My father recently went to Australia and met with one of his old friends who had been living in Australia for a couple of decades. His old friend, let’s call him Mr. Chen, in his late fifties, runs a restaurant seven days a week. While Mr. Chen admits it is an extremely unbalanced work life, he nevertheless finds his Zen when he counts the cold, hard cash that comes in at the end of every night.
Mr. Chen decides to invest in real estate as a result of his economic situation steadily improving. Mind you, he is not making money like Gordon Ramsey (otherwise he would not be working seven days a week). However, he recently bought a 2 bedroom apartment in Canberra for A$500,000 and bought a piece of land to build a 300 sq. meter (that’s right, this is international talk, go make the conversion) house for him and his family that will ultimately cost A$900,000.
He just invested A$1.4 million (at this point Australian dollar is actually stronger than the dollar, but for practical purposes, let’s just say $1 to A$1) in real estate and will only have two properties show for it!
The 2 bedroom apartment, his investment property, can only be rented out for A$500 per week, getting him only about A$2,000 a month. A gross return of 4.8% that will be more like less than 3% after expenses. His old house, which I believe is now free and clear, probably rents for about the same.
How Does Cashflow Look?
So with A$4,000 a month, will that amount allow him to service his debt?
Briefly looking into the Australian mortgage market, I would say he is probably paying 6.5% over 25 years. Assuming that he put 20% down in the A$1,400,000, his principal and interest will cost him A$7,562 a month!
That’s more than A$3,500 out of pocket every month! That’s a pretty dangerous operating level (believe me, I get enough flak from the BP community about investing in properties that break even in cash flow every month)! Yet, Mr. Chen is quite happy that owns several pieces of real estate and talks grandly about how fantastic his new house is going to be. Also from what I hear the bankers have enticed Mr. Chen to borrow more than he originally had intended to borrow.
The grease that pushed America home prices up seems to have shown up in Australia as well. Yet Australians are continuing to buy houses despite the exorbitant price levels. Home constructions are still booming. Every few years I return I see new subdivisions popping up here and there.
But why does it make sense to buy now? Is it the fear that homes will continue to get more expensive if you wait? Australia has gone a couple of decades without a housing crash. Is it the golden child?
The Problem for Australia
I fear that Australians do not believe that they are living in a housing bubble. Perhaps they do not think real estate collapses in America, Great Britain, Spain, and etc will apply them. I do not see the economic justification for Mr. Chen, who works like a dog seven days a week, to borrow so much money to buy so little. Although his business has been going well, can he be sure that he will have enough savings to pay out A$3,500 a month if business begins to suffer?
With that being said, Mr. Chen’s case is just one of many cases happening all over Australia. Keep in mind that the median household income for Australia is only about A$65,000 a year. So for the average Australian, buying a home at half a million Australian dollars or above is not something that is easily affordable. Since the country’s economy is extremely dependent on China and commodity pricing, the oncoming slowdown can really decimate Australians’ ability to keep up with expensive house payments.
What’s the moral to all this? If I were an Australian I would’ve looked at what happened in America and say, “you know what? This is starting to get a little crazy. I think I should get out of the market.” Since I love Australia, I will be sitting here in America looking across the moon and waiting for Australia’s real estate market to collapse. I would love to get into the market at that point. You never know. You have to keep your eyes out there.Opportunitiescan appear at any moment.
I hope Mr. Chen will be okay.
Photo: paul bica