Housing Affordability Crisis – “What I would do, if I were 20 and knew what I know now”
According to the media, and for the most part also the government, the numbers of young people in metropolitan areas purchasing homes is in rapid decline, as a direct result of what we now call “the housing affordability crisis”.
There is no doubt a massive shortage of housing supply, increase in investor activity, low wage growth, combined with sky-rocketing house prices. All making it much harder for young people to save enough for a deposit and enter the great Australian dream of buying your own home. So how can young people help themselves into their first home?
You often here the saying, ” If only I knew then what I know now”. Well with that in mind, we wondered if an old head on young shoulders approach could actually assist with this seemingly insurmountable challenge.
So here at Catalyst, we interviewed our senior accountants to see how they would advise their children to tackle the housing affordability crisis, and here’s what we found.
Advice Note # 1
Find the cheapest way to live
You need to create the biggest gap you can between income and expenses. Earn as much as you can, and minimize your living costs. It sounds so simple, but it is the temptations of a young life of adventure and experience which can really put you behind the ‘property’ eight ball here.
It might mean living at home with your parents while you’re studying at university or TAFE, or finding low cost accommodation during your studies by sharing with mates. It may also mean working some extra shifts or running multiple jobs back to back, however if you are serious about getting into property, then get serious about taking action
In short; work hard <> save hard, instead of; work hard <> play hard
A part-time or casual job may not seem to be bringing in the big bucks, and while living at home with mum and dad might not be the most comfortable arrangement, but keeping your living expenses down will show significant savings rewards in the long term.
Advice Note # 2
Start saving for a deposit ASAP – Create the habit
Typically, to get into a home you’ll need at least a 10 per cent of the purchase price for a deposit; (more likely 20 per cent if you want to avoid incurring Lenders Mortgage Insurance). SO the sooner you get started the better.
Start by putting aside even just $50 a week into an account designated to a home deposit, will see you building a good chunk of a deposit up quickly. Just think, $50 a week, that’s $2,600 in a year. The key here is to ensure the ‘Savings’ come out FIRST, before any other spending. Set up an automatic transfer within your online banking so it happens without thought and you’ll never miss it. ALso ensure any lump sums you come across, a significant portion (if not all) goes into your savings account.
Start the habit and then begin to stretch yourself by gradually increasing it every month or two. You know, you didn’t miss the $50, could you make it $60 or $70 and so on. You will find it very surprising how far you can stretch it and before you know it you’ll have a massed an amazing saving fund building rapidly. If you could stretch it to $200/wk, after 4 years you will have $40,000+.
Advice Note # 3
Decide to be an investor instead of a home owner
Our top tip is to aim to get in to the market as early as you can. You are always better ‘in the market’, even at a low level, that not in it at all! You will rarely be able to save faster than a property will increase in value.
We encourage you to remove your ‘home owner’ hat and put on an ‘Investors’ hat. For now forget about buying a house to move into to.This first home you purchase is not designed to be your dream or ‘forever’ home, it should be a place where you can build equity, and set yourself on the right path to buy that dream home in the future. Be patient, the rewards will come later. So we need to find something to purchase with the aim of renting it out and creating it’s own cash flow.
Let’s say you start looking for a property around the $200,000 mark. (You will need to have a deposit of approx $40,000). Now there’s the investors rule of thumb you can use to see if it is a guide investment from a cash flow perspective. If a property sells for $200,000, you need to have someone renting it for about $200/week. This will give you a gross rental yield of 5.2% which is a good starting position for establishing a positive cash flow investment. Of course it depends on a number of other factors, but it’s a good starting point.
Advice Note # 4
Start Small, but Just Start
With the spiraling cost of housing in metropolitan Australia, it is almost impossible for young people to muster a deposit. With the median housing price for a 1 bedroom unit in Sydney being $605,000 (Jun 2016). It would mean a young person would need likely $120,000 for a deposit. So for the first step we encourage people to get in to the market at the lowest possible entry point. This is purely to ensure you get in the market sooner rather than later because you will need a much smaller deposit.
In regional centres outside of places like Sydney, housing is far more affordable, with a 5 or 6-bedroom mansion on acreage typically selling for the same amount as a 1-bedroom or studio apartment in the inner city. Excellent value for money can be found and often even better rental returns. This will mean the income you receive from the property will go a long way toward funding the loan repayments.
The key here though is to not just find the cheapest place around, you still need to consider the location and what’s happening in the region to ensure there is some likely hood of capital growth occurring, even if it is only modest.
Once you’ve found an area that has stable, modest growth, find the cheapest price point and dive on in. There are likely to be periods of slow or even no growth at all, but as we mentioned before; it is better to be in the market and remaining stagnant or moving slowly, than to not be in the market at all.
Advice Note # 5
Reduce Debt as Fast as Possible
Securing your first home with a Principle and Interest (P&I) loan is the most sensible way to go. Even though with many of our ‘more mature’ investors we recommend interest only loans, for the purpose of building equity fast, we recommend choosing a principle and interest loan to ensure the principle debt level is reducing.
Now remember, it is these first few years that you will be paying the most interest to the bank. So now is the time to really ramp up additional repayments. So whatever you had set down as your savings habit, should now become your additional repayment habit. To see the real power of this you only need to check out any of the banks online loan calculators to see the impact the additional repayments can make.
You’ll find that, with a renter pretty much paying the mortgage on your investment property, you’ll increase equity in the home, without too much of your own outlay, meaning you’ll be in a good position to re-mortgage, and look for a second property with which to do the same.
Advice Note # 6
Find the Critical Mass Point – To make your next move
Now your next move will unlikely be your dream home, it may be your first live-in home or it may be a second small investment property. We predict that if you followed the above advice, by now you will have caught the investment bug and want to continue building equity with renters continuing to help you build a portfolio.
However the lesson in all this is you need to understand the power of equity building and how to leverage off it. If you get this you will be able to quickly and easily self-assess if your in a position to make your next move. So here it is.
Banks are typically only comfortable to lend you 80% of what you’re assets are worth. (sometimes more but there a many things to consider and it’s getting harder) This is what we call an LVR (or a Loan to Value Ratio).
Let’ assume, as in the example above, you bought a house for $200,000. You would have needed a $40,000 deposit and so would have got a loan for $160,000, in this case an LVR of 80%. After a few years of standard principle and interest repayments as well as your additional repayments 2 things will likely have changed;
- You will likely have reduced the principle amount of the loan significantly.
- You may also have received some growth in the asset value itself.
These two combined create a lower LVR, and when the LVR is low enough you may be ready for your next move. To calculate if your ready, you need to have in mind the value of the next asset you want to purchase. Once you know that then here is how you run an initial test.
Calculate your Total Future Asset Value (TFAV)
(Property # 1 estimated current value) + (New Property Purchase Price)
Eg $220,000 + $200,000 = $420,000 TFAV
Calculate your Total Future Lending Needs (TFLN)
(Property # 1 current debt + New Property Purchase Price)
Eg $120,000 + $200,000 = $320,000 TFLN
Calculate Future LVR (FLVR)
Make TFLN as a Percentage of TFAV
$320,000 / $420,000 x 100 = 76% LVR
The aim is to have an LVR less than 80%. In this example it has worked and so it passes an early test of whether you are in a position to make your next property move or not.Remembering there are many other things to consider, but from a basic security view point the banks will like have an appetite to support this loan.
Now you can continue to repeat this process for as long as you like or until you are in a position to perhaps sell some or all of you investments to make that coveted ‘own home’ purchase.
With a keen eye kept on interest rates, the time will eventually come for you to buy your own home. Banks will look favourably upon you as someone who has built a small investment portfolio, even if you are looking at selling both investment properties to fund the purchase of your own home, as the equity built in your investment properties will go towards a significant deposit.
Then with a large amount of equity built into your ‘personal'(own home) asset, you will again be in a strong position to continue with property investing, if you so choose.
If you would like any advice, or have questions on getting into the property investment market, talk to the team at Catalyst Accountants today.