The danger in over-paying for Sydney Property

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Another weekend is here and i have many clients off to auctions again. Over the past three months in particular, every Monday morning I wake up to hear about the crazy prices that have been paid for property all over Sydney and that most of my clients have missed out again.

While increasingly frustrating for them, I am personally glad that they have walked away from the deal. If they did buy it, they would have paid over the odds by not $50,000, $200,000 or $300,000 in some cases.

Only a few years ago, an inner north two bedroom unit would sell for around $500,000, now that same unit would go for over $850,000. A three bed cottage in the inner-west was around $700,0000, now that same property would go for over $1,400,000. There are also parts of outer areas that are going for prices well above anything the average Sydney family can afford.

We all know that these price rises are not sustainable. That does not mean they are going to stop rising however. There is still a huge amount of demand each week as can be seen by clearance rates at auctions of 90% and the prices that are being paid.

I do believe however that they are starting to hit a territory that is highly risky for the people crazy enough to pay these inflated prices. The last few months have been the first time in the Sydney market that I am slightly worried for the people on buying side of the transaction.

It is no doubt the Sydney market was at a fair price a few years ago. While it was still expensive by world standards, after 6 years of not really going up in value it was a great time to buy.

Sydney is a special city. It’s a super city and now with population closing in on 5 million. Lets not beat around the bush, it is unique. The demand to live around the CBD and beaches is unmistakably huge. This demand will increase dramatically over the next 30 years as population rises, the transport problems persist and overseas wealth continues to flood in.

The problem with building a global city on the coast is that you lose half the land for the people. That halves your supply and importantly transport access to the city becomes much more difficult. This causes an ever-increasing pressure on prices on the coast and inner city as you can see in the image below.

I admit there is two lines of thought on the current prices. One line is to justify paying these prices as interest rates are low and due to this buyers can afford repayments. I agree with this, as long as the buyer does not pay an over inflated price and well over the odds; something difficult to do in the current market.

The other line is to sit out and wait till prices stabilise. The problem with this view is that prices may stabilise 15% above where they currently are. Leaving you in a position to buy at the same price you would have today anyway.

If you are looking to invest, I would argue that Sydney is not the best place to invest over the next few years, unless you can get something quality at fair value. Difficult to do.

If you are looking for a home, you have a choice to make do you buy or do you continue to rent.

My advice for people looking to buy a home is to focus on the two most important things. The property you purchase and the price you pay for it.

I will leave out of this article how property prices work, but it is important to understand how both demand and supply push up prices but also in times of distress push down prices. If the demand dropped in a market (less buyers) and supply increased (new developments, more sellers) you will see a fall in prices. In these scenarios it can get very messy and very fast. The GFC showed that to places like Noosa and the mining towns more recently. Simply, the problems all around the world with property prices was because of this.

New off-the-plan developments in apartment heaven around the airport could have a fate along these lines if Australia went through a tough phase. The outskirts of Sydney would be affected first by a rise in unemployment and incomes not rising.

When times are good, the money flows in to the middle and coast first, then pushes out to the outer suburbs as the inner city becomes too expensive. When times are bad, the money flows out of the outer suburbs first and the inner suburbs last.

The further you buy out generally the more risk you are taking and the lesser the growth due to the incomes do not rise as much.

 Fundamentally, be VERY careful with what you are risking your life savings on.

The second point, I want to raise is the problem you have if you do buy a great property but overpay by $100,000 or $200,000.

What does this really mean?

  1. Your debt will take many more years to pay off
  2. Your cash flow is under more pressure as your minimum payment is much higher
  3. You investment options are limited and delayed due to the equity growth taking longer to achieve. This can then create a timing issue where you cannot invest.
  4. You are at risk of loss if the market does cool off and you need to sell for any reason IE: Relocation, Divorce or changing needs.
  5. You pay more stamp duty and costs. Not a biggie but adds up.
  6. You limit the value a renovation would add
  7. You limit the amount of tax free growth that you can walk away on sale

 I will stop there but I will show you two scenarios.

Scenario 1: A client pays a fair price of $1mil for a new home and can afford $6,000 a month in repayments. At best they can afford $8,000 if they were really tight each month.

Scenario 2: All stays the same but they pay $1,200,000. They loved the place and thought interest rates are low so why not.

This shows how their debt looks in each scenario. Take notice of the additional time and pressure scenario 2 had to endure by just saying yes to buying it and not no.

This article may sound negative towards Sydney prices and in more and more cases I am concerned. I do have clients who have been patient however who have bought absolutely brilliantly. One couple in Paddington about 6 months ago, that now looks like a brilliant buy based on recent sales only doors away. The key is to be patient, stay true to what you can afford and finally try to remove the emotion out of the purchase.

If someone else is going to be crazy enough to overpay by $100-200,000, it is best to go home empty handed and pray for the person overpaying that they can afford it.