Upgrading your home is typically a huge financial decision. Sometimes, timing is everything. There are lots of issues to weigh up including lifestyle needs, cash flow, future changes to income, the quality of the properties for sale on the market, the health of the property market and the list goes on. Another complexity is that financial and lifestyle considerations often battle against each-other making the decision even more difficult.
With the recent improvement in the property (prices) market, we’ve seen a rise in the interest in (home) upgrading. Now could be a perfect time to do it before the momentum behind property price rises builds further.
Obviously, I can only talk about the financial pros and cons. When selecting a home, often lifestyle considerations are as important (or more) than financial ones. Fair enough too. This article focuses on the financial considerations only (which are much easier to quantify) – so please read it with that in mind.
Doing it safely
It’s worth looking at the financing aspects first – because at the end of the day, that may dictate or limit your options.
Most people have heard about bridging finance – i.e. taking out a short term loan to bridge the gap between having to pay for your new home before receiving the money from selling your existing home. Most lenders will only provide bridging finance if you have already sold your existing home. If you haven’t sold your existing home yet, then there are a small number of lenders that will give you a 6-month bridging loan – but you have to have enough equity in your existing home to qualify.
One of the risks with buying before you have sold your existing home is what happens if you end up having trouble selling your home (for the price you want) and you need to drop your price? I’ve seen people get themselves into awful trouble by doing this and it’s resulted in lots of stress and tens to hundreds of thousands of dollars in losses. My advice: I we can’t find a financing solution that will allow you to buy now and sell your existing home in a way (time) that allows you to maximise the sale price, then selling first is the safest option. The only practical issue with selling first is what happens if you can’t find a replacement home in time. You might have to rent for the short term and put your furniture in storage. But that’s a small price to pay compared to the risks of the alternative approach.
Another great option could be to hold both properties for a period of time and rent one out (i.e. rent out your old home or rent out the new home). This may give you some tax benefits (and help with affordability) and allow you to buy now. In short, there are a few financing options to investigate and this should be your (our) first step so that you can understand what’s doable and what’s not.
I believe that when buying or selling property, 5 to 10% is luck. The right day, the right time, the right property, the right agent, good sentiment – or the complete reverse – luck can swing both ways. It’s possible to buy a good quality, blue-chip property for less than fair market value. I’ve seen it happen. It’s not a common occurrence so you’d be silly to plan for it but it can happen. I’ve done it myself when I bought my house in September 2008 – the week after investment bank, Lehman Brothers collapsed in the US. I’m not suggesting its skill – I was just lucky – right time, right place. That said, you do have to be in it to win it. You have to be active in the property market to have any chance. In our experience, the property market and buyers’ sentiment has certainly improved in 2013 and we’re expecting momentum to build throughout the rest of the year.
To sell or to rent?
Often people that upgrade want to keep their previous home as an investment, maybe because they’ve heard people suggest the rule; “never sell property”. I agree with the rule to some degree but I’d add two words: “never sell blue-chip property”. Homes are typically purchased for reasons other than investment fundamentals. In fact, in my experience, it’s rare that a former home will make a good investment. Apart from the quality of the property (from an investment perspective), the ownership structure of the property and the structure of the loans is typically sub-optimal. So there are a number of factors that come into play. That said, 80% or more of the deciding factor whether to sell or rent a former home is the potential for future capital growth and the risk associated with achieving that growth.
For example, of course one option is to sell the former home and therefore borrow less non-deductible debt (because you’d have more cash from the sale to contribute). This would reduce the amount of interest you pay in respect to your home loan – say 6% p.a. saving. That is a risk free saving. That is, you’ll save 6% regardless of what the market does. Therefore, if you’re going to take the risk (of not selling the property) then you’d need to be pretty sure that the property’s capital growth will be more than 6% over the long term. Probably the most compelling evidence of this is the property’s past growth. Therefore, I would go back and calculate the capital growth rate over the previous 10 to 20 or more years. If it’s less than 6%, I’d be concerned and probably sell.
If you’re optimistic about the property’s capital growth, then typically I’d recommend keeping the former home. If there’s any doubt, sell it, reduce non-deductible debt and you can always buy a pure investment property immediately or at a later stage.
The ultimate solution
The ultimate solution arises when you can buy an ‘upgraded’ home for less than intrinsic value, retain both properties (for a period of time) and then sell your former home (if it doesn’t warrant retaining for investment reasons) over a time period that allows you to maximise value.
If you are considering upgrading in the next 12 months we’d be happy to prepare a preliminary analysis of your options including whether you should retain your existing home and how to achieve the most tax effective structure. Simply call the office or contact your Credit Advisor directly.