Saturday, June 13, 2015

Buy! Buy! Buy! The Joe Hockey Real Estate Primer Part One

Normally you think of shills and touts as those shifty, hard- living sociopaths in the movies; drinking their  endless cups of coffee in some sleazy boiler room, shouting into phones; living their hard, hedonistic amphetamine-fueled, licentious  lives.  And on the other end of the line you and I; decent and honest joes with no more than the usual streak of larceny in our hearts.  It is usually dormant except when you are surprised in your home or workplace with a great script and you don't get a chance to get a word or thought in edgewise and it rises up; the brain is put on hold and you are only a schmuck who is going to get lumbered with a time-share in Oklahoma; a ridiculous piece of mining moose pasture or an IPO of some revolutionary piece of crap like Twitter or

Who were going to make billions selling dog food and cat scratchers on line, and you could get in right at the bottom!  And after you have been taken down once or twice you come to understand that these people rank well below pimps, who will at least see you get your money's worth.

Maybe you even heard those three little words from familiar, eminently- respectable and besuited characters on TV in your home -or in a home belonging to some other schmuck who is working two jobs to make it his one day and who DIDN'T get in at the bottom and your rent isn't a patch on his mortgage.

From the treasurer Joe Hockey: "Real Estate is not a bubble!"
"It's supply and demand; It's Economics 100! Get out and build. build, build.  Interest rates are at record lows!  There's never been a better time to buy!  Get a good job and buy a good home!

The last is especially poignant as he not only has a good job, his special parliamentary living-away-from -home allowance is going as rent to his wife in HER home where he stays when he is in Canberra, and no doubt that goes a long way to paying the mortgage, and perhaps that means there is a 2nd capital gains tax- free residence for the Hockeys, with each having a different 'principle residence.'   And some of us remember how Joe's Liberal predecessor Peter Costello taunted Senator Nick Sherry for claiming his allowance when he stayed with his mother in Opossum Bay back in Tasmania.

"What does mum say when Nick walks in the door?  Oh, Possum!"

And Sherry, even though he is/was a politician had some residue of conscience and shame and had the human decency to go and cut his wrists.  Joe just shrugs it off, all these guys do it or some permutation - it's allowed by the fully independent Remuneration Tribunal and not covered by the criminal code so its not his problem.  But is the tribunal really independent, like say Gillian Triggs, the Human Rights Commissioner who has been mercilessly hounded by cabinet heavyweights for her own independent moral stand on conditions for asylum seekers in our own little Guantanamo.  I wouldn't even ask why a prison corporation can be paid more to brutalize people behind barb wire than I would need to make a profitable business out of it by giving someone a house of their own, living allowance, car and a college education.  Maybe this has implications for future conflicts; if we could have corporatized the Japanese Imperial Army, they would have met their Waterloo years earlier, broken and bankrupted at Changi and the 'co-prosperity sphere' laughed right off the world stage.

But back to housing prices and bubbles.  Firstly it is self-evident that since real estate prices are at record highs there have been better times to have bought, ANY other time would have been better. I have seen a few bubbles over my lifetime and have done very well by doing precisely the opposite of the tactics touted by our esteemed treasurer.  It's Economics 200!  You buy low and sell high!  And when mortgage rates are at their highest that's when houses are cheapest!  But you have to have some capital because nobody wants to lend!  So maybe you rented for a while in the boom and saved while  the other schmuck paid out the vast difference between the capital value and enterprise value of the house.  So you have money when the time comes and its harder to borrow BUT you don't need a big mortgage and no matter what happens you aren't going to lose your butt!  And it's stress-free after you have completed the contract it feels comfortable and you don't need to work two jobs!  And with "animal spirits" at their lowest ebb you don't expect to make a killing but you probably will! And you can easily hedge against falling rates in the face of your fixed rate mortgage by insisting on a clause by which you can pay more off at any time without a penalty.  If it starts looking too uncompetitive just pay it out or refinance with someone else!

Even Economics 100 dopes know that markets tend to revert to a mean so if interest rates are at record lows they will probably go higher.  Even if inflation draws a line under the book value it might still see you s****ed.  So let's go from Economics 200 to some really basic accountancy to glaze over your eyes and tickle your funnybone when you look at the real, enterprise value of a house as a business venture which is a wake-up call if you have been counting capital appreciation chickens on your fingers.  Strings of words with capitals denote a popular acronym.

Generally Accepted Accounting Practice defines earnings as  Earnings  Before Interest Taxes Depreciation and Amortization, all of which have to be paid off from the rent except for the 'negative gearing' tax loophole for investors by which they can apply the generally negative earnings figure after expenses to their other income, like those his and hers night cleaning jobs where you roam the CBD office buildings with your backpack vacuum cleaner while the kids are asleep.  You only  get to use negative gearing if it ISN"T your actual primary residence and  you sacrifice the tax free capital gain status.  But that's no problem, there is unlikely to be anything to worry about when it's all added up at the end.  Save your dockets.
 Firstly interest on your mortgage: there is a set-up fee after which you have to pay say 4% every year on an average $300 thousand dollar housing loan which is $12000 per year after-tax money for the non-investor  which is eating up your ultimate capital gain.  And you still have to pay off the whole 300 thousand dollars of the loan on top of that over the period of the mortgage or when you sell the thing.  That's the amortization and they generally structure it so you pay the same money every month from start to finish.  There are tables you can access.  And there are council rates, land taxes, stamp duties in the 'taxes' bracket and depreciation too which means houses and fixtures have a lifetime just like human beings; the house is growing old and frail and slowly falling down around your ears (deep-sixing capital gain) and if you don't do something expensive about it on a regular basis, renters will dodge their responsibilities and it will eventually be condemned as 'unfit for human habitation' and serve only as shelter for itinerants and drug addicts while waiting to be demolished despite your protests.

In the lead-up to the 2000 Olympics I did like a lot of Tasmanian tradies and after a marital tiff loaded my tools in a van and drove up to Sydney.  On arrival it took about 4 hours to get work, firstly doing fit-out out  above Grace Brothers at Centrepoint for Fairbrother and when that was finished I was everywhere; working for subcontractors on projects run by most of the big general contractors like Multiplex and Horniblow and even some residential work, pubs, the Leichardt Cathedral, Kell and Rigby, shop fitting, you name it.  So I was  there putting some of the biggest and smallest Sydney real estate projects together in the biggest boomtime ever, and in spite of that every subcontractor I worked for was going out backwards.  The big guys would get eight or a dozen quotes for every aspect of a job and some newbie or fool or general optimist could always be counted on to make some glaring mistake or cut it too fine in the competitive catfight.  And it is then that you come to realize a fundamental law of business: whatever you have to sell from your own labour to boiled lollies-unless you enjoy some kind of protected position - that the return on   all endeavours subject to market forces has only one direction which is downwards towards the fine line between life and death.  A month after the races were run I was given a day's notice at Kell and Rigby (I was first to go being a subbie with my own tools on $10 an hour more than everyone else) despite being very well thought of, having had the drive and imagination to be seen always beavering away flat out at the German Club; the foreman and I; getting double pay knocking out 'foreigners' when there had been delays at the factory.  Of course the clueless occasional supervisor had no idea or maybe there are times when  everybody looks so much better if they know when to keep their mouths shut.

But I could see the writing on the wall and went home for good.   Kell and Rigby, the oldest joinery firm in Sydney, lasted another five years or so.  In other words there are NO intrinsically good jobs or businesses that someone else who is hungrier or younger or more or less indebted than you cannot do as well in the fullness of time in the hard light of Struggle Street as touted by our political geniuses.   Economic rationalism is best born by some other guy.  So we seek safe harbour, be it bad ones like the CFMEU or good ones like the AMA, a Macdonald's franchise or the 'independent' Remuneration Tribunal.  And if you do too well selling Big Macs they squeeze your territory and sell a closer franchise to another hopeful.   Or used to, things have not been going so well as tastes and styles change and that ugly word competition comes ever closer.

Every time I went home I would move out of some shared accommodation and find another on my return, mostly in the inner west.  On the job or in accommodation: wherever; I always took note of the particulars of the real estate market.  Retirees were selling multi-million dollar north shore homes to vie with Chinese investors and move into something like our Anzac Bridge faux Italianate waterfront units which were essentially stacked two and three bedroom frame or cement block white-trash small town ranch-style pieces of crap or Renzo Piano's supposed masterpiece on Macquarie Street which has top end beautiful apartments but they were very expensive including an extra $10 thou for every layer of persons below. 

I stayed in Marrickville with an extended family of kiwis for a while in a four bedroom federation brick terrace which cost $100 per week per person.  Somebody I never met was gearing it.  He received $400 per week and this place needed $30-50 thousand worth of work which was typical for that vintage.   The market value would have been $600 thousand, now around 1 million 15 years later.  If he owed 400 thousand then interest at 5% was $20,000 per annum and he received that but with no return for his 200 thou equity except a leveraged capital gain potential and nothing for depreciation, repairs, rates or amortizing the 400 thou.  There is a rule of thumb for enterprise value of a rental property.  Purchase price equals 100 monthly rental payments which gives you a few percent on your invested funds and enough left to cover all the rest of the taxes, repairs, depreciation etc.attached to your investment.  For the Marrickville home that would have been $160 thousand.   So supply and demand has engendered this crazy disconnect with reality.  The why has to do with old simple-stupid Economics 400!  Interest rates define the value and future of ALL OTHER investments whether you like it or not!  It's all about rational markets as a price discovery mechanism.   If  you could get a low risk return of 8% (a real 5% after inflation) on your government bonds or bank account;  mortgage rates in a real world would be correspondingly higher and NOBODY would be sticking their necks out to pay more than enterprise value for some decaying little working-class rabbit hutch.

So is there a bubble?  The maestro Allan Greenspan said you can't tell until it pops.  Which allowed him some margin for error and public approbation all those years until it or they did.  Similarly the man who in retrospect won't have been up to turning back used-car odometers much less Treasurer of Munchkinland will do all he can to hold the day of reckoning beyond another election or better yet his retirement to that great inflation-indexed Pollie's Paradise in the Sky.  He might stay lucky for a time so go for it kiddies.

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