Imagine you were in the market for a pair of birkenstocks. Imagine it was your very first pair. Now imagine the salesperson at the store said that they were running a promotion. The salesperson tells you that all first-birkenstock buyers qualify for a 5% discount. Well that sounds pretty appealing doesn’t it? Not really. Because you’re a self-respecting human being. And no self-respecting human being would ever say yes to birkenstocks. Instead imagine if the government told you that similar concessions had been put in place to help first-home buyers get into the housing market. Well much like Monsieur Candie in Tarantino’s 2012 masterpiece, Django Unchained, now they have our attention.
Valuing a property and understanding its income streams can be a tricky exercise. Unlike shares listed on the ASX, a lot of information we might use to value a property isn’t readily available. To be perfectly frank, a lot of guesswork goes into forecasting property valuations and it’s hard to determine what available information is well-researched, particularly when you have real estate agents throwing around obscure statements like “we think the Lower North Shore Sydney area should see a 3-4% rise in prices in the third quarter of 2020”. Why? On what basis? Show me your modelling. Do you even DCF? Below we also discuss some of the finance-y things you might want to keep in mind when searching for your first home.
So that they may be seen as if they give two [insert dysphemism for feces] about first home buyers, the federal and some state governments in Australia offer first home buyers a bunch of tax concessions and/or grants to help you make the jump.
First Home Super Saver Scheme (FHSSS)
Having recently dealt with the FHSSS myself, I genuinely feel as if it was deliberately designed to be so complicated so as to deter anyone from actually taking advantage of it. Have no fear, some idiot with nothing better to do on a Monday afternoon is here to help. First you direct your employer to make voluntary contributions into your superannuation account (see Salary sacrificing). You can voluntarily contribute up to $15,000 per financial year (July 1 to June 30) for a maximum of two financial years. This brings you to $30,000. These contributions are pre-tax. The average Australian’s marginal tax rate (the highest tax bracket you fall into) is 32.5%. However, your voluntary contributions are taxed at 15% (seriously, please see Salary sacrificing, there are important exceptions). Still with me?
When you’ve sacrificed all that you’re willing to sacrifice, you apply to the tax office for a ‘FHSSS determination’. Your FHSSS determination spells out how much you’re permitted to withdraw which will be – what you contributed less 15% (contributions tax) plus ‘associated earnings’ (which is about 4.54% p.a. multiplied by your contributions) less withholding tax (which for someone who normally pays 32.5% income tax is 4.5% (32.5% less 30% (tax offset) plus 2% (medicare levy))). Confusing isn’t it? It really begs the question whether anyone would honestly bother. Well I did, and for me it was worth the trouble. You end up saving a hefty sum in income tax. You only receive the funds after ~5 weeks of applying for the FHSSS determination and release though so do it well in advance.
First Home Buyers Assistance Scheme (FHBAS) (NSW only)
Okay this one’s super valuable. In NSW when you buy a home you have to pay transfer duty (formerly and still colloquially known as stamp duty). If the value of your home is <$650,000 you may apply to be exempt from having to pay any transfer duty at all. For a property valued at $650,000, you could save just shy of $25,000 in taxes. That’s like buying your home at a discount of almost 4%. Huge. If the value of your home is between $650,000 and $800,000, you may apply for a concessional rate of transfer duty to be applied. The concessional rate becomes less appealing as you go higher and becomes valueless at $800,000. A similar system applies to the purchase of vacant land, with a purchase price of $350,000 attracting no transfer duty and a purchase price between $350,000 and $450,000 attracting the concessional rate.
First Home Owner Grant (New Homes) Scheme (FHOG(NH)S?) (NSW only)
This one’s actually super simple. If you buy (a) a newly constructed home or a substantially renovated home <$600,000 OR (b) land and the combined value of the land and any dwelling you intend to build <$750,000, you may qualify for a $10,000 government grant. Crystal? Good.
First Home Loan Deposit Scheme (FHLDS)
In May 2019, in a last ditch attempt to score the young vote, the Australian Federal government introduced the FHLDS and it goes something like this. In Buying your first home – Part 1 we discussed LMI and LVR. Under the FHLDS, if you have a deposit between 5% and 20% (LVR between 80% and 95%), the government will ‘guarantee’ the difference up to 20%. This figure still gets added to your loan amount, but you won’t have to pay LMI. I can’t comment on whether you should apply for the scheme (because laws) but I can state a few facts:
- (1) Banks tend to apply higher interests rates on LVRs >80% and as we learned in The time value of money, that can make a big difference in the long run.
- (2) The FHLDS has been the subject of intense scrutiny from professionals in the industry because it encourages riskier borrowing. Whatever you decide, please do your homework first.
- (3) The larger your loan, the higher your mortgage repayments, the less disposable income you have to run (and enjoy) your life.
- (4) The larger your loan and the higher your interest rate, the harder it is for you to subsequently take on more credit – including a second mortgage for an investment property if you have plans for a property portfolio.
- (5) The higher your LVR, the closer you are to falling into negative equity territory. This essentially means the value of your home is less than the outstanding balance you have on your loan (LVR >100%). This is not a good place to be.
Keep in mind that for you to be able to take advantage of any of the above tax concessions, you must genuinely be buying your first home (in Australia) and not an investment property. This means you must not have ever held an interest in property anywhere in Australia and you must live in your property for at least 6 months in the year after purchase. I’ve noted above that a couple of these schemes are NSW only. If you live in another state or territory, check your state or territory government’s website for similar schemes. You’ll recall that we took an innocent dig at birkenstocks running a 5% promotion at the start of this article. Well if you group together some of the concession examples above, you’re looking at well over a 5% discount. Hopefully, now I have your attention.
The investment (cool) bit
Alright, I’m all sorted. I’ve got my deposit and I got pre-approval from my lender to make an offer because I have kick ass borrowing capacity. What do I do now? There are a stupid number of considerations you should be keeping in mind when you’re looking for your first home. Obviously as a first home, investment might not be front and centre in your mind. But property will after all be the biggest investment you ever make, and you’ll likely hold it for decades so it can’t hurt to pick a good one that’ll make you a lot of money. In Accumulating assets we discussed two fancy finance terms – ‘capital growth’ and ‘rental yield’. To recap, the first is how much your property appreciates in value over time and the second (if/when you eventually rent out your property) is a source of income.
Rental yield is super easy to calculate, but I’m going to show you the right way of doing it. Most people calculate rental yield as annual rental income over a property’s valuation. And strictly speaking that’s correct but it doesn’t really give you a proper understanding of just how much income your property is bringing in. So, I prefer to deduct ongoing expenses (e.g. strata levies, council rates and water fees) from annual rent before calculating rental yield. If you do this exercise, and you live in Sydney or Melbourne, you’ll find that your yield is an abysmal 2-4% – unless, like me, you love doing your DD and you’ve really done your homework ;).
If rental yield isn’t working in your favour, you may want to rely on capital growth. Favourable capital growth is almost impossible to predict but some considerations include: public infrastructure developments, forecasted population growth, expected zoning changes, high density residential developments etc. Keep in mind that as we learned in Leverage, your gains/losses on property are geared. Your gains/losses are leveraged 5x on an 80% LVR investment which is why even a 4% p.a. yield on an investment property might beat an 8% p.a. yield on your non-leveraged share portfolio. Remember – I said gains/losses. Any losses will also be leveraged 5x. I hope the above has helped but we will nonetheless revisit the topic of real estate investment in many future articles.