Introduction

The Real Estate Institute of Australia (REIA) says that at December 1980 the median home price in Sydney was $76,000. By September 2016, the same body reported that the median home price in Sydney was $1,076,878. The story was much the same across the other major capital cities, although Melbourne and Sydney had ‘performed’ slightly more strongly across the period.

That’s a significant increase in value over three decades. The increases have been bigger in the better suburbs.

Home values don’t go up every year. But they do go up every decade. When you look at home values over the decades there is a significant upwards-sloping trend line. The GFC dampened home values in the final part of the 2000s. But the Real Estate Institute of Victoria reports that the median house price in Melbourne rose by 5% in the last three months of 2016 alone. That tends to be the way with property prices: flat years are interspersed with strong ones, meaning that growth is generally lumpy, but positive over time.

How have GPs gone investing in their homes?

As good as these results are, many GPs have done even better. This is because GPs tend to buy better homes in better suburbs, and these homes appreciate faster than others. Some GPs have made fortunes just owning their homes.

Consider the scene in a Vaucluse lounge room in 1997, when a young financial adviser could almost not believe the GP when she said her home was worth more than $1,000,000. It did not seem that big or that good a home. It just seemed like an average home. And it was. The average home was worth more than $1,000,000. Vaucluse was the first suburb in Australia to break this price barrier. Paul Keating lived around the corner. It was the place to be.

The GP was wealthy because she bought there ten years earlier for less than $500,000. She is even wealthier now: the median value for Vaucluse is now more than $4,000,000. That’s an excellent return on investment. Sure it’s taken three decades. But that’s how long property takes to generate real returns, and it’s how long good properties should be held for.

Most GPs don’t live in Vaucluse. But most GPs live in better suburbs that have experienced better price increases over the last thirty years. Most GPs have experienced significant tax- free capital gains as well as enjoying the amenity and lifestyle the home offers.

What are future home prices expected to be?

Fifty years is a long time. But it’s how long property should be held for – Dr Vaucluse is 60% of the way there already. Property is an intergenerational asset and over the decades and generations will produce excellent rates of return.

How excellent? Well, obviously precise predictions of future prices are not possible. There are too many variables in the equation. But let’s stick to the basics, and look at what is expected to happen to Australia’s population over the next fifty years, and try to make an educated guess about home prices from that.

The Australian Bureau of Statistics provides the following data:

State Population 2012 Population 2062 Increase %
Sydney 4,700,000 8,500,000 80%
Melbourne 4,200,000 8,600,000 105%
Perth 1,900,000 5,500,000 187%
Brisbane 2,200,000 4,800,000 118%
Adelaide 1,300,000 1,900,000 46%
Darwin 131,900 225,900 71%

Population growth underpins property price growth. In 1997, Australia’s population was 18.5 million. In 2016, it was 24.3 million. That’s an increase of more than 30%.

Income levels will rise too. Inflation runs at roughly 3% a year, so a $1,000,000 home in 2017 will be worth at least $4,384,000 in 2067 if it does nothing more than keep up with inflation.

Much of Australia’s population growth is driven by immigration. More than 220,000 arrive each year, and most are well educated, reasonably well off, and very aspirational: they want to get ahead in the Lucky Country and they work very hard to do so. Of this 220,000, nearly half arrive just in Melbourne, keeping demand for Melbourne property, particularly the fashionable inner, eastern and bayside suburbs rising and rising each decade.

These aspirations are shared by older Australians too: just listen to talk back radio for a day to witness the energy and effort put in to buying and keeping a home. It’s an intrinsic part of the Australian culture and psyche, and there is a stigma attached to not owning a home.

Obviously the more fashionable suburbs will be in more demand. They are privileged locations and people will fight to get there.

Vaucluse in 2017 is probably still a very good buy. One day a GP will boast she bought Vaucluse for a song at just $4,200,000 way back in 2017.

Should you own a home?

The above anecdotes and tables seem to be a persuasive case for home ownership, particularly in the suburbs GPs like to live in.

But not everyone agrees.

Phil Ruthven is a well-known economics and social commentator. He argues owning a home as an investment is irrational and unlikely to produce optimum investment results. He says home ownership is nice emotionally but most will be better off renting different homes that suit them at different times in their life and implementing a disciplined investment strategy based purely on rational grounds (perhaps – indeed probably – including one or more investment properties).

Mr Ruthven says this is particularly the case if  the hidden costs of home ownership are considered, such as hours and dollars spent improving the home, rates and repairs, and stamp duty, legal fees and other transaction costs when we move every seven years.

There is something in what Mr Ruthven says. This is particularly if you move  more than once every seven years or if your home is not in a good performing suburb.

In July 2014 the Reserve Bank released a report saying that house prices need to go up by more than 2.9% a year for buying to beat renting.

On balance, though, we do not offer the same advice as Mr Ruthven. Fundamentally, the great advantage of home ownership is forced savings. Apart from super, most people would not save a cent were it not for the forced saving of regular home loan repayments. Most GPs own homes in good performing suburbs for more than seven years (and as you know we recommend homes be owned for decades and even generations).

GPs are more likely to pay off the (expensive non-deductible home) loan fast and to implement a separate disciplined investment strategy. Once again, it’s the unusual height, stability, scalability and longevity of the GPs’ income coming into play: put simply, GPs can afford to buy better homes, pay them off quickly and keep them as investments when they up-grade to the next home.

This means homes work well as investments for GPs. And on balance we expect the Reserve Bank’s 2.9% price increase to be easily beaten by the better suburbs in most major capital cities: 2.9% is barely the inflation rate, and well below the historical rates of return actually generated in these markets.

Our approach to family homes

Nearly every meeting we have with a GP discusses the GP’s home.

Questions include: Should it be sold? Should it be kept? Should it be renovated? Should it be protected? Should it be left in a will? Should it be used as security for an investment loan?  Should it be used as security for an adult child’s home loan?

For GPs who do not own homes some questions include: Should I rent or buy? Should I buy something small and affordable for now, pay it off fast and up-grade later? Or should I buy something more than I can afford now, and work harder than ever before? Should I invest in shares instead, buying a fixed amount every month rather than paying off a home loan? Should I buy a practice first?

There is some evidence that Australia’s historically high home ownership rates are falling. Home ownership rates have fallen from 71.4% to 69.5% since the 1990s, with Australian being one of only five OECD countries where home ownership rates fell during this period.

This does not seem like much of a drop, particularly as the population grew strongly during this period and home prices grew even more strongly. The level of home ownership, and aspiring home ownership, in the medical profession has certainly not dropped.

Owning a home, and variations on the theme, is a major point of interest amongst GPs of all ages, and the home remains the greatest store of wealth for most GPs. Super is catching up, and may be one day will overtake home ownership as the most valuable asset for many people. But I would not mind betting that as GP super balances grow average home value will grow even faster, due to a wealth effect between these two asset classes. That is, GPs (like many others) will be more willing to take on more loans to buy more home as their super balances rise. Basically, wealth derived from anywhere tends to get invested back into property.

What are the advantages of home ownership?

The advantages of home ownership can be as much psychological than financial. It’s all about the nesting instinct and territoriality: this is your home, and your home is your castle.  Home ownership provides a sense of permanence and control that is important to overall psychological happiness.

Residential properties, and the loans used to buy them, are a great way to save.

Many people, GPs included, would not save a cent if it was not for the principal component of their home loan repayments. Later, when the home is paid off, home owners do not have to pay anything, while non-owners pay rent for the rest of their life.

The family home, including improvements, is usually free of capital gains tax. The principal place of residence is excluded from the CGT net by dint of social policy and political survival. Improvements to the home are CGT-free, so if a $100,000 improvement creates $150,000 of value, that extra $50,000 is tax-free.

For older people, the home is outside the assets and income test for the age pension. Pensions are usually not an issue for GPs. But sometimes they are.

Increasingly older GPs without significant investments are using reverse mortgages to access the equity in their home without having to sell it. Reverse mortgages turn homes into tax-free reservoirs of wealth. Individuals can smooth consumption over their expected lifespan by building up the reservoir during their working years and running it down in retirement.

The Australian Master Financial Planning Guide 2013-14 (Walters Kluwers) recognises other advantages as including:

  • Provides security since the alternative, renting, may involve the owner selling the property;
  • Avoids the stigma that some feel may attached to not owning a home;
  • Lifestyle choice where wealth creation is not the primary objective;
  • Paying off the home loan is a form of personal saving; and
  • Freedom to make personal changes to the property.

What are the disadvantages of home ownership?

Property can be expensive to buy and hold. Acquisition costs include stamp duty (work on 5% of the cost), bank fees, solicitors’ fees and titles office costs. Holding costs include council and water rates interest, land tax, maintenance and repairs, and real estate agent’s fees. These can be significant and are often ignored when people calculate the gains made on their homes.

Critics also list the opportunity cost on foregone investments and a lack of diversification, which means higher risk. But historically neither has held true. Think of the numbers we discussed above. Any lack of diversification is to the homeowners’ advantage – who wants to diversify into a lower-earning asset class?

Critics say residential property is not a liquid asset. This is not a problem for GPs because they have high, stable, secure, scalable and long income streams, so cash flow is rarely a concern. It has been even less of a problem in the past 10 years because equity access loans (debt facilities linked to the value of the home) allow GPs to cash out some of the value of their home, whether for consumption, investment or business purposes. Illiquidity is not a problem for property owning GPs.

The Australian Master Financial Planning Guide 2013-14 (Walters Kluwers) recognises other potential disadvantages as including:

  • Property prices can go down, as well as up;
  • Demand for property may be lower in the future due to:
  • Low inflation, which reduces the potential for high capital gains;
  • Increasing unemployment rates;
  • The global financial crisis and continued global financial instability;
  • The high costs of buying and selling property, including legal fees and stamp duty;
  • The opportunity cost on missing out on other better performing investments;
  • Lack of diversification;
  • Property not being suited to investment;
  • Miss out on other tax concessions, even though homes are CGT free; and
  • Homes are illiquid, ie hard to convert to cash.

So, what do we say to GPs?

We generally say GPs should own as much home as the bank will let them as soon as they can, and then pay off this loan as fast as they can. GPs who followed this advice have done well so far and it is unlikely this will change much over the coming decades.

We are not sure what will happen to home prices over the next five years. But we do know that well located homes in good suburbs will cost a lot more in 2034 than they do in 2014. GPs should be fattening their residential property portfolios and buying a home, or up-grading to a better home, is one way of doing this.

The advantages and disadvantages of home ownership set out above are all valid and relevant. We believe the advantages outweigh the disadvantages.

In particular, the strong population growth over the next few decades dominates our thinking and means home values will rise significantly in the popular suburbs, particularly Melbourne, Brisbane and Sydney. We therefore routinely recommend GPs buy good quality well located premises in these areas, with a holding period of two decades, both as homes and as investments.

When should you sell your home?

Many GPs are too quick to sell their homes, particularly when upgrading to a new home.

Homes have been incredibly good investments over the years. So usually it’s not long before the sale of the old home is regretted.

GPs should consider never selling their old home when they up-grade, and should instead retain it, rent it out and let time do the rest. The first few months, or even years, may be tight, but before long the value of the new home and the old home will rise and the decision will be validated.

As a helpful hint, use interest offset accounts as much as possible: you can withdraw your equity and transfer it to the new home, reducing non-deductible debt, while the old home becomes a negatively geared investment property.

What if your home is not expected to appreciate?

GPs in capital cities think home prices always go up. And in most capital cities they almost always do always go up, at least eventually.

But outside capital cities the position is more complex. In some places prices do not go up at all. In other places prices fall. That’s why we always recommend rural GPs own at least one residential property in a capital city. The historically poor performance of rural residential property and the expected price increases for major cities makes this a must for both investment and lifestyle reasons.

The experience of one rural GP illustrates the point. He bought a property in the Melbourne suburb of North Fitzroy in the early 1980s using 100% borrowed funds. The property was rented through an agency for about 10 years under a classic negative-gearing strategy. The tenant and tax deductions basically paid for the property, while its market value rose … and rose and rose.

The GP chose to pay off the investment loan as quickly as possible, which is always the way to go with any investment or business loan.

By the early 1990s, its value had doubled and the original debt was almost gone. The eldest of the GP’s three children came to study in Melbourne and moved into the house. It became a student house, with rooms rented on a monthly basis and a kitty for common costs.

The child used the money from the other students to cover her own living costs. This was in line with an ATO ruling that says board is an offset to a private, and hence non-deductible, cost, and is not assessable income.

The parents could not claim tax deductions for the property, since it was no longer producing rent. But this did not matter, as the interest cost was negligible and not worth worrying about. Interest rates were dropping too.

Over the next few years the other two children took up rooms in the house. This meant the board from the other students dropped off, but was offset by the savings in living costs and the convenience of having a Melbourne base. It meant the children could live together and the parents had a place to stay when they came to Melbourne for a weekend (which the kids were not always glad to see happening).

The children lived in the North Fitzroy home into their late twenties, and their parents visited every few weeks. Each of the children then bought their own home elsewhere in Melbourne (few people return to the country once they have moved to the city). The kids bought these homes much earlier than they otherwise might have – living rent free for years meant they had bigger deposits years earlier than otherwise.

The North Fitzroy purchase stood the test of time. Not only has it stacked up as an investment on its own, it has also offered definite lifestyle advantages. The children stayed together in a secure and pleasant house, and mum and dad visited whenever they wanted. This gave the children a real head start in buying their own homes, and saved them tens thousands of dollars.

The parents have now retired to Melbourne to be close to their grandchildren. They renovated the house, and had a readymade home bought at 1984 prices, not 2017 prices.

And its pre-capital gains tax to boot!

Interest offset accounts

GPs should use interest offset accounts rather than paying off home loans directly.

A young GP registrar had $400,000 in the bank. She wanted to buy a smaller home, but was aware that her needs may change in five years time when she expected to up-grade to a bigger home better suited to a young family.

The advice was to buy a town house that suited her now (ie high security, low maintenance) in North Sydney for $750,000, borrowing 100% and asking her father to guarantee the loan, and place her $400,000 in an offset account.

This meant she only paid interest on the net amount of $350,000, rather than paying non- deductible interest at 5% on $750,000 and being paid taxable interest at 3% on $400,000.

She saved a total of $12,800 a year cash after tax, calculated as follows:

Without interest offset With interest offset Amount saved after-tax
Interest paid at 5% $37,500 $17,500
Interest income at 3% $12,000 Nil
Less tax at 40% $4,800 $7,200 Nil Nil
Net cost   $30,300   $17,500 $12,800

But it gets better. In five years when she needs a bigger home better suited to a young family she can withdraw her $400,000, plus any extra amounts deposited into this account principal repayments, and use this to help pay for the new home. She then retains the old home as a geared property investment – and gets a tax deduction for all of the interest on the $750,000 loan.

In summary, we recommend GPs use interest offset accounts rather than directly pay off loans because this allows GPs to transfer the equity in their old home to the new home when they up- grade, and retain the old home as a geared property investment.

Homes for children

Investing over the decades and the generations mean children and even grandchildren are very much in our minds.

GPs with children over the age of 18 should encourage those children to buy their first home. A loan, or a bank guarantee, from mum and dad means the next generation can enter the property market much earlier than otherwise, and can buy properties at 2017 prices rather than 2037 prices. And if the children stay at home and rent the property the tenant and the tax benefits pay most of the costs, really accelerating the wealth creation process.

It’s a great way to create a permanent financial advantage for your children.

The only real down side is the risk that the property may fall in value and the parents become exposed under the guarantee. This is a manageable risk, and one most GPs are prepared to take on.

It’s never too early

A recent experience of a GP highlighted the effect of time on residential property investments, and the power of gearing to increase returns many times over.

The GP finished her medical training in the early 1990s. She did not earn much in the early days and took on an extra session each week in an outer-suburban practice. Her friends thought her a bit excessive and her parents thought her a workaholic. None understood her. University was gruelling, so why not kick up your heels a bit before the next phase of your life starts?

The pay was good and she easily saved an extra $500 a week. It was left intact in a separate bank account that she never touched.

Three years later she and her fiancé were looking to buy their first home. They checked their finances and found they had none – except for the $500 a week extra pay, which had grown to $75,000. This was just enough for a deposit on a nice townhouse in a fashionable beachside suburb. The loan was scary – $300,000. Even on two incomes, it seemed they would be working forever to pay for it. So all her income went to paying off the loan, and they lived on his salary. They had to beat this debt as soon as they could!

Time moved on and housing prices rose. So did her income. Soon the $300,000 debt was almost gone and the townhouse almost owned. Circumstances changed (they always do) and something bigger was needed. “Sell the town house,” the parents and friends urged, “buy yourself something bigger. Get a new car too.” But the GP had other ideas. Instead she kept the townhouse and plunged head first into another bucket of debt, borrowing $800,000 to buy a new home just around the corner, with a big yard for the kids.

She let the townhouse and used the rent to pay off the home loan. She paid her spare income on to the loan as well. Melbourne housing prices rose and the beachside areas became even more fashionable. The debt-equity mix was good, so she borrowed again and bought another property.

She never doubted her strategy would work – borrow against the existing properties, pay the rent and spare income to the bank, and let time do the rest.

The GP and her husband now have a portfolio worth more than $15 million. Each property is well tenanted and has excellent prospects. Cash flow is good. There is no financial stress.

So far she has never sold a property, which means she has never paid capital gains tax. This is despite enjoying millions in unrealised capital gains.

The big pay-off came in early 2014 when her husband was retrenched. Prospects for retrenched bank managers are not excellent, but in this case, rather than being a financial catastrophe, retrenchment was (almost) a welcome event. The husband now spends even more time working on the properties, sprucing them up, and identifying potential good buys. Sometimes you have to stop working to start making money,

This GP’s story is unusual. It’s also simple and straightforward. All she did was work hard, forgo some current consumption, borrow money, buy quality assets, pay off the loans and let time do the rest.

Now, at age 59, the GP has achieved financial security for herself, her children and even her grandchildren. That part time job was the best move she ever made.

Apartments

Don’t invest in apartments. There is an over-supply, and the capital gain prospects just aren’t there. Sure, some will be OK. But most won’t be. It’s better to be safe than sorry.

On 2 April 2014 the Age newspaper quoted Robert Mellor, managing director of real estate researcher BIS Shrapnel, as saying there could be 2,000 apartments in excess to demand in Melbourne alone, and Louis Christopher, the managing director of property researcher SQM Research, as indicating that the Sydney apartment market was over-supplied too, with higher planning approvals, low rental yields and rising vacancy rates forcing values down.

Some apartment developers are offering up to 10% commission to financial planners to get them to flog their stuff. If an apartment needs a 10% commission to be sold you can be sure its not going to be a good investment.

Tourist accommodation

Don’t invest in tourist accommodation either. There is an over-supply and the capital gain prospects just aren’t there either.

In 2011 a GP made the classic mistake of buying a Gold Coast apartment for $400,000 while on holidays. It seemed a good idea at the time. The rent was good, $30,000 a year, which meant the interest of $22,000 a year is more than covered. The problem is management fees of $15,000 a year and cleaning costs of $6,000 a year. Throw in rates and water and total outgoings are more

$45,000 a year.  The cash shortfall is more than $15,000 a year.

The apartment is worth less now than it was in 2011, and brand new apartment blocks are springing up all the time. Any capital gain is decades away.

The share market has risen 20% since 2011.

Holding costs of $15,000 a year means the family’s week in Surfers each May costs more than $2,000 a day, and he has missed out on nearly $80,000 of capital gain.

That’s what we call an expensive holiday. Don’t ‘invest’ in holiday accommodation.

In summary, tourist accommodation is too risky. The Australian dollar has made overseas holidays cheaper and virtually killed in bound tourism. There are too many apartments and too few genuine buyers, and you are at the mercy of the apartment managers.

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