Regardless of your purpose, purchasing a property is first and foremost an investment, and for most people, entering the property market as an owner occupier or an investor is one of the biggest financial investments that can be made in life. Property spruikers and wealth creation companies are not slow to point to the enormous wealth that has accrued to entrepreneurs and investors in the property market. Of course these are facts that are indisputable, many people have made a fortune in real estate yet not everyone’s a winner in the property game for a number of reasons. By far the biggest reason is that the price paid for a property does not stack up in terms of value. As once observed by billionaire Warren Buffett “price is what you pay, value is what you get”. Price is the critical factor in a property’s subsequent financial performance over the life cycle of the investment and is often an issue that is totally ignored by many property spruikers. Compare the two charts below, both based on the assumption of a 10 year, 400K loan on a 500K purchase calculated at the 25 year average interest rate of 8%. The red “Net Relative Value Position” bar refers to the actual price paid less the costs which include Stamp Duties, Fees, Charges and the Selling Commissions which the vendor’s factor into the price. This chart is a relatively healthy one from a purchaser’s point of view climbing into positive equity (yellow bar) within a year or two of purchasing. While you can change the input assumptions these graphs are based upon, the principles remain a constant.
As the first chart indicates buying a property is a little like buying a new car. Due to the costs involved your net relative value position suffers the moment you take possession whereby your equity position reduces in direct proportion to the costs involved in buying, the Stamp Duties, Fees and Charges and the Commissions paid by Vendors, Developers or Builders to Agents, Financial Planners and Wealth Advisers. The second chart however indicates the effect of paying too much for a property. In the first chart there is just over 50K of negative equity applicable at settlement but after 10 years of growth the figure climbs to 235K of positive equity. In comparison to the second chart, based on paying 50K over the true market value, which we have treated as a purchase “cost”, negative equity begins at over 100K, only climbing to 147K positive equity after 10 years of growth, taking 5 years or more to reach a positive equity position adding to the truism that real estate is a long term investment, in this case 5 years or so longer than necessary. In terms of capital growth the first chart indicates growth from 500K to 776K (4.5% compounding) while the second chart reveals growth from the same 500K invested to 698K based on exactly the same growth rate (4.5% compounding) but on an asset that was actually worth 50K less than the purchase price at true market value. As the charts demonstrate, its just not a case of too bad, so sad for paying 50K too much, the purchase continues to under perform for the entire financial performance of the asset over the cycle. In the case of the second chart, interest is being paid not only on the asset, the stamp duties, charges and commissions but on an unnecessary 50K premium with the result that the purchaser is paying interest on over 100K or 20% of the entire value of the asset purely in costs. In summary, we are told that time is money, by paying over the odds for a property we are squandering both the time and the money, which are both lost forever. If you extend the chart to twenty five years the situation improves for both classes of purchaser, however the financial performance of the purchaser who’s property was purchased at true market value will be even more significantly better off than those who have paid the unnecessary premium of buying above true market value. Here we see the truth in the old adage that the profit is realized “when you buy the property rather than when you sell”.
We are not investment or financial advisers, it is not our role to encourage or discourage people who decide to buy or invest in property, neither is it our role to influence those who choose not to. We recognize that along with the significant financial benefits there is always a degree of risk attached to real estate investment given it’s long term nature which must endure the potential of changing economic fundamentals such as interest rates and political influences that may, for one example, impact jobs and employment which affect the ability to service mortgages. Our role, our passion if you like, is to see that our clients, who do decide to invest in property for either owner occupier or investment purposes enjoy the benefits of being in the group described in the first chart, those wishing to avoid the penalties of paying too much for property. As a matter of course we do consider property fundamentals such as position, forecast and historical growth, vacancy rates, rental return, depreciation schedules, amenities and infrastructure both planned and existing, lifestyle appeal, job availability, the general affluence in any given area when recommending any property purchase, however these considerations are secondary to the question of price which is absolutely crucial in a determination of the overall value for money proposition.
After 25 years of involvement and experience in the real estate industry we understand the environment intimately, we understand the big picture, the marketing stunts, and how the property game works in reality. In balance however, we also understand the subtle nuances of applying effective strategies in the negotiation process, strategies that apply universally whether you are building a new home, buying an established home, development site, apartment, or lifestyle property. If you are purchasing, there may well be many good reasons to call us, perhaps many thousands of them.
Cheers, John Andrews