With residential property prices in Sydney on a seemingly endless upwards trajectory, many investors feel they need to enter the market now, or else risk being left in the cold. But there are a number of issues that need to be considered before investing in residential property, according to Jonathan Philpot, partner, wealth management, HLB Mann Judd Sydney.
“With interest rates at historical lows, and showing no signs of rising anytime soon, there is a perception that now is a good time to buy property as low rates make housing more affordable,” Mr Philpot said.
“But Sydney property is not affordable by global standards. A common way of measuring affordability is to compare median house prices to household income. By this measure, house price affordability in the US and UK is sitting at 3.6 and 4.7 respectively. In Australia, it is at 6.4 and in Sydney it is at 9.8. By this measure, Sydney is one of the most expensive cities in the world and for first home buyers a much tougher market to enter than other Australian capital cities or regional areas.
“It won’t surprise house hunters to learn that the Sydney median house price has increased 14.5 per cent for the year to 30 April 2015. But the wisdom of investing in a property in Sydney needs to be considered from the point of view of income as well as capital growth.
“With a net yield of less than 2 per cent for many properties in Sydney, from a price/earnings (PE) perspective Sydney property is sitting at 50 or above. This is far higher than the Australian share market PE of 15.
“Of course, property investors do not have to experience the daily volatility of shares, and from an investor’s view, the tangible benefits of being able to see your property and make ‘DIY’ improvements will often increase the preference for property.
“Equally, most people are invested in property for the long term, so are unconcerned about a property correction over the next few years. But what about the next 10 years?” Mr Philpot asked.
“Our long term view on the Australian share market is very good. With low interest rates and very good dividend yield of close to 6 per cent including franking credits, we forecast a 10% return for Australian shares over 10 years.
“Our 10 year number for Sydney residential property sits at half the Australian share market expected return, at only 5 per cent. This is mostly due to the low net yield of about 2 per cent and the logic that if a market has already experienced strong growth, this typically suggests that the next period of growth will not be as strong.
“It is impossible to call the end of any bubble, but certainly investors who already have Sydney investment properties should consider whether their wealth has appropriate diversification before purchasing further in Sydney.
“Two investment properties and a handful of Telstra and bank shares do not make a diversified investment portfolio,” he said.
Mr Philpot also expressed caution about the trend for young investors to gear up self managed super funds with investments in Sydney property.
“Negative gearing is more effective the higher the tax rate payable. For this reason it is a popular strategy for those on the highest marginal tax rate. Superannuation, with its concessional tax rate of 15 per cent, is below most of the individual tax rates. It will usually provide less of a tax benefit, compared to simply negative gearing into a property personally, outside of the superannuation environment.”
Another consideration is whether the geared property is the only investment within the SMSF, Mr Philpot said.
“With the loan repayments taking up all of the contributions and rental income for the length of the loan period, it could lead to a very poor return and a low super balance at retirement for those that adopt this aggressive strategy, as opposed to just leaving their super in an industry or retail fund.
“Rising interest rates pose another risk for this strategy. If interest rates were to rise a couple of percentage points, cash flow may become a problem because of the limited concessional contribution levels. This may result in having to make additional superannuation contributions that do not receive a tax benefit (called non-concessional contributions), in order to meet the repayments on the loan within the SMSF, a strategy that will most likely divert money away from the home mortgage.”
House price affordability information from AMP Capital. Sydney house price increases from RP Data.
HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and a member of the HLB Mann Judd Australasian Association.
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