CHAPTER NINE:
Buying a House
"Location, location, location."
—William Dillard
Buying a house is one of the biggest single investments we all make during our life and the process can be very daunting and the consequences of getting it wrong can be financially devastating. To minimise the risk of making a poor decision, it is important that you do your own research. There are many people that you can ask for advice but, at the end of the day, no one is going to look after your financial interests better than you in this instance. You need to be an informed buyer, as the more knowledge you acquire, the better negotiating position you will be in.
In the first instance, you need to decide which State and which suburb you would like to live in. This obviously depends on many factors, such as where you work, where your parents and friends live, what you can afford and what your long term plans are. The most important factor that determines the price of a house is the location in which you choose to live. You can have two identical houses in two different suburbs with vastly differing prices due to the fact that one suburb is more desirable than the other from a purchaser's point of view. You can change most factors about a house except its location. Once you have brought in an area you are stuck there until you sell. The old real estate saying "buy the worst house in the best street rather than the best house in the worst street" is as true today as it has ever been.
Once you have worked out where you would like to live it is worthwhile meeting with your local bank or a mortgage broker to discuss how much you can afford to borrow, as there is no point going any further if you cannot afford to buy a house in the area you want. As a general rule, a lending institution will lend you 80-85% of the purchase price of a property provided you are in stable employment and can afford to service the loan.
When you can afford to buy a house, you can commence the process of finding the right house in the right area. The internet is a good starting point to browse for homes in a non-threatening environment, which will give you an idea of what it is about. This process can be stressful and daunting, but by breaking the process into a series of small steps it can be fun.
What to look for when buying a house
When you are looking at buying a house, it is important to look at the process as objectively as possible and not let emotions take over in the decision making process. The process can be very difficult. Once we inspected a property and, as my wife walked in, she told the agent "I love it", which immediately put us on the back foot in the negotiating process. This part of the process is easily resolved if the purchasers have talked through their strategies prior to the inspection.
There are factors that add to the value of a house and factors that detract from it, making it harder to sell in due course. This is not as great an issue if you are going to live in the house, as opposed to using it as an investment. It is important that you consider both the good and bad factors of a property before making an offer. What is a positive for one person may be a negative for another.
Some positive points to consider are:
• Close to services such as shops, bus stops, schools, parks and ovals
• The backyard is flat
• The house offers natural light
• The house has recently been re-wired or painted
• Off street parking
• The house has a self contained flat which can be used as an additional income stream
• Panoramic views
• Storage space
• Amenity and kerb side appeal of the neighbourhood
• Easy to maintain
• Can you renovate if needed?
• It is a mortgagee sale which means they need to sell the property quickly to minimise any losses
Some of the negative points are:
• Close to a main road, which may cause undue noise or traffic congestion
• A long distance from services such as shops, bus stops, schools, parks and ovals
• The house needs significant maintenance, such as rewiring or re-painting
• The house is difficult to heat
• A renovation has only been partially completed
• Has no off street parking
• The house is unique in some way. It may be built as a castle and the market for people wanting to buy a castle house is smaller than those just wanting a comfortable residential home
• Has narrow and small rooms
• A swimming pool, due its high ongoing maintenance
When you are looking for a house to buy, you need to consider what is important to you and make a list of these points. For example, you may require a minimum number of bedrooms, or a short journey to work. The criteria you use to assess a property as a place to live versus an investment property are very different. As a place to live or a lifestyle asset, you can make compromises. If you pay, for example, an extra $20,000 to secure the house and you live there for twenty years, does it really matter? This probably does not matter, whereas if the property is for investment, you need to be more objective in your decision making. For example, if you buy an older property as an investment property it is likely that you will have more maintenance than if you purchased a newly built property.
Who can assist you in buying a house?
There are many people who can assist you in bridging the knowledge gap between what you know and what you need to know. As a starting point, it is important to realise that the agent selling the property is employed by the vendor, otherwise known as the person selling the property, and although they may appear as though they are helping you, they are working for the vendor. It is in their interests to get you to pay as much as possible for the property as the more you pay for the property, the more they get paid. The agent will emphasise the positive factors on the property and ignore the negative factors.
To enable you to be fully informed, you should:
• Look at the relevant websites to find out what the recent sales history in the area has been like
• Arrange for a valuer to attend an inspection of the property with you and you will pay them on a time basis. When we purchased our last house, we had a valuer inspect the property for us. We walked around with him and it cost a total of $250 for forty-five minutes work. We did not require a written report. He was able to highlight a number of deficiencies in the property that we were not aware of. The valuer also brought along a sales history of the property we were buying, and a sales history of all of the houses in the street sold in the last ten years. An investment of $250 when you are spending hundreds of thousands of dollars is money well spent, if you get objective and accurate information. I have always found it amusing that most people spend $100 having a car checked before purchasing it, but fail to do the same with their house when the financial consequences are considerably higher
• Arrange for a building inspector to assess the house before signing a contract. You need to be careful if an agent says that the contract is conditional on a building inspection. For example, the building inspection clause only allows you to avoid the contract if there is serious structural damage and you notify the vendor within seven days. To ascertain this you often need a structural engineer and a report of this nature takes time to prepare. There are building clauses that favour the vendor and those that favour the purchaser to ensure it is a fair and equitable contract. Ask your lawyer or conveyancer to draft the clause
• You may wish to engage the services of a buyer's advocate or agent. This is a relatively new phenomenon and is not encouraged by the vendor's agent, despite their increasing popularity. A buyer's agent is an agent that specialises in searching out, locating and negotiating the purchase of property on your behalf. You can use a buyer's agent for a limited role such as bidding at an auction or for the complete transaction. A buyer's agent usually charges either a flat fee or a percentage of the purchase price
• A lawyer or conveyancer can assist you in understanding the certificate of title to the property, the implications of making an offer to a vendor and signing a contract. For example, in one instance a prospective purchaser went to see a lawyer in relation to buying a vacant block of land. Attached to the land was a set of covenants or restrictions on what you could do on the property, which the prospective purchaser was unaware of. One of the restrictions was what is known as a building envelope, which prohibited building a dwelling on a large part of the land. This has substantial impact on the value of the land as the purchaser could only build in a small part of the land at the bottom of the hill and could not build at the top of the block where they would get a view. The prospective purchaser walked away from the property; however, if they had not sought legal advice the result would have been very different
• As part of the pre-approval process when applying for a loan a bank needs to have the property valued and, if you can arrange for the pre approval to be undertaken before you sign a contract, the bank manager or mortgage broker may allow you to view this valuation. This will give you an independent view on what the property is worth, which is handy when you commence negotiations on a purchase price
• Contact an insurance broker and obtain a quote on the cost of insuring the property and ascertain if there are any particular insurance issues associated with the area. For example, the property may be in a landslip zone and any damage caused to the property by a landslip may not be covered by the insurance policy
Potential problems to avoid
In buying a house there are a number of potential pitfalls you need to avoid. These include:
• Although it is worth stretching yourself when you buy a house, you need to be careful not to overstretch and be stuck on the mortgage treadmill. This can lead to a situation where you have a great house but do not have the financial ability to enjoy life. You cannot go out for dinner or go on an interstate holiday. Before you buy, it is worth trying to budget on an imagined mortgage. For example, when we were newly married and without children, we had my wife's wage going directly against the mortgage and part of my wage paying the mortgage. When we had our first child, the mortgage payments continued albeit at a lower level, but they were still being paid without any interruption to our day-to-day cash flow
• Avoid procrastinating and not making a decision. If you are going to buy a house, it is important to buy when a suitable house is on the market. I had a colleague who was interested in buying a property in 2001 in a regional mining town, and he was saving and saving to buy a house. He would save $20,000 per year and he could never make a decision on what was suitable. It took five years before he purchased a house in 2006 and over that time he had saved up $100,000, which was a substantial deposit. The problem was that house prices doubled in the time he took to make a decision and this cost him far more in lost opportunity. In 2001 he could have purchased a house for $150,000 and that same house in 2006 would cost him $300,000
• Avoid the trap of trying to live tomorrow's life today which in essence means trying to live the life your parents can afford at sixty and you are trying to live at thirty. Many young people fall into the trap commonly known as affluenza—of having to have the best of everything; a plasma television, a coffee machine, fancy furniture or a renovated house. Spending large amounts on lifestyle assets make us feel good for a short period but they do not provide you with financial security. There are many people in Australia who look like they are worth millions in the way they dress or the gadgets they own, but if you examined their assets closely you would be surprised at how little they have when you deduct their liabilities from their assets
• Look beyond the cosmetics in a house as there are many investors and contractors who buy a house, make a few minor cosmetic changes, such as painting the house, fixing the kitchen and bathroom, and then sell the property at a profit. The problem with these types of properties is that on the outside they can look fantastic but when you dig a little deeper there may be wiring problems or lack adequate insulation. There is a common phrase, which is used amongst the property industry, "the easiest way to get a capital gain is to invest in a four-litre can of paint'"
In summary, do your research and always seek the opinion of someone who is not emotionally attached to the property for an independent view.
The cost in buying and selling property
Buying a house is expensive and there are many costs that you are going to incur over and above the purchase price. As a general rule, it will cost you between 3-4% of the purchase price in costs to complete the transaction. The main costs you are likely to incur, aside from the purchase price are:
• Home loan costs—In applying for a home loan, the financial institution will usually charge a loan establishment fee and often mortgage insurance if you are borrowing more than 80% of the value of a property
• Government Fees—A number of government fees apply in any property transaction including registration fees, stamp duty, land tax, and rates. As a general rule, the higher the price of the property the higher these fees will be. These costs vary between the States
• Legal costs—A lawyer or conveyancer charges a professional fee for acting for you in the transaction. The amount they will charge varies depending on the complexity of the transaction
• Removalist costs—Although many people elect to move themselves, the older you get, the more you realise it makes sense from a physical preservation point of view to employ removalists for the heavy items. When we last moved, we employed a removalist to move the larger items on a per hour basis. It took them two hours and it was money well spent. We had the removalists lift the heavy awkward items and it saved a lot of stress
• Pre-inspection fees—If you prepare thoroughly before you purchase your home, you are likely to incur a number of costs before you sign the contract. Some of these pre-inspection fees are likely to include valuation fees, solicitor's or conveyancer's costs, building inspection costs, pest inspection costs and accounting costs
• One-off costs—There are a number of one-off costs you incur in moving into a new residence including connecting the electricity, telephone, internet or gas
Given the costs of buying and selling a property, I cannot understand why people sell an investment property in a particular suburb at a profit and then use the proceeds to buy another investment property in the same suburb. It is a waste to pay an agent to sell the property, approximately 3-4%, and then pay 3-4% to buy another property in the same area. If you spent $500,000 on buying and selling a property, you have wasted approximately $40,000 in transaction costs, which is more than most people can save in a twelve month period. When buying a large investment with large acquisitions costs, you need to minimise the turnover and subsequent transaction costs on these investments.
The main costs in selling a property are the agent's costs and the associated advertising fees. These usually equate to 3-4% of the sale price. It is worth negotiating with the agent for a lower commission rate or adding a performance bonus to incentivise the agent if they exceed a certain sale price.
When looking at renovating or adding value to your existing home, it is important that you do not over-capitalise if you are looking to sell the property in the short term. As a general rule the more changes you make to a property from the traditional basic design the smaller the pool of potential buyers who are interested in that property.
Some of the more common mistakes include:
• Adding a swimming pool. This may seem like a fantastic idea on a hot day, but having a pool can be a huge, ongoing liability with large installation costs, subject to water restrictions and lead to regular maintenance costs
• Specialised décor which, whilst appealing to you, will have a limited appeal to the broader market. For example, if you select a particular style for renovation you might limit your future market. If you paint your house entirely pink inside or install naked white Greek marble statues in your front garden similar to the ones displayed in the movie My Big Fat Greek Wedding, you might find that this style only appeals to a limited market
• Adding specialist sporting facilities, such as tennis courts, pool rooms and gyms reduces the value of your home as the majority of prospective buyers will want to pay to remove these facilities
• Using expensive or specialist building material that will make maintaining the house expensive over time. Using cheap building material also has the same effect
How much should you borrow?
How much you can borrow depends very much on your particular circumstances. As a general rule, a lending institution will look at two main factors to determine how much you can borrow:
• Your ability to meet your repayments. In assessing your ability to meet any repayments, a lending institution will look at your income and this includes your employment income, investment income, government support, child support payments or any other regular source of income. The higher your income the more you can borrow. Your ongoing financial commitments are also taken into account, such as personal loans or child support payments
• The security, including the deposit, provided. The greater the deposit and security offered the more secure a loan is from a lending institution's perspective and the more you can borrow
To buy or rent?
At some stage in life, most people are faced with a choice of whether they should buy or continue renting. The easier option is to maintain the status quo and continue renting; after all it gives flexibility and more money in your pocket each week. There are advantages and disadvantages with each option that need to be carefully considered. From a financial point of view, over the long term, buying a home is generally the best option. Buying a home builds wealth through forced savings by paying off your mortgage and the capital growth in the property.
The main problem with renting is that it entrenches behaviour that does not lead to long term financial security as when you rent you generally pay less each fortnight than if you are buying a home. This leads to a false sense of security in that you have more money in your pocket each week which inevitably is not used for investment but rather for the day-to-day temptations of life. The lower the rent, the greater the difference.
A school friend lived in a share house with three others and, in the mid 1990s, paid $80 per week as his contribution to the rent. He was earning a substantial salary but he was not saving anything, with his salary being used to pay a car loan, overseas holidays and the latest designer wardrobe. After discussing the options with him, I suggested he should look at buying the house where he lived and maintain the status quo. After doing his calculations, he agreed and purchased the property for $145,000, getting a gift from his parents as the deposit and borrowing $140,000 from a bank. The interest rate on the loan was 7.50% and he took the loan over a twenty-five year period. His mortgage re-payments were $478 per fortnight. After taking into account the rent he received, buying the house cost him an extra $158 per fortnight. The price of the house was obviously a lot lower than it is now, but so is the rent. The rent which you pay now is a lot more than you paid at that time. You will be pleased to hear that fifteen years on he no longer lives in a "men behaving badly" type environment, and has now renovated the house and lives in it with his wife and two young children.
The advantages of buying are:
• You do not need to move house each year, a process which gets more difficult as we accumulate more and more possessions
• Gives you a sense of security and stability
• Builds your wealth over time
• You can make alterations to the property or garden as and when you like
• You are not at the mercy of the landlord and you cannot be evicted from your own home, providing you continue to make your mortgage repayments
The advantages of renting are:
• You do not need to spend any money on maintaining the property
• You remain flexible and can move easily to an alternative location if needed
• You generally have a higher discretionary cash flow
To assess which option is more attractive for you this can be illustrated in the table below, which shows the cost comparison between a tenant and a property owner over a seven year period,
• A tenant pays $1200 per month on rent with annual rent increases of 5%
• The homeowner purchases a property for $300,000 and has a mortgage of $250,000 with an interest rate of 7%. The monthly mortgage repayment is $1,766.95
From the table above you can see that initially, from a cash flow point of view, you are better off renting. Over the long term, you will only be better off renting, providing that you invest the difference (i.e. that you save $597 per month24) and get a greater return from this investment than capital appreciation of the home.
24 This sum of $597 was calculated by dividing the yearly difference in year 1 of $6,803 by 12
When comparing the returns, it is necessary to take into account the borrowing costs associated with the home loan. For example, if your home appreciated at 5%, let's look at what happened:
If, on the other hand, instead of buying a property you invested your savings of $50,000 and obtained an identical return with the accumulated rental savings:
From these tables, you will note that if the returns are identical you will be better off buying a home over the long term. In any event, renting over the long term you often end up in a worse financial position than that outlined above. The reason is that most people do not have the discipline to invest the difference they save by renting versus buying.
As a general rule, the property owner will be better off on the long term. It is important to note that despite the common myth to the contrary property values do fluctuate and often fall during periods of economic downturn. For an example of what can happen after a property bubble we need to look no further than the sub prime debacle in the United States where property prices in many areas fell in excess of 50%.
Useful websites
Homes for sale, real estate listings, home prices, new homes, real estate agents and mortgage rates.
This is an alternate website to Real Estate.com which has been developed in recent years essentially containing very similar information.
This is the website for the Real Estate Institute of Australia and contains some useful information for those interested in property in Australia.