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New paths to home ownership - Eureka Report article

New paths to home ownership

By Scott Francis
March 24, 2010

PORTFOLIO POINT: As houses become harder to afford, buyers should consider new strategies to secure them.

New housing data shows median prices are rising faster than the average incomes, making it harder to buy a house and prompting a change in the way Australians are organising their finances.

Suncorp-Metway figures show that in 1960 the median house price was the equivalent of 3.38 times average annual earnings. By 1990 it was 4.01 times, in 2000 it was 5.08 times, and is now about eight times. There are various ways of measuring the average wage so we should not pretend the data is too precise, but the underlying trend is clear.

The glaring message - which buyers are all too familiar with - is that it is tougher than ever to buy a home, and requires greater effort and strategy that ever before. The days of turning 30, sobering up and throwing out the empty pizza cartons to start a life by putting together a modest deposit and buying a home are over.

Today, it takes a lot more heavy lifting. So with that in mind, what are the options available to people to get themselves into the property market?

Here are five strategies worth considering:

Buying as a rental property first

Most people are aware that a benefit of investing in a residential property is that the tax system allows negative gearing, where the loss from a rental property can be used to reduce your taxable income, and therefore the amount of tax that you pay. If you are struggling to buy into a residential property, one way to start is to use this tax benefit and have the rental income help pay for the property you will live in one day.

The rent and the tax benefit can be added to your own mortgage repayments to reduce your mortgage before you start living in the property. How much might this be worth? Over a five year plan, a tenant paying $350 a week gives you $18,200 a year of extra cash flow, and the tax benefits on a property making a "loss" of $150 a week for an investor in the 31.5% tax bracket (30% plus 1.5% Medicare) is worth $47.25 a week, or $2475 over a year.

The combined impact of these two factors over five years is a not inconsiderable $103,285. Better than any first-home owner's grant for sure!

Buy a cheaper property!

I used to work with a financial adviser who spent a lot of time working with people trying to buy their first home. He said first-time buyers often made the mistake of trying to buy a property as good as their parents'. His advice was move a few suburbs further out, start with a smaller house and take advantage of the lower repayments to clear the mortgage quickly.

That then puts buyers in a very strong position to upgrade as your first house increases in value and your mortgage decreases through extra repayments. Alternatively, an increasing numbers of investors are pairing up with others to make their first purchase (see Monique Wakelin's feature, Property investment buddies).

Living with your parents longer

A recent report by the Bureau of Statistics showed that nearly one-quarter of all Australians aged between 20 and 34 were living with their parents, largely because of financial pressures. But living at home can be a double-edged sword. At its best it allows a young person to buy a rental property, as described above, and use their excess income to start paying that property off. Or it may allow them to start saving for their home deposit - perhaps taking advantage of the First Home Savers Scheme.  At worse, children staying at home longer sees them squander their excess money, develop expensive spending habits and sees them further than ever from buying a property.

Making the 30s count

The 20's have been seen as a time of recreation. Overseas holidays, weekends partying and paying off fast cars have long been seen as rites of passage in early adulthood. However, if home ownership is a goal, then a subtle rethink is in order. Rather than coming out of this period with $15,000 of credit card debt - which can easily happen if a person spends $20 a week more than they earn from age 18 to 26 - they could come out with a $10,000 in cash or substantial investment portfolio if they can find a way to save $20 a week.

Spending or saving just $20 a week is about what stands between someone at age 26 being ready to make a concerted effort to home ownership with $10,000 of assets to help, or having to pay down a pile of credit card debt before they can even start to think of the next step.

Renting rather than buying

The latest data shows Brisbane's median house price is $420,000. Given mortgage rates of 8% (assuming that this is around a historical average - and is where we will be with another 100 basis points of rate rises), council rates of $2000 and property maintenance of $2000 a year, the cost of owning the median house in Brisbane (given "normal" interest rate levels) is about $40,000 a year. The most recent residential tenancies authority reported that the median weekly rent for a three-bedroom house in Brisbane was $370 a week, or $19,240 a year.

The difference is about $20,000 a year. If a person saves and invests this difference, renting can be a reasonably attractive option. Of course, one of the key arguments for buying a property is that paying off a mortgage is a form of "forced saving" - and if the $20,000 a year is not saved and spent on luxuries then it becomes the less attractive option. Five years of saving $20,000 a year (the difference between renting and owning) will put someone in a strong position to buy a property, particularly if combined with the first-home saver scheme.

There is a lot of debate about whether Australian house prices will stay about eight times the average income or follow US and UK falls. Either way, we can say with some certainty that it is difficult to break into the property market at the moment. However, strategies such as buying a rental property first, spending a little longer staying at home and saving a deposit, renting for a while or being prepared to trade up from your first property all make sense. Using these strategies, with a determination to avoid debt in the early years of your 20s, and the government's first-home savers scheme and you will be still be able to build a plan toward the great Australian dream.