Changeover – The Key Number

If the market is rising or falling in price, the crucial number when it comes to buying and selling is the changeover number. Simplistically, buy high/sell high or sell low/buy low. The market is relevant if you are buying and selling at the one time. Surprisingly, not everyone wins when the market is rising and not everyone loses when the market is falling.

With prices currently under pressure, many people are finding that this is the best possible environment to upgrade their existing home. Conversely, many people are resisting current market prices because they are downgrading therefore losing too much on their sale and not making enough up on the purchase.

As the real estate market gyrates, there will be beneficiaries and casualties. For simplicity, every person looking to buy and sell in the current market needs to be aware of one number. Their changeover number.

What is the total cost of buying and selling? Work out on paper the total transaction costs, the difference between your selling price and purchase price and any improvements that may need to be made. The sum total of these costs is your changeover number. This is the amount you will need to put into the transaction, whether it be in cash or borrowings.

Upgraders are the winners when the market is falling. But, if they focus on how much their existing property has fallen, they won’t see it that way. The reason upgraders are the ultimate winners in a falling market is the property they are purchasing drops in value more than the property they are selling. If you are buying a $1 million home to buy a $1.5 million home, a 10% drop in the market means your existing home drops $100,000 but the home you are purchasing comes back by $150,000.
Furthermore, most real estate transaction costs are based on a percentage formula i.e. sales commissions, stamp duty, mortgage insurance etc. The 10% drop in the market can also result in a 10% drop in transactions costs.

In a strong market, there are fewer sellers than buyers. When the market drops, it does so because there are more sellers than buyers. People whom have sold first in a falling market also find more stock (more options) on market than they expected. This choice can result in a less compromised purchase.

People looking to unlock the equity in their home can come out of a falling market worse off for the same reasons upgraders benefit. If you are downgrading to capitalise on the value of your home, the stronger the market the better. Generally speaking, baby boomers are the most likely segment of the market downgrading. The question facing people looking to downgrade and unlock their equity is whether they should sell now in the current market or wait for a rebound in prices. After the GFC, house prices bounced back stronger than any other asset class, but it remains to be seen if it will happen again. With superannuation funds taking a battering in recent times, many baby boomers are looking at their homes as their nest egg.

Demographers such as Bernard Salt and Harry Dent have touched on the challenges ahead in the next decade with baby boomers and asset prices. As boomers look to sell down their assets, there will not be enough buyers to support the supply and prices at current levels. Gen X are smaller in numbers than boomers, potentially creating more sellers than buyers on a demographic front – which is far harder to overcome than a drop in buyer sentiment. Gen X and Gen Y are being asked to go deep into debt to support house prices at current levels. Many boomers are on the cusp of retirement and many will look to sell down and/or take a sea change. As a result of excess supply coming onto the market, some commentators such as Dent believe that boomers could face challenges achieving their price goals in the next 10 years.

Investors can focus on income or growth. In recent times, capital growth has been all the focus for investors. When the market tightens, focus shifts to income. Both for investors entering the market and existing investors looking to maximise their returns. The rental market has been shrinking in recent years, which will see continued upward pressure on rents.

Investors buy for profit, so ultimately only a rising market is of interest to investors. It depends on whether one takes a short or long term view when investing though. Quite often the best value can be found when the market is falling. Every property sells well when the market is rising, but properties with flaws can under perform in a weak market. When clearance rates are slow, properties requiring works get left on the shelf. In turn, renovators and developers that have been squeezed out in recent times may find opportunities emerge.

Prior to purchasing a property, it is always good to establish the objective of the purchase. Are you chasing a certain percentage return? Are you “investing” purely for capital growth? (If so, this could be speculating not investing) Are you buying & renovating with a view to a attaining certain profit margin?

In recent times, putting your name on a contract meant investors would make money. This is less likely going forward. We are now seeing numerous instances in the market place where properties that sold during 2003 are re-selling in 2011 for about 15% more. As an investor, these returns lag inflation. Take the double whammy of being negatively geared the entire time and many investors during the boom of 2003 are coming out with a loss.

Buy in gloom, sell in boom not the other way around.

First Home Buyers
Entering the market is about to get that bit harder for first home buyers as major stamp duty concessions are slashed on December 31 2011. There are two key numbers for first home buyers when entering the market. Firstly saving a large enough deposit to enter the market and secondly knowing exactly how much it costs to run a property. Every cost from mortgage repayments to council rates to strata levies should be broken down into a figure amounting to the weekly running cost of the property. This then needs to be balanced against income and lifestyle to see if the purchase is sustainable. Leasing out the second bedroom (and third if applicable) is a great way for first home buyers to manage the mortgage in the first few years.

Regardless of what category you may fit into, you have more chance of succeeding in real estate if you have a written plan that is simple, right down to a single figure. If the plan does not work on paper, its no chance of working in reality!