Shooweee... with all the sport on the go I clean forgot the Saturday open thread...
19 comments:
Doubting Bear
said...
Hello fellow bears. I urgently need your help. This weekend I was arguing with a property bull who was using the old line, "Renting is money into a black hole". I fought as hard as a I could but he kept telling me to "do the maths". So I went home and did the maths. What I found has shocked me and I am hoping that I went wrong somewhere in my sums. Because what I found was this:
Let's say a Buyer pays a "starter" house for R750,000 at current interest rate (10%) and puts down a deposit of 10%. That leaves him with a loan amount of R675,000 to pay off over 20 years.
Now, if interest rates don't change and he never pays more than he has to, he'll pay R78166 a year for 20 years.
Add onto that bond costs of R31,100, rates and taxes of about R288,000 over 20 years (R1200 a month) and repairs of about R120,000, he will have spent a total of R2,072,892.
That's the ammo I've always used: haha, I say, you suckers are spending R2 million on a R750k house.
So then I compared it to a Renter.
I reckoned he could rent that house for about R5,000 a month. At current interest rates, inflation is heading up by about 6% a year, so I allowed for an annual rent increase of 6%.
Our buyer is spending a total of R98,566 every year (R78,166 bond repayments plus R14,400 in rates plus R6000 in running repairs). So I did the following:
Renter invests the same amount up-front that the buyer invested up-front: R106,100 (deposit plus bond cost). We renters always say, Yes, we don't have a property but we can invest the extra money we save on rent. So let's let this Renter do that: let him invest R98,566 (the Buyer's annual outlay) minus his annual rent. In the first year that's a fat R38,566 that he can invest.
But it starts dwindling fast. By the 8th year of renting he is only R8,348 ahead of the curve. The next year he can only invest R2,936. And by the 10th year he is having to pay more in rent than the Buyer is paying in bond repayments, rates and repairs.
Meanwhile his investment is ticking along. If he's been conservative and stuck it in the bank at 5.5%, after 20 years (and 20 years of tax on his interest), he's going to have R778,965. His total outlay in rent is going to be R2,399,545.
SO...
After 20 years the Buyer has spent a total of R2.07 million.
If the Buyer's house has kept pace with inflation (6% pa), he now has a house worth R2.43 million. He has made a R360,000 profit over 20 years, and now has an asset worth R2.43 million.
The Renter has spent R2,4 million. He has R779,000 in the bank. He has made a loss of R1.62 million over 20 years, and has no assets.
PLEASE PLEASE PLEASE tell me I have made a mistake somewhere.
The bears only see the last 8 years as an example. Man buys R750 house in 2002, man has R3m to R4m house in 2007/2008. With inflation like that it DOES make sense to buy a house. But that is bubble inflation. We won't see that again for a while, maybe never.
I would not advise anyone to buy property at the moment. It's better to rent and save the difference between bond repayment and rent (which in CT can be a fucking huge difference).
@ Anon, I want to agree with youbut as I've just discovered by doing the maths, investing the difference doesn't even come close to making renters better off.
I'm no economist, but if owning was not more sensible financially than renting (in general) where would renters find places to rent?
In other words, if it doesn't pay to purchase even your own home, why purchase additional properties to rent out? Same factors, just scaled up and without the attraction of ownership.
I am no financial guru but to my mind simple maths dictate as follows:
You have to consider the ultimate net financial position of both the buyer and the renter to get a clear picture of who comes out on top.
After 20 years the buyer will only show a profit of R357,108 if he able to sell the property for R2,430,000 i.e. he is left with R357,108 cash and no asset after having spent R2,072,892 in total.
On the other hand, the renter, after 20 years has R778,965 cash in the bank having spent R2,399,545 in total.
However, you still need to take into account that over the same period the renter has spent R326,653 more than the buyer (i.e. R2,399,545 - R2,072,892).
Now, to level out the playing field, deduct the R326,653 difference in spending from the R778,965 cash that the renter has in the bank and he is left with R452,312 cash in the bank.
How does that compare to the cash position of the buyer? Well, the renter has R95,204 more than what the buyer has in his pocket after 20 years! Certainly not an astronomical amount but consider the position if interest rates go up to 18%+.
A few points -firstly, can you presently get R5000 rent for a R750,000 house ? A few years back I was paying R6000 for a R1.9m house - now double that for a house double the worth - that's the reality down in Cape Town.
Your rent / price ratio is near what a normal ratioo should be, so already the sums are going to work better.
I am not sure whether you factored in that the maintenance costs and rates also increase yearly with inflation.
You also didn't factor in that graphs show houses to be 40% overvalued so after inflation has increased 40% the houses can't increase in price to rebalance the excess of the bubble years.
Factor in bad economic times which means increasing rent is not such an easy option - in my price range already 20% of renters have stopped paying and a further 13% are behind.
Factor in that bond rates are also at the lowest point and from here can only go up - one MD of an estate agent chain predicted they could rise 50% in the next 2 years.
Also remember that although the R2.4m sounds a lot of money, after inflation it is just the same as the house is worth now, ie R750,000. If the house lags 40% behind inflation then in inflation adjusted terms you will sell the house in 20 years for the equivalent of R530,000.
Factor all this in and suddenly your maths doesn't balance so nicely and could well end up being a money pit with the potential to bankrupt you.
Over priced houses, a recent peak of a housing bubble, interest rates that have bottomed and our heading up soon, financial stressed renters ... this is not the sort of combo you want in BTL. 10 years ago you had the reverse - that is why is worked out so well. To think you can do the same now is gullible wishful thinking. Times have changed. The writing is on the wall and the more enlightened BTLetters are bailing out.
And of course, when more discover the truth and an increasing number of buy-to-letters bail out, down come the prices.
@ Anon #2, thanks for the breakdown. However, I think you've made a mistake. If the buyer does manage to sell his house after 20 years, he and the renter will be in the same position - neither will own a house. But the buyer will have the sale price in cash - R2.4 million - because he owns it free and clear. The renter will have only R780k in the bank. This is what makes me concerned that I've been overlooking something in my arguments for so long.
@ CJ Says, good points. I suppose I can't just create a mathematical scenario based on current numbers without taking into account current fundamentals. I'll go back to my spreadsheet and fiddle with some bearish factors.
There is no point in buying an overvalued asset. EVER. People don't get rich buying things that are overpriced. That said, if property dips 30-40% from current prices, it may be worthwhile buying again.
Is Cape Town still that over-valued? I know that the Atlantic Seaboard and City Centre are, but places like Parklands, Blouberg, Durbanville, Constantia - are these still over-valued.
My feeling is the residential CBD lower-end is overbuilt and overvalued. It will be some time before a rising tide floats those boats. The higher end and Atlantic Seaboard follow their own path, though and I suspect the correction for actual value has occurred, not to say there will not be bargains as distressed sellers finally unload.
I think the only effect of the World Cup on Cape Town will be secondary, with some who had never visited before considering a future purpose. I doubt many will be looking at property during their visit.
Hotel occupancy in Cape town is presently only 60% ! Remember when people were buying in Century City's residential complexes and boasting about how they were going to make a killing during the World Cup !
The backpackers are full though - maybe estate agents can organise show day bus tours in Clifton for the backpackers !
In case anyone is interested, there is still no sign of the Argus weekend food basket making a return. I highlighted that the Argus basket of food ( that they had been pricing and graphing every week for the last 3 years ) vanished 6 weeks ago when I started highlighting that it was showing that food had increased in price 20% in a 4 month period and that interest rates would surely soon follow ... someone didn't like me pointing this out ( the Argus' estate agent paymasters are my primary suspects) and the feature was hastily removed and hasn't been seen since.
I would still be interested if there are any insiders out there who can spill the beans and tell us what happened. Who made the phone call ?
At this time it makes sense to take advantage of a few things: 1) rent to buy monthly cost ratio hugely in favour of renter in higher price bracket - therefore rent a nice house to live in. 2)Cost of acquiring a smaller property is lower than buying expensive (ie first 500 000 free of transfer duty), and those propoerties tend to yield higher and pay themselves off more quickly 3) Prices of property have stabilised and dropped over the past few years, so it is less risky to invest in small higher yielding properties 4) Initial losses on your negative cash flow on buy-to-rent are somewhat offset by tax deduction, so that helps to get you to break even more quickly.
Thus, accumulating a few low end safer properties in a portfolio is not such a bad ideas - as long as you project you can cope with higher interest rates that are in the offing, and higher costs such as rates and taxes (which are tax deductions anyway of you rent the properties). You also need to be bullish on a stable SA (or Western Cape) future, as this strategy takes a few years to really start paying off. This might work even with a further slight drop in property prices, I think.
Bottom line - rent the expensive stuff to enjoy your lifestyle, and own and rent out the cheap stuff to build a stable cash flow.
I've made a similar simplified spreadsheet that you can access here: https://spreadsheets.google.com/ccc?key=0Auu_0fbpf0oSdE9fYWVRWEh0Y0N5VVJ6MWJoYWR6cmc&hl=en if you're interested
What's most telling is that the rent-to-bond-payment ratio is very important, which makes sense. For the numbers I've got, it's better over 20 years with:
to rent when the ratio is less that 44%. Anything above that, it's better to buy. Cape Town?
Now, what's also very important is the major impact that inflation bears on the calculation. If average inflation goes up to 10%, it's almost impossible to make renting a better proposition, as the rent-to-bond ratio needs to be around 10% to better the buying scenario.
So, as we know, higher inflation helps the owners, and screws those who cannot afford to buy.
Thanks Benjamin - so given a tax deduction of around 30% of bond repayment initially (conservatively) on a rental property purchase, what rent:bond ratio makes sense for an investor to dive in ?
And, by the way, an assumption o 10% property price escalation seems a bit high at this time, especially on an expensive property.
Anyone tracking the new SIX development in Sir Lowry Rd (yes the dodgy area near the Goodhope centre). This has got to be one of the ugliest new developments. Well, besides Upper East Side, but Upper East Side had to work with the existing building so I'll forgive them. (kind of). I've seen lots of appartments available to rent in SIX on gumtree.
The implications of the real trend in UK house prices are:
a. The housing market is nowhere near reaching another boom phase which only coincides when house prices pass their previous peak in REAL terms i.e. after inflation, this suggests that any upward trend in house prices is going to be shallow where the next boom could be as long as a decade away.
b. That the housing market in real terms has barely lifted off of its March low and is thus highly susceptible to a prolonged period of stagnation in real terms, i.e. the housing market basically goes nowhere for several years in real terms.
c. That it is highly likely that we have yet to see the low in UK house prices in real terms, which either means a sustained period of inflation or that the UK house prices revisit there 2009 March Bear market lows.
19 comments:
Hello fellow bears. I urgently need your help. This weekend I was arguing with a property bull who was using the old line, "Renting is money into a black hole". I fought as hard as a I could but he kept telling me to "do the maths". So I went home and did the maths. What I found has shocked me and I am hoping that I went wrong somewhere in my sums. Because what I found was this:
Let's say a Buyer pays a "starter" house for R750,000 at current interest rate (10%) and puts down a deposit of 10%. That leaves him with a loan amount of R675,000 to pay off over 20 years.
Now, if interest rates don't change and he never pays more than he has to, he'll pay R78166 a year for 20 years.
Add onto that bond costs of R31,100, rates and taxes of about R288,000 over 20 years (R1200 a month) and repairs of about R120,000, he will have spent a total of R2,072,892.
That's the ammo I've always used: haha, I say, you suckers are spending R2 million on a R750k house.
So then I compared it to a Renter.
I reckoned he could rent that house for about R5,000 a month. At current interest rates, inflation is heading up by about 6% a year, so I allowed for an annual rent increase of 6%.
Our buyer is spending a total of R98,566 every year (R78,166 bond repayments plus R14,400 in rates plus R6000 in running repairs). So I did the following:
Renter invests the same amount up-front that the buyer invested up-front: R106,100 (deposit plus bond cost). We renters always say, Yes, we don't have a property but we can invest the extra money we save on rent. So let's let this Renter do that: let him invest R98,566 (the Buyer's annual outlay) minus his annual rent. In the first year that's a fat R38,566 that he can invest.
But it starts dwindling fast. By the 8th year of renting he is only R8,348 ahead of the curve. The next year he can only invest R2,936. And by the 10th year he is having to pay more in rent than the Buyer is paying in bond repayments, rates and repairs.
Meanwhile his investment is ticking along. If he's been conservative and stuck it in the bank at 5.5%, after 20 years (and 20 years of tax on his interest), he's going to have R778,965. His total outlay in rent is going to be R2,399,545.
SO...
After 20 years the Buyer has spent a total of R2.07 million.
If the Buyer's house has kept pace with inflation (6% pa), he now has a house worth R2.43 million. He has made a R360,000 profit over 20 years, and now has an asset worth R2.43 million.
The Renter has spent R2,4 million. He has R779,000 in the bank. He has made a loss of R1.62 million over 20 years, and has no assets.
PLEASE PLEASE PLEASE tell me I have made a mistake somewhere.
The bears only see the last 8 years as an example. Man buys R750 house in 2002, man has R3m to R4m house in 2007/2008. With inflation like that it DOES make sense to buy a house. But that is bubble inflation. We won't see that again for a while, maybe never.
I would not advise anyone to buy property at the moment. It's better to rent and save the difference between bond repayment and rent (which in CT can be a fucking huge difference).
@ Anon, I want to agree with youbut as I've just discovered by doing the maths, investing the difference doesn't even come close to making renters better off.
I'm no economist, but if owning was not more sensible financially than renting (in general) where would renters find places to rent?
In other words, if it doesn't pay to purchase even your own home, why purchase additional properties to rent out? Same factors, just scaled up and without the attraction of ownership.
@ Doubting Bear
I am no financial guru but to my mind simple maths dictate as follows:
You have to consider the ultimate net financial position of both the buyer and the renter to get a clear picture of who comes out on top.
After 20 years the buyer will only show a profit of R357,108 if he able to sell the property for R2,430,000 i.e. he is left with R357,108 cash and no asset after having spent R2,072,892 in total.
On the other hand, the renter, after 20 years has R778,965 cash in the bank having spent R2,399,545 in total.
However, you still need to take into account that over the same period the renter has spent R326,653 more than the buyer (i.e. R2,399,545 - R2,072,892).
Now, to level out the playing field, deduct the R326,653 difference in spending from the R778,965 cash that the renter has in the bank and he is left with R452,312 cash in the bank.
How does that compare to the cash position of the buyer? Well, the renter has R95,204 more than what the buyer has in his pocket after 20 years! Certainly not an astronomical amount but consider the position if interest rates go up to 18%+.
A few points -firstly, can you presently get R5000 rent for a R750,000 house ? A few years back I was paying R6000 for a R1.9m house - now double that for a house double the worth - that's the reality down in Cape Town.
Your rent / price ratio is near what a normal ratioo should be, so already the sums are going to work better.
I am not sure whether you factored in that the maintenance costs and rates also increase yearly with inflation.
You also didn't factor in that graphs show houses to be 40% overvalued so after inflation has increased 40% the houses can't increase in price to rebalance the excess of the bubble years.
Factor in bad economic times which means increasing rent is not such an easy option - in my price range already 20% of renters have stopped paying and a further 13% are behind.
Factor in that bond rates are also at the lowest point and from here can only go up - one MD of an estate agent chain predicted they could rise 50% in the next 2 years.
Also remember that although the R2.4m sounds a lot of money, after inflation it is just the same as the house is worth now, ie R750,000. If the house lags 40% behind inflation then in inflation adjusted terms you will sell the house in 20 years for the equivalent of R530,000.
Factor all this in and suddenly your maths doesn't balance so nicely and could well end up being a money pit with the potential to bankrupt you.
Over priced houses, a recent peak of a housing bubble, interest rates that have bottomed and our heading up soon, financial stressed renters ... this is not the sort of combo you want in BTL. 10 years ago you had the reverse - that is why is worked out so well. To think you can do the same now is gullible wishful thinking. Times have changed. The writing is on the wall and the more enlightened BTLetters are bailing out.
And of course, when more discover the truth and an increasing number of buy-to-letters bail out, down come the prices.
@ Anon #2, thanks for the breakdown. However, I think you've made a mistake. If the buyer does manage to sell his house after 20 years, he and the renter will be in the same position - neither will own a house. But the buyer will have the sale price in cash - R2.4 million - because he owns it free and clear. The renter will have only R780k in the bank. This is what makes me concerned that I've been overlooking something in my arguments for so long.
@ CJ Says, good points. I suppose I can't just create a mathematical scenario based on current numbers without taking into account current fundamentals. I'll go back to my spreadsheet and fiddle with some bearish factors.
@ CJ, I agree with you.
There is no point in buying an overvalued asset. EVER. People don't get rich buying things that are overpriced. That said, if property dips 30-40% from current prices, it may be worthwhile buying again.
Is Cape Town still that over-valued? I know that the Atlantic Seaboard and City Centre are, but places like Parklands, Blouberg, Durbanville, Constantia - are these still over-valued.
I'm not tracking them, so cannot answer.
Is it too soon for any news on the impact of SWC tourists on buying Cape property?
I know many realtors were hoping that cash rich Europeans SWC fans would "snap" up Cape property when they were in town.
Anything in the news on this topic? Just curious.
My feeling is the residential CBD lower-end is overbuilt and overvalued. It will be some time before a rising tide floats those boats. The higher end and Atlantic Seaboard follow their own path, though and I suspect the correction for actual value has occurred, not to say there will not be bargains as distressed sellers finally unload.
I think the only effect of the World Cup on Cape Town will be secondary, with some who had never visited before considering a future purpose. I doubt many will be looking at property during their visit.
My upfront apologies, this is besides the point but I had a giggle when I saw this:
6 Bedroom Clifton Villa for rent for a measly R35k per month.
http://capetown.gumtree.co.za/c-Flat-House-Real-Estate-houses-flats-for-rent-Magnificent-6-bedroom-house-available-in-Clifton-Bantry-Bay-W0QQAdIdZ210332508
And don't tell me this house would not "command" at least R35 million if it were for sale. R1k per month per million... GREAT INVESTMENT
Hotel occupancy in Cape town is presently only 60% ! Remember when people were buying in Century City's residential complexes and boasting about how they were going to make a killing during the World Cup !
The backpackers are full though - maybe estate agents can organise show day bus tours in Clifton for the backpackers !
In case anyone is interested, there is still no sign of the Argus weekend food basket making a return. I highlighted that the Argus basket of food ( that they had been pricing and graphing every week for the last 3 years ) vanished 6 weeks ago when I started highlighting that it was showing that food had increased in price 20% in a 4 month period and that interest rates would surely soon follow ... someone didn't like me pointing this out ( the Argus' estate agent paymasters are my primary suspects) and the feature was hastily removed and hasn't been seen since.
I would still be interested if there are any insiders out there who can spill the beans and tell us what happened. Who made the phone call ?
At this time it makes sense to take advantage of a few things:
1) rent to buy monthly cost ratio hugely in favour of renter in higher price bracket - therefore rent a nice house to live in.
2)Cost of acquiring a smaller property is lower than buying expensive (ie first 500 000 free of transfer duty), and those propoerties tend to yield higher and pay themselves off more quickly
3) Prices of property have stabilised and dropped over the past few years, so it is less risky to invest in small higher yielding properties
4) Initial losses on your negative cash flow on buy-to-rent are somewhat offset by tax deduction, so that helps to get you to break even more quickly.
Thus, accumulating a few low end safer properties in a portfolio is not such a bad ideas - as long as you project you can cope with higher interest rates that are in the offing, and higher costs such as rates and taxes (which are tax deductions anyway of you rent the properties). You also need to be bullish on a stable SA (or Western Cape) future, as this strategy takes a few years to really start paying off. This might work even with a further slight drop in property prices, I think.
Bottom line - rent the expensive stuff to enjoy your lifestyle, and own and rent out the cheap stuff to build a stable cash flow.
Interesting.
I've made a similar simplified spreadsheet that you can access here: https://spreadsheets.google.com/ccc?key=0Auu_0fbpf0oSdE9fYWVRWEh0Y0N5VVJ6MWJoYWR6cmc&hl=en if you're interested
What's most telling is that the rent-to-bond-payment ratio is very important, which makes sense. For the numbers I've got, it's better over 20 years with:
10% Interest rates
10% Investment return
6% inflation
to rent when the ratio is less that 44%. Anything above that, it's better to buy. Cape Town?
Now, what's also very important is the major impact that inflation bears on the calculation. If average inflation goes up to 10%, it's almost impossible to make renting a better proposition, as the rent-to-bond ratio needs to be around 10% to better the buying scenario.
So, as we know, higher inflation helps the owners, and screws those who cannot afford to buy.
Thanks Benjamin - so given a tax deduction of around 30% of bond repayment initially (conservatively) on a rental property purchase, what rent:bond ratio makes sense for an investor to dive in ?
And, by the way, an assumption o 10% property price escalation seems a bit high at this time, especially on an expensive property.
Anyone tracking the new SIX development in Sir Lowry Rd (yes the dodgy area near the Goodhope centre). This has got to be one of the ugliest new developments. Well, besides Upper East Side, but Upper East Side had to work with the existing building so I'll forgive them. (kind of). I've seen lots of appartments available to rent in SIX on gumtree.
Supposedly houses are becoming less affordable:
http://www.fin24.com/PersonalFinance/Property/More-expensive-to-buy-a-house-20100613
I wonder what will happen when interest rates begin to go up?
L.S
Look to the UK for what we can expect here:
http://www.marketoracle.co.uk/Article20377.html
The implications of the real trend in UK house prices are:
a. The housing market is nowhere near reaching another boom phase which only coincides when house prices pass their previous peak in REAL terms i.e. after inflation, this suggests that any upward trend in house prices is going to be shallow where the next boom could be as long as a decade away.
b. That the housing market in real terms has barely lifted off of its March low and is thus highly susceptible to a prolonged period of stagnation in real terms, i.e. the housing market basically goes nowhere for several years in real terms.
c. That it is highly likely that we have yet to see the low in UK house prices in real terms, which either means a sustained period of inflation or that the UK house prices revisit there 2009 March Bear market lows.
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