Provision Newsletter

It’s probably not the sexiest thing the two of you have on the to-do list but putting it off could see you butting heads.

Whether or not money issues got in the way of past relationships, you may be thinking, there’s no way you’re going to pull back on that long passionate kiss you might get after work today to drop the f bomb (I’m talking your ‘financial expectations’ going forward).

If you’re still in the honeymoon period, the idea might sound ludicrous, particularly if everything has been champagne and lingerie up until this point, or sport and beer (each to their own).

If you’re only a couple of months into the relationship, not wanting to have this conversation may make total sense (unless you’re about to wire some overseas lover you’ve never met your life savings).

If you have been together for a while though or are edging on making a big financial decision together, having the money talk could make a big difference to whether you go the distance.

Understandably, it may not be the easiest topic to broach, so feel free to use this article as a bit of a conversation starter, depending on what the two of you have planned going forward.

Talk about where you’re at and what you (really!) think

Here is a list of things worth discussing with your partner before you consider merging your money, moving in together, or buying any big-ticket items in both your names.

1. Your views on cash management

Talk to your partner about your views around spending and saving. Kicking off with a light-hearted conversation, without judgement, can often be a good place to start for couples. And, you might even want to share some examples of things in the past that may have influenced your current views and behaviours.

2. Sneaky spending habits if you have any

While around seven in 10 Aussies, who are in a relationship, say they don’t hide transactions from their other half, about three in 10 do, with fashion and beauty items topping the list, followed by gambling and money spent on junk food¹.

With that in mind, if there are a couple of common transactions you make that you know you haven’t always been forthcoming about (how many times do you really go to Maccas rather than pack your lunch?), now may be a good time to get that out in the open.

3. Your income, expenses, assets and debts

Your financial situation is an important one to talk about because even if you’re both earning a decent income (and potentially have some assets behind you), big expenses and potentially thousands of dollars of debt between you may impact any plans you have in the short and longer term.

To throw a few figures at you for context, 24% of generation X Aussies, 22% of generation Y Aussies and 12% of Baby Boomer Aussies have more than $5,000 worth of credit card debt alone².

4. Whether you’ve been paying your bills on time

If you’ve got a credit card, personal loan, mobile phone plan or utility account, there’s more than likely a credit reporting agency out there that has a file with your name on it. This file, also known as a credit report, will summarise how good you’ve been at paying your bills and making your repayments on time.

If you have a chequered history, your report mightn’t read particularly well, and this could affect your ability to borrow money. If you’re unsure how your report reads, consider requesting a copy from one of the reporting agencies (Veda, Dun & Bradstreet, Experian or the Tasmanian Collection Service).

5. What’s on your bucket list now and down the track

If one of you has plans to travel, buy property, get married or have children and the other doesn’t, this could raise issues or perhaps opportunities for further discussion and compromise.

Depending on how important these things are to you or your partner, it may be worth nutting this out early on, or if you don’t come to a solution straight away, knowing that it’s something you’d like to raise again at a later date.

6. What a joint budget and savings plan might look like to you

Committing to something that you both think is fair could go a really long way here. If you’re not sure where to start, a good first step might be drawing up what money is coming in, what money is needed for the mandatory stuff and what may be left over for your social life and savings.

While not everything has to be shared, if one person’s saving more and the other’s spending more, arguments may arise, so try to come to an agreement that works for both of you.

7. Your job security and whether you see a change on the cards

If you’re on the verge of quitting your job or are aware of redundancies happening at work, this is probably worth flagging with your partner as well.

Speaking up so the other isn’t caught off guard could make a big difference to the holiday, wedding or new-car plan that you’re working on as a team.

8. Your contingency plan if one of you isn’t earning an income

One in five Australians doesn’t have enough money set aside to cover a $500 emergency³, so it’s probably worth talking about whether either of you have an emergency stash of cash, personal insurance, or anything that may help you get by through a tough period.

If you don’t have a plan b, now might be the time to talk about how you might be able to create one together. Plus, it may reduce the need to rely on high-interest borrowing options, such as credit cards or payday loans, which can often be an expensive way to borrow and create unwanted debt.

9. How you’ll divide costs and or repayments

You may decide to tackle this 50/50 or proportionate to each other’s income. That is something you’ll want to nut out before you take on a big financial commitment together. And, you may also want to take into consideration anything additional you might be bringing to the table, like money or assets.

10. The potential risks that may arise if you merge your money

If your partner defaults on a repayment, you may be liable for the amount owing, even if your relationship ends. On top of that, ignorance isn’t an excuse, so if you sign papers you don’t understand, you’re no less liable for any loans or guarantees you may have signed off on.

With that in mind, it’s important both of you understand your responsibilities and consider whether you want to put anything you might agree to in writing.

Please contact us on |PHONE| if we can be of further assistance .

1 Finder – Out of sight, out of mind: One in three Aussies spend secretly
2 Finder – State of the Credit Card Market Report page 21
3 Finder How a $500 emergency could spell financial ruin for millions of cash-strapped Aussies

Source : AMP Novemeber 2018 

 Important:
This provides general information and hasn’t taken your circumstances into account.  It’s important to consider your particular circumstances before deciding what’s right for you. Although the information is from sources considered reliable, we do not guarantee that it is accurate or complete. You should not rely upon it and should seek qualified advice before making any investment decision. Except where liability under any statute cannot be excluded, we do not accept any liability (whether under contract, tort or otherwise) for any resulting loss or damage of the reader or any other person.  
Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business, nor our Licensee take any responsibility for any action or any service provided by the author.
Any links have been provided with permission for information purposes only and will take you to external websites, which are not connected to our company in any way. Note: Our company does not endorse and is not responsible for the accuracy of the contents/information contained within the linked site(s) accessible from this page.

If you’re going to balance the future of your own home or property on your child’s reliability to pay their mortgage, make sure you’re across the risks.

The majority of Aussies take about 3.7 years to save for a deposit on a first home, with a third of the nation taking just over five years¹.

If you’ve got a kid who wants to get into the market sooner rather than later, you may have discussed whether you’d be willing to up their ability to borrow (if you’re in a position to) by going guarantor.

This is where you use the equity in your own property as security for the loan being taken out by your child. Meaning, you promise the lender your child will make the necessary repayments and if they don’t, or are unable to, that you’ll repay the loan for them.

While there may be benefits for your kid, things can still go wrong, so here is a list of things to avoid.

1. You don’t really know what your signing up for

Depending on the lender, you can use your property as security on your child’s entire home loan, the entire loan amount plus additional costs, or limit the guarantee to a portion of the loan.

How long you act as guarantor will depend, but once your child’s loan has reduced beyond a certain level, you can ask to be removed as guarantor, but this will have to be approved and fees may apply.

You also may be required to get legal advice before a lender will accept the arrangement.

2. You haven’t considered what’d happen if your kid was without an income

You always want to hope for the best, but in reality, over the term of your child’s loan, there could be a point where they lose their job or become injured or ill and be unable to make repayments for a while.

For this reason, you may want to find out if they have a back-up plan, any emergency cash stashed away or personal insurance (what type and how much).

If things don’t go as expected, the loan does become your responsibility, so unless you have additional capital, worse-case scenario, you may have to sell your home to clear your child’s debt.

3. You haven’t really thought how this could affect what’s on your bucket list

Going guarantor reduces your ability to borrow funds, so it’s important to think about whether you have other plans that could be affected – holidays or other big purchases.

You may also want to give some thought to your retirement. June 2018 figures show individuals and couples, around age 65, who are looking to retire today, need an annual budget of $42,953 and $60,604 respectively to fund a comfortable lifestyle². This assumes you own your home outright and are in relatively good health³.

4. You haven’t chatted with your kid about any expectations you have

Having an agreement in place could go a long way to ensuring everyone is on the same page. You may even consider writing down what you’ve agreed to so there are ground rules in place.

It’s also worth discussing how long you intend to act as guarantor and what your exit strategy is, as you may only be required to do it for the first few years as they pay down their loan.

5. You haven’t explored other financial avenues that may work better for you

• Could you gift a deposit?

If you can afford it, gifting a deposit might be something you’d prefer to do. A good deposit will reduce the amount your child needs to borrow, and the interest paid over the life of their loan.

Bear in mind, if you happen to receive Centrelink payments, you’ll need to consider that a gift of this nature could impact your benefits so do your research.

• Could you go in as a co-owner?

When you buy a home with your kids you share responsibility for the costs involved while receiving the benefits of investing in property.

It’s important to understand that as a co-owner you are included on the loan and you’d technically own only half of the property.

If you sign as a joint borrower, you’re equally responsible for the home loan and must repay the entire debt with the principal borrower—your child—whether they default or not.

This is also a big commitment and you’ll need to understand the risks and get the right advice.

• Could you let them save money by staying at home for longer?

Nearly one in three adults aged 19 to 34 still live with their parents, with financial reasons dominating why people said they stayed at home4.

With that in mind, you may prefer offering your kid their old room for a while for low or no rent to help them get some more savings behind them.

Please contact us on |PHONE| to discuss any potential risks, benefits and tax implications.

Source : AMP October 2018 

1 Finder – one in three first home buyers stuck saving for a deposit for over five years – press release
2, 3 ASFA Retirement standard – table 1
4 Mozo – The cost of stay at home children – press release

You don’t have to be a landlord, deal with tenants or put a deposit down on a home to get your foot in the property market

While investing in property may be a dream of yours, saving for a deposit, dealing with tenants and paying off a mortgage mightn’t be.

The good news is there are opportunities where you can invest in property without actually buying one, with two options you may have heard of including real estate investment trusts (REITs) and real estate crowdfunding.

While these investment options provide different avenues to get your foot in the door (as well as pros and cons you’ll need to weigh up), both offer a piece of the pie without some of the risks that may come if you decide to buy a property yourself.

What are real estate investment trusts (REITs) and how do they work?

A REIT is a type of property fund that you can purchase units in. You can generally access REITs via managed funds, super funds, or public markets, such as the Australian Securities Exchange (ASX).

The money you invest in a REIT is pooled and usually invested in a range of properties, which can focus on a specific property type or a mix of property types. This might include commercial, retail, or industrial properties (so anything from office buildings to shopping centres).

For this reason, REITs can provide investors with exposure to the property market in a way that is more diversified, and which will generally be more cost-effective than buying a single property, as you won’t have the upfront and ongoing costs that come with buying your own home.

While you don’t have the duties you would as a landlord managing your own property, when you invest in a REIT, you also don’t have control over the assets held in the trust, as an investment manager will be making the investment decisions (and property maintenance and development decisions), with returns also dependent on property markets.

What’s real estate crowdfunding and how does it work?

Crowdfunding websites enable people to raise funds for various projects, ideas and business ventures, without necessarily the need of a lender, with real estate investment opportunities no exception.

Real estate crowdfunding, which is a newcomer to the space, is a type of direct real estate investment that allows multiple people to invest smaller amounts of capital to fund a purchase collectively.

Essentially it enables you to become a shareholder in a piece of real estate through a crowdfunding company without owning or having to maintain the actual building, with any profits that the real estate venture sees (profits that come from rental income for instance) passed on to the investor.

How crowdfunding is different to a REIT, is it provides investors with stakes in a specific property or project, while REITs give investors shares in a fund that invests across multiple properties and property sectors.

It should be noted that regulation around real estate crowdfunding is still in its infancy in Australia.

What to look out for

When deciding what’s right for you, some things to note down might include upfront costs, associated fees, minimum and maximum investment amounts, and considerations around potential returns.

Choosing the most suitable investment for you will also come down to your goals, your attitude to risk and the time you have available to invest.

Different options may suit you at different ages and will depend on what responsibilities and other financial commitments you have currently.

Other things to think about

When you’re thinking about investing, it’s important to look into any potential legal and tax implications, as these can vary depending on the type of investment you’re looking at.

You may also want to consider a mix of investments as this could reduce your risk and help smooth out short-term ups and downs when it comes to the potential returns you may be able to make.

You might want to chat to us on |PHONE| before making any decisions and like with any investment, always be sure to read and understand the fine print.

 Source : AMP October 2018 

Important:
This provides general information and hasn’t taken your circumstances into account.  It’s important to consider your particular circumstances before deciding what’s right for you. Although the information is from sources considered reliable, we do not guarantee that it is accurate or complete. You should not rely upon it and should seek qualified advice before making any investment decision. Except where liability under any statute cannot be excluded, we do not accept any liability (whether under contract, tort or otherwise) for any resulting loss or damage of the reader or any other person. 

Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business, nor our Licensee take any responsibility for any action or any service provided by the author.

Any links have been provided with permission for information purposes only and will take you to external websites, which are not connected to our company in any way. Note: Our company does not endorse and is not responsible for the accuracy of the contents/information contained within the linked site(s) accessible from this page.

Introduction

Some commentators claim shares are way overvalued and so a crash is inevitable. As always, it’s a lot more complicated, but given the current turbulence in share markets it’s worth having a look at whether share markets are expensive or not as a guide to how vulnerable we are to further falls. More broadly, valuation measures provide a guide to future return potential.

Why valuation matters – the cheaper the better

First a bit of background on valuation. A valuation measure for an asset is basically a guide to whether it’s expensive or cheap compared to the income it generates. Simple valuation measures are price to earnings ratios (PEs) for shares (the lower the better) and yields, ie the ratio of dividends, rents or interest payments to the value of the asset (the higher the better). An obvious example of where the starting point valuation matters critically is cash. For some years now, bank term deposit rates have been historically low meaning returns are low and value is poor.

For government bonds the yield is similarly a good guide to value. Over the medium term the main driver of the return a bond investor will get is what bond yields were when they invested. While the relationship is not perfect, it can be seen in the next chart – which shows a scatter plot of Australian 10-year bond yields (horizontal axis) against subsequent 10-year returns from Australian bonds based on the Composite All Maturities Bond index (vertical axis) – that the higher the bond yield, the higher the subsequent 10-year return from bonds.

View larger image

Source: Global Financial Data, Bloomberg, AMP Capital

Again, despite rising a bit in the last two years, bond yields remain low so low returns should be expected from bonds.

For shares a similar relationship holds. The following chart shows a scatter plot of the PE ratio for US shares since 1900 (horizontal axis) against subsequent 10-year total returns (ie dividends and capital growth) from shares. While it is not as smooth as with bonds as there is more involved in shares, it indicates a negative relationship, ie when share prices are relatively high compared to earnings subsequent returns tend to be relatively low.

View larger image

   Source: Global Financial Data, Bloomberg, AMP Capital

The next chart shows the same for Australian shares. Again, there is the expected negative relationship between the level of the PE and subsequent total returns (based on the All Ords Accumulation index).

View larger image

   Source: RBA, Global Financial Data, AMP Capital

The key is that the starting point valuation matters. The higher the yield (or the lower the PE) the better.

Complications to be aware of

Of course, there are several pitfalls with valuation measures that investors should be aware of:

• Sometimes assets are cheap for a reason (value traps). This is more often associated with individual shares, eg, a tobacco company subject to an impending law suit. These traps can really only be picked up by thorough research. 

• Valuation measures are a poor guide to timing. Eg, if an investor sold shares short in 1996 when Fed Chair Greenspan warned of “irrational exuberance” they would have lost out as shares rose for another four years. Australian residential property has been overvalued for almost 15 years but that’s been no guide to timing a fall in home prices. The key is to have a thorough investment process that depends on more than just valuations. 

• There is a huge range of share market valuation measures. For example, the “earnings” in the PE calculation can be earnings reported over the last 12 months, consensus earnings expectations for the year ahead or earnings that have been smoothed to remove cyclical distortions. All have their pros and cons. For example, the historic PE is based on actual data with no forecasting, but it can give the wrong signal during a recession as earnings may collapse more than share prices and so the PE may not give a buy signal. 

• Finally, the appropriate level of valuation can vary depending on the environment. For example, in a period of low inflation and low interest rates it’s well-known that assets can trade on lower yields as the interest rate/yield structure in the economy falls. This in turn means higher PEs. So low inflation, say down to around 2%, can be good for shares via higher PEs. But if inflation goes from “low” to deflation it can be bad as it tends to be associated with poor growth and so shares trade on lower PEs. 

The message from all this is that share market valuation is important, but you ideally need to assess it along with other indicators if you are trying to time market moves. The key is to acknowledge that when a range of valuations measures are at an extreme then they are probably providing a signal that should not be ignored.

So what are current share market valuations signalling?

Let’s start with price to earnings ratios using historic earnings, ie, earnings reported for the last 12 months. In the US, this PE is currently around 21 times which is consistent with subdued medium-term returns going by the second scatter plot on the previous page. But in Australia at around 15.3 times it’s consistent with reasonable medium term returns according to the third scatter plot on the previous page. Of course, current levels for historic PEs in the US and Australia have both been associated with a very wide range in terms of subsequent returns historically. Furthermore, PEs based on historic earnings are not totally reliable given the cyclical volatility in reported earnings.

Given this, calculating the price to earnings ratio using 12 month ahead projected earnings are arguably more useful. These are shown in the next chart for global shares, the US and Australia. None are way out of line with their averages since the early 1990s but in a relative sense US shares on a forward PE of 16.1 times remain a bit expensive albeit less so than earlier this year, and global shares are a bit cheap trading on a forward PE of 14.2 times thanks to cheap markets outside the US.

View larger image

   Source: Thomson Reuters, AMP Capital

In emerging countries, the average forward PE is quite low at around 10 times.

The next chart looks at price to earnings ratios calculated using a 10-year moving average of earnings, which is often referred to as the Shiller PE (after economist Robert Shiller) or the cyclically adjusted PE. On this measure US shares are clearly more expensive than since the tech boom. However, markets outside the US, including Europe and Australia, are not expensive at all. It should also be allowed that the 10-year moving average earnings calculation is distorted by the earnings slump a decade ago. As the 2008 and 2009 earnings slump starts to fall out of the calculation, the US Shiller PE will start to fall. But still there is better value elsewhere.

View larger image

   Source: Global Financial Data, AMP Capital

Finally, it’s worth looking at share market valuations that allow for the fact we are still in an environment of relatively low interest rates and bond yields. The next chart subtracts the 10-year bond yield for the US and Australia from their earnings yield (using forward earnings). This basically gives a sort of a proxy for the equity risk premium – the higher the better. While this gap is well down from its post GFC highs, it’s still reasonable, suggesting shares are still more attractive than bonds. Of course, this will change as bond yields drift higher, but as we have seen over the last two years since bond yields bottomed, this is likely to remain a relatively slow process.

View larger image

   Source: Thomson Reuters, AMP Capital

The overall impression is that measured against their own history developed country share markets are not dirt cheap, but they haven’t been for several years now and they are not at overvalued extremes. The main risk relates to the US share market, but other markets’ valuations are reasonable. So while the pull back in shares we have seen over the last few weeks could go further yet – as worries around the US interest rates, US/China trade, rising oil prices, problems in the emerging world, President Trump and the US mid-term elections and the Italian budget remain – at least most share markets are not trading at overvalued extremes which would potentially accentuate downside risks.

Source: AMP Capital 24 October 2018

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

Your kid may not have listened to anything you’ve said over the past umpteen years, particularly when it came to their dating preferences, coming home on time and cleaning up after themselves.

However, now they’ve landed their first full-time job, there’s a possibility that could change, which might be music to your ears, particularly if you wish you’d had greater guidance around what to do when you started earning a salary.

With that in mind, here are some things you may want to cover off with them (which you could also text to them using shorter bullet points, or screenshot and tag them on Insta, followed by #parentsknowbest).

Things your child needs to know

1.    Your bank account details and tax file number

Your kid will need to give their bank account details to their employer if they want to get paid, so this will no doubt be high on their list of things to do.

On top of that, they’ll need to provide their tax file number as well, because if they don’t, they may end up paying a lot more tax on the income they earn¹.

If your child needs a tax file number, they can contact the Australian Taxation Office (ATO) about applying for one.

2.    Whether you can choose your super fund

Super is money set aside during your kid’s working life to support them in retirement. It’s deposited into a fund, where it’s invested to potentially earn interest and grow over time.

Most employees can choose their own super fund but your kid will need to check with their employer or the ATO. If they can choose their fund, they’ll typically have a choice between their employer’s fund or a fund they select themselves.

There are things they’ll need to consider though, such as any fees they might pay, how the fund performs and their super investment preferences. 

In addition, super funds generally offer a few types of insurance cover as well, which your kid can pay for using their super money, so it’s worth them looking into whether it’s something they want.

3.    What tax you’re going to pay on the income you earn

Your kid may not be pleased, but they’ll have to pay income tax on every dollar over $18,200 that they earn. And, on top of that, many taxpayers are also charged a Medicare levy of 2%.

The amount of tax they pay will depend on how much they earn. If they’re not sure how much they’ll fork out, the below table includes income tax rates for the 2018/19 financial year².

You might also want to point out that if they’re lucky enough to receive an annual bonus, they’ll also pay tax on this (yes, we know, life isn’t fair).

4.    What tax you can claim back when tax time rolls around

If your kid spends some of their own money on work-related expenses (work uniforms, safety equipment, or travel costs to attend training for instance), there is some good news. At the end of the financial year, they may be able to claim some of this money back when they do their tax return.

Remind them that they’ll need to have a record of these expenses, such as receipts, but in some instances if the total amount they’re claiming is $300 or less, they may not need receipts.

Meanwhile, if their expenses are for both work and personal use, they’ll only be able to claim a deduction for the work-related portion. Perhaps point your kid to the myDeductions tool in the ATO app to save records throughout the year, so they don’t have a bag full of receipts to go through.

Meanwhile, tell them if they’re lodging their own tax return, that they have until 31 October to lodge it each year, or maybe longer if they would prefer to use a tax agent.

5.    What’s in your contract and what you’re entitled to

An employment contract (which can be in writing or verbal) is an agreement between your kid and their employer which sets out the terms and conditions of their employment. It’s a good idea to know what’s in their contract should questions ever arise around what they’re actually entitled to.

Regardless of whether your kid signs something or not, their contract cannot provide for less than the legal minimum, set out in Australia’s National Employment Standards, which covers things such as³:

• Maximum weekly hours of work

• Requests for flexible working arrangements

• Parental leave and related entitlements

• Annual leave

• Personal/carer’s leave and compassionate leave

• Community service leave

• Long service leave

• Public holidays

• Notice of termination and redundancy pay.

While National Employment Standards apply to all employees covered by the national workplace relations system, only certain entitlements will apply to casual employees. For more information, check out the Australian Government Fair Work Ombudsman website.

6.    How to read your payslip so you’re across potential errors

Pay slips have to cover details of an employee’s pay for each pay period. Below is a list of what a pay slip typically includes:

• Your kid’s before-tax pay (also known as gross pay)

• Your kid’s after-tax or take-home pay (also known as net pay)

• What amount of money your kid has paid in tax

• The amount of super their employer has taken out of their pay and put into their super fund

• HELP/HECS debt repayments (if they have an education loan).

Meanwhile, mistakes can happen, so if anything doesn’t look right, tell them to chat to their employer and if your kid has raised an issue they’re not satisfied with, they can also contact the Fair Work Ombudsman.

7.    How much super is coming out of your pay and if it’s correct

If your kid is earning over $450 (before tax) a month, no less than 9.5% of their before-tax salary should generally be going into their super under the Superannuation Guarantee scheme.

If they’re under 18 and work a minimum of 30 hours per week, they may still be owed super. For this reason, it’s important that they check their payslip and if something doesn’t look right, that they speak to their boss or contact the ATO.

Another thing to note, is if your kid does change jobs, this is when super accounts can start to multiply. It might not sound like a big deal, but multiple accounts can often mean multiple sets of fees, so they may want to ensure that they only have one account rather than many.

8.    How to budget and save so you can get what you want in life

Budgeting may be another point that makes your kid’s eyes glaze over but jotting down into three categories – what money is coming in, what cash is required for the mandatory stuff and what dough might be left over for their social life (or saving for their future), could really go a long way.

If they’re paying off debts, or on a more exciting note, want to buy a car or go on a holiday, getting a grip on their money habits early on could see them get a lot more out of life.

Please contact us on |PHONE| if we can be of further assistance .

Source : AMP October 2018 

1 Money Smart – Starting work (Get a tax file number)
2 Australian Taxation Office – Individual income tax rates
3 Australian Government Fair Work Ombudsman – Introduction to the National Employment Standards

Important:
This provides general information and hasn’t taken your circumstances into account.  It’s important to consider your particular circumstances before deciding what’s right for you. Although the information is from sources considered reliable, we do not guarantee that it is accurate or complete. You should not rely upon it and should seek qualified advice before making any investment decision. Except where liability under any statute cannot be excluded, we do not accept any liability (whether under contract, tort or otherwise) for any resulting loss or damage of the reader or any other person. 

Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business, nor our Licensee take any responsibility for any action or any service provided by the author.

Any links have been provided with permission for information purposes only and will take you to external websites, which are not connected to our company in any way. Note: Our company does not endorse and is not responsible for the accuracy of the contents/information contained within the linked site(s) accessible from this page.

Australian capital city home prices have fallen for 12 months in a row and are down 4% from their peak. Most of the weakness relates to the previous boom time cities of Sydney and Melbourne but prices are continuing to fall in Perth and Darwin.

Source: CoreLogic, AMP Capital

This begs the questions: how far will prices drop? and what will it mean for the broader economy?

High prices and high debt – how did it come to this?

The big picture view on Australian property is:

• Real house prices started to surge in the mid-1990s. This has led to them being expensive relative to income, rents, their long-term trend and by global standards. On our valuation measures prices are around 30% overvalued. The boom since the mid-1990s has rolled through different cities at different times, eg, starting in Sydney & Melbourne, then Perth, then Sydney & Melbourne again more recently.

• As a result, affordability is poor and while interest rates may be low it’s become hard to save for a sufficient deposit.

• The surge in home prices has gone hand in hand with a surge in household debt. See the next chart. This has taken the household debt to income ratio from the low end of OECD countries to the top end. The shift to overvaluation and high debt mostly occurred over the 1995-2005 period.

Source: OECD, RBA, AMP Capital

It’s popular to blame negative gearing, the capital gains tax discount and foreign buying for high home prices and debt. However, the basic drivers are a combination of the shift from high to low interest rates over the last 20-30 years boosting borrowing power, along with a surge in population growth from mid-last decade and the inadequacy of a supply response (thanks to tight development controls and lagging infrastructure) to suppress the resultant rise in the ratio of prices to incomes. Since 2006, annual population growth has averaged about 150,000 above what it was over the decade to the mid-2000s, which required roughly an extra 50,000 new homes per year, but dwelling completions have only recently caught up.

The tide has turned – expect more price falls

However, starting about a year ago it seems the tide has turned against property prices reflecting a range of factors:

• Poor affordability – which has reduced the pool of buyers.

• A tightening in bank lending standards under pressure from regulators – particularly around tougher income and expense verification and total debt to income limits for borrowers. The latter will particularly impact cities like Sydney and Melbourne which have high price to income ratios necessitating high debt to income ratios. It will also impact property investors with multiple properties (with around 1.5 million properties held by investors with multiple properties) with banks cracking down on lending to such investors. This is all making it harder to get housing loans.

• A significant pool of interest only borrowers are scheduled to switch to principal and interest over the next few years resulting in a sharp rise in total debt servicing costs.

• Banks withdrawing from lending to Self-Managed Super Funds – reducing the pool of property investors.

• A cutback in foreign demand, partly due to Australian authorities making it more difficult. Chinese investment into Australian real estate has fallen by roughly 70% since 2015.

• Rising unit supply – as the ongoing surge in unit construction completes and hits the market with Sydney and Melbourne most at risk. This risk is highlighted by Australia’s residential crane count of 528 cranes being way above the total crane count (ie residential and non-residential) in the US of 300 and Canada of 123! 

• Out of cycle bank mortgage rate increases may also be playing a role – although a minor one as the moves have been small, mortgage rates remain near record lows and some banks have cut rates for new borrowers.

• Falling price growth expectations in response to falling prices risks resulting in a negative feedback loop for prices – as the FOMO (fear of missing out) phenomenon of up until a year ago risks turning into FONGO (fear of not getting out), particularly for investors as they realise they are only getting very low returns from net rental yields of around 1-2%.

• Expectations that negative gearing and capital gains tax concessions will be made less favourable if there is a change of government are likely also impacting and have the potential to become a major drag on prices.

On their own some of these are not significant, but together they risk creating a perfect storm for the property market.

Home price outlook

For some time, we have been expecting top to bottom falls in Sydney and Melbourne prices of 15% spread out to 2020, implying price declines around 5% per annum. However, the risks are starting to skew to the downside – particularly around tighter credit and falling capital growth expectations made worse by fears of a change in tax arrangements. Auction clearances in recent weeks have been running around levels roughly consistent with 7-8% pa price declines. See next chart.

Source: Domain, AMP Capital

As such we are now allowing for a 20% decline in prices in these cities, again spread out to 2020, which would take average prices back to first half 2015 levels.

Source: CoreLogic, AMP Capital

By contrast home prices in Perth and Darwin are either at or close to the bottom having fallen back to levels seen more than a decade ago, and prices are likely to perform a lot better in Adelaide, Brisbane, Canberra and Hobart along with regional centres as they have not seen anything like the boom in Sydney and Melbourne. But they will see some impact from tighter credit. Overall, we now expect national average prices to fall nearly 10% out to 2020 which is a downgrade from our previous expectation for a 5% national average fall.

A crash is a risk but remains unlikely

With prices now falling naturally the calls for a property crash are getting a lot of airing. But these have been wheeled out endlessly over the last 15 years or so. Our assessment remains that a crash (say a 20% or more fall in national average prices) is unlikely unless we see much higher interest rates or unemployment (neither of which are expected) or a continuation of recent high construction for several years (which is unlikely as approvals are falling) and a collapse in immigration.

Strong population growth is continuing to drive strong underlying demand for housing. While mortgage stress is a risk, it tends to be overstated: there has been a sharp reduction in interest only loans already; debt servicing payments as a share of income have actually fallen slightly over the last decade; a significant number of households are ahead on their repayments; and banks’ non-performing loans remain low. Finally, while Sydney and Melbourne are at risk other cities have not seen the same boom and so are less vulnerable.

However, the risk of a crash cannot be ignored given the danger that banks may overreact and become too tight and that investors decide to exit in the face of falling returns, low yields and possible changes to negative gearing and capital gains tax.

The property cycle and the economy

The downturn in the housing cycle will affect the broader economy via slowing dwelling construction, negative wealth effects on consumer spending, less demand for household goods and via the banks as credit growth slows and if mortgage defaults rise. This will provide an offset to strong growth in infrastructure spending and solid growth in business investment and will constrain economic growth to around 2.5-3% which in turn will keep wages growth and inflation low. All of which is consistent with our view that the RBA won’t be raising rates until 2020 at the earliest and given the downside risks related to house prices it may have to cut rates. Housing weakness will also continue to constrain bank share returns.

Source: ABS, AMP Capital

Implications for investors

Over the very long-term, residential property adjusted for costs has similar returns to Australian shares. So, there is a role for it in investors’ portfolios. However, now remains a time for caution regarding housing as an investment destination – particularly in Sydney and Melbourne where it remains expensive, prices are likely to fall further & it offers very low rental yields. Best to look at other cities and regional areas that offer much better value.

Source: AMP Capital 18 October 2018

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.