
"The federal government is planning a tax on bank deposits at the May budget in a move that will raise about $500 million a year but which bankers warn could be passed on to customers.
Sources have told AFR Weekend that the government is set to proceed with the bank deposits insurance levy, first proposed by the former Labor government, to shore up revenue and to act as an alternative to forcing banks to hold extra capital as insurance against collapse."
What does that mean in practice?
"The money would be put in a Financial Stability Fund and be used to protect depositors against the highly unlikely event of a bank collapse. In the meantime, the fund would also be used to offset gross debt. If the Coalition adopts the same model as Labor and if banks pass the levy on to customers, it would mean a term deposit currently paying 2.6 per cent would pay 2.55 per cent."
So to correctly frame the situation we need to define what this tax is, is it a tax on money (as per the headline) or a tax on savings as Armstrong suggests in his article?
"The new compulsory control is provided in the 2015 Australian budget, so that everyone who has any savings must pay taxes on their savings. The measure is expected to serve as a global test balloon for Europe and North America, who will watch for the outcome in Australia. If there is no massive resistance of Australian savers, the rest of the world should expect this outright confiscation very rapidly."
In my opinion framing it as a tax on money or savings is implying (wrongly) that bank balances will be reduced in order to fund it. Really it's a tax on deposits and it's levied on the banks, not customer balances. Of course any cost to the bank will likely be passed on in the form of higher fees or lower interest rates, but very unlikely to touch balances (i.e. it's not outright confiscation).

The original Labor proposal was for the levy to apply on deposits under $250,000. Why that amount? Probably because that is the deposit size per customer, per Authorised Deposit-taking Institution (ADI), that the government guarantees. Is it fair that depositors insured by the government (taxpayers really) fund the cost of their own bailout should it be needed? I think so (but welcome opposing views in the comments below).

I wrote about Labor's proposal back in 2013 ($250k+ in an Australian bank? Beware the bail-in.):

"The banks are up in arms over who will foot the bill and there has been a media storm over the tiny fraction of a % that this insurance will cost (for example a bank would need only lower the interest rate paid on a deposit from 3.50% to 3.45% in order to recoup the cost). While the media, banks and politicians get into a scuffle over who will fund the minuscule cost of insuring funds under $250k, there seems to be no investigation or reporting by the media on what might happen to funds over the 'guarantee' limit in the case of a bank failure..."

I'm no fan of 'Too Big To Fail' banking institutions and don't pretend to have all the answers on the best way forward from the position we're in. Ideologically I think banks should be allowed to fail and individuals could organise their own insurance against such events, but would it be responsible of the government to just implement a change like this and pull all guarantees in one swoop?

Armstrong continues:
"Take your money and buy tangible assets, even gold, but you just cannot store it in a bank. Movable assets will be the key and buying equities in the USA may be the only real game in town to protect money."
Now anyone reading this blog for some time (or even if you are looking at it for the first time) should be able to deduct that I'm an advocate for Gold ownership, but that doesn't mean I think you should take out all your savings and buy Gold. Also I think keeping your Gold stored in a safe deposit box with a bank is probably just as safe as any private facility (in Australia) as I concluded in a recent article focusing on this very topic (Storing Gold & Silver: Safe Deposit Box In Australia):

"Bank SDB facilities get characterised as unsafe due to their connection to the banking system, but in my opinion there are some pros and some cons that result from this association and on the whole I don't see bank SDBs as less safe than their private counterparts."

Armstrong concludes on this note:
"The introduction of this tax on money in Australia led by Tony Abbott is the trial balloon for the global economy. The IMF’s Christine Lagarde has led the battle to impose French socialism/communism upon the entire world. I have warned that she is the most dangerous woman on the planet. Do not forget, it was the French elite who sold the idea of communism to Marx – not the other way around. Now the French elite have control of the IMF and they have persuaded all other global financial institutions to also require such a compulsory levy for several years because they see it as the only way to resolve the debt crisis – just confiscate the people’s money."
We've already identified that this isn't really a confiscation of people's money, but rather a levy on the banks to fund a Financial Stability Fund in order to support depositors in event of a bank failure. Is Australia really the first country to implement such a scheme as suggested by Armstrong in the paragraph above and even his article's title (Australia First to Introduce a Compulsory Tax on Money Itself)? No. Perhaps Armstrong should take a look at the history of the FDIC, which could be seen as an equivalent to this fund, guarantee & levy, it looks to me as if the US has had something similar implemented for almost 100 years or more (from: A Brief History of Deposit Insurance in the United States):
Assessments on participating banks. All of the insurance programs derived the bulk of their income from assessments. Both regular and special assessments were based on total deposits. The  assessments levied ranged from an amount equivalent to an average annual rate of about one-eighth of 1 percent in Kansas to about two-thirds of 1 percent in Texas.
Australia's 0.05% levy looks rather small in comparison. And from the FDIC's website:
"The FDIC receives no Congressional appropriations - it is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities. The FDIC insures approximately $9 trillion of deposits in U.S. banks and thrifts - deposits in virtually every bank and thrift in the country."
Australia is hardly the first country to implement such a scheme and we won't be the last.

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