Episode Details

Perhaps a softer property market will allow you to buy a future home now for below intrinsic value – especially if you plan to upsize or downsize in the next few years. Purchasers are in a stronger position in a softer market – especially with a backdrop of lower median property prices and lower auction clearance rates. This blog considers the financial merits of this strategy and what to look out for.

What’s the benefit of doing this now?

The advantage of buying at the bottom of the market (or close to it) is the probability that you will pay less for a property than you would if you purchased it in a more balanced or buoyant market. I wrote a piece for The Australian (here) in December stating that I believed we were close to the bottom of the market. And I still hold this view (e.g. auction clearance rates picked up over the weekend). So, if you agree that the market is unlikely to fall materially from here, then now might be a good opportunity to purchase a future home.

In addition to the benefit of buying below intrinsic value are lower transactional costs (stamp duty) and lower reoccurring holding costs (i.e. lower borrowings means a lower annual interest expense).

Buy now and rent it out

One strategy could include buying a replacement home now and tenanting the property until (1) you are ready to occupy it and/or (2) the property market improves and is more of a sellers’ market. This might help you to ‘buy low and sell high’ thereby maximising your equity and financial position.

An additional benefit to this strategy is that you will ‘lock-in’ your entitlement to benefit from negative gearing. This is important if you believe that the ALP will win the federal election in May and implement their ban on negative gearing. Purchasing before this ban is implemented could save you a lot of tax.

In order to do this, you must consider two factors:

1. Does your borrowing capacity allow you to buy now and sell later? As I have written about in the past, borrowing capacity has contracted a lot and just because you think you can afford a loan, doesn’t mean a bank will share the same opinion; and

2. Can you afford the debt from a cash flow perspective? Typically, I test affordability at an interest rate of 7% p.a. – to ensure debt is still manageable in a higher interest rate environment. Obviously, interest rates are a lot lower than 7% p.a. at the moment. And the market has priced in an RBA rate cut this year – although we’d probably need to see the unemployment rate increase for that to happen. So, there is a reasonable argument to be made to say that rates will remain low for a while. But don’t get seduced by the lower rates and risk over-borrowing.

Market arbitrage has its risks

Market arbitrage refers to buying and selling in different markets. This strategy is not without risk. Obviously, the key assumption behind this strategy is that buying today will cost you less than say buying in 5 years’ time. And it’s also assumed that selling your existing property in 5 years’ time will yield a higher sales price than selling now. However, this is merely an assumption and it could turn out to be wrong. Therefore, the lowest-risk approach is to buy and sell in the same market (i.e. this year).

However, for some people, the risk is worth taking i.e. buying now and selling in a few years’ time. This depends on your risk profile, financial position, location of properties and so on. If it’