A lot of people will say I am crazy..... I have not really pulled the number out of thin air. Just to illustrate my point, a 30% general price decline is not really that outrageous.
Remember in the first blog, I used 4% gross rental yield as the current yardstick ? I arrived at the 4% range by going to www.realestate.com.au and look up the rental section. At the moment, there are currently a few houses which were for sale as recent as last month. Take the house on Congewoi road in Mosman for example, it is currently asking for $2000/week (for rent). We are looking at gross rental income of $104000 p.a. for the property owner. The original asking price was $2.75M and more recently, the asking price was lowered to $2.5M. We can work out that the gross rental yield is around 4.16%. While we do not know if the property will actually be leased at the asking rate, the information is useful because it does reflect the thinking of the real estate agents concerned.
How do I arrive at the 30% price decline target ? Let's assume, a property is worth $100 and it currently yields gross rental income of $4. What if the property owner suddenly demands 5% or 6% or 7% in rental return ? The property would be worth:
5% $80
6% $67
7% $57
Mortgage rate at present is around 6-7% from the major banks.
We can see that the cost of fund is currently higher than the return available. If one were a rational person, owning a home at this point in time should be seen as a consumption item, not an investment.
To be absolutely fair, the rental yield argument hasn't worked for quite some time. It is because property is widely perceived to be an appreciating asset. Using the $100 property example above, we can illustrate the leverage if rental yield drops to say 2%.
3% $133
2% $200
If one wants to be bullish, one can certainly argue that Reserve Bank is poised to push interest rate to a very low level. However, I would like to point out that no one can properly forecast interest rate. If one were to take on a very long term obligation (say 20-30 years), even being able to guess the interest rate movement over the next 3-18 months is not going to be especially helpful.
In summary, despite my concern about the un-economical nature of home ownership, I suppose I would be happy to pick up a property after a 20-25% price correction (or roughly 5% rental yield). I am happy to do so because it is a personal consumption/lifestyle choice.
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I think many people fail to realise that property prices have gone up significantly in the past decade and rents since the start of the sharemarket boom of Mar-2003.
ReplyDeleteThe property on 27 CONGEWOI ROAD is still available for rent (2,000pw) and sale (2,450k) with a gross yield of 4.24%.
Assuming rents in Mosman will fall around 10%, which is not impossible given recent rental hikes in the area and the current economic climate. The rent is adjusted to 1800pw and the yield falls to 3.82%.
Even if the RBA does reduce the cash to around 2.5% by the end of 2009, the banks will still be charging around 4-5% interest, assuming inflation will also ease to around 1-2%.
An investor will need a gross yield of at least 7% to break even after inflation - and this does not include upkeep costs such as land tax etc.
To obtain a yield of that magnitude the price needs to be lowered to 1,337k (1800*52/0.07) - a discount of over 45%.