The importance of your first property purchase!

The choice of your first property purchase is one of the most important financial decisions you can make due to:

• Capital Growth Variability (and opportunity cost)

• Large Transaction Costs (such as Stamp Duty and Lenders Mortgage Insurance)

• Each property having potential for fundamental flaws and defects

Let's unpack this...

Capital Growth Variability (and opportunity cost)

The primary allure of property ownership lies in its potential for capital growth.

Over the past 30 years, Australian house prices have experienced substantial increases. For instance, Sydney's median house value surged from approximately $221,770 in July 1992 to $1,346,190 in July 2022, marking an increase of about 6.8% per annum.

You may have heard of the old saying " a good property should double every 10 years", which is equal to a compound growth rate of 7.17% per annum.

However, not all properties are created equal!

Apartments and units have only grown at 4.7% per annum over the last 30 years, and in many areas growth rates of apartments have been next to non-existent over the last decade due to oversupplies of those types of dwellings.

To illustrate, let's assume you have $800,000 for a property purchase. Based on average rates of return it would be worth the following after 10 years:

• $1.18m in an apartment.

• $1.54m in an house.

The capital growth differential would be a significant $360,000.

The easy answer you could derive is to buy a house (where it's value is underpinned by the land content) rather than an apartment. However, obviously, mortgage serviceability (the amount you can borrow) often precludes people from buying houses in the areas they want to live.

For this reason, the concept of 'rent-vesting' has become more and more popular. This is the concept of buying a property in an area that you can afford and will likely achieve good capital growth, whilst you rent in the area you want to live. This can be an effective strategy, particularly given the negative gearing benefits.

The important point I want to re-iterate is the property purchase you make must have sufficient capital growth potential, otherwise, you will incur an opportunity cost.

An opportunity cost is the potential benefit you miss out on when choosing one investment over another. You need to consider your property purchase against other alternatives such as purchasing investments (including investment properties and shares) and renting.

The old adage 'rent money is dead money' is not actually true. In some cases your rent expense can be similar to the monthly interest component of your loan. Provided you then achieve a higher rate of return on your investment and you save the same amount each month as you would have contributed to the 'principal' component of the loan, you can be ahead by 'rent-vesting'.

Large Transaction Costs (such as Stamp Duty and Lenders Mortgage Insurance)

The property you purchase should be one that you are able to live in for at least 5 - 10 years because property transactions trigger considerable transaction costs! This means you need to consider:

• Will the property fit my work and lifestyle in 5 years time?

• Will you have kids in the next 5 years and need more space?

For example, if you purchase a $1m home with a 90% LVR (Loan to Value Ratio), you could pay:

• $55,000 of Stamp Duty in Victoria

• $30,000 of Lenders Mortgage Insurance

That's $85,000 in transaction costs!

If you spread those costs over 10 years by holding the property it is only $8,500 p.a.

By contrast, if your purchase a house that you later find is too small, and sell after two years, it is an effective cost of $42,500 p.a. and will likely erode most if not all of your capital growth (particularly after selling costs are considered).

If you can't afford a house that will fit you and your family long term, it may be better to 'rent-vest' to build your purchase capacity further or buy a house that you could live in long term in a more affordable area.

Individual Property Flaws and Defects

Every dwelling has different potential flaws and defects that could cost you thousands.

For older style houses, it may need electrical rewiring, restumping, asbestos removal, plumbing works and much more.

Many new apartments have issues with combustible cladding or leaky balconies which require costly repairs.

You should never purchase a property without a building inspection report from a qualified building inspector.

If you decide to purchase an apartment or unit (although as we have outlined above this can be problematic due to the low capital growth rate potential), you should read the section 32 which includes past body corporate meeting minutes. You can find disturbing but important information regarding what maintenance works are required in the future and how much it could cost you as a potential future owner.

Conclusion

Are you in the market to buy but confused on what to buy? You can reach out and book an initial call below. On the call we can discuss these considerations in more detail and if necessary, put you in contact with a range of professionals such as buyers advocates, mortgage brokers and building inspectors.

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The purpose of this blog is to provide general information only using historical average data and the contents of this website do not purport to provide personal financial advice.  We strongly recommend that investors consult a financial adviser prior to making any investment decision. The contents of the our blog does not take into account the investment objectives, financial situation or particular needs of any person and should not be used as the basis for making any financial or other decisions. The information is selective and may not be complete or accurate for your particular purposes and should not be construed as a recommendation to invest in any particular product, investment or security. The information provided on this blog is given in good faith and is believed to be accurate at the time of compilation.