It’s very common for parents to worry about whether their children will be able to afford to buy into the property market, and we get asked about this regularly.
There are several complexities involved: some financial, and some more related to parenting choices.
I’d like to share an idea that could work well for both parents and their children.
Put your financial position first
The top priority must always be ensuring you can comfortably fund your own retirement.
While we all want to support our children, it’s vital not to put your own retirement at risk, as doing so could ultimately put a financial burden on them.
The stronger your financial position is, the more likely you’ll have surplus wealth (more than you need), which you can use to help your children in the future.
That’s why I always advise my clients to prioritise their own retirement and financial future first.
Challenges with planning how to help kids
As the saying goes, you can lead a horse to water, but you can’t make it drink.
While we might believe that entering the property market as soon as possible is the smartest financial move for our children, ultimately, it’s their decision.
One thing I’ve learned is that you can’t motivate someone to build wealth – that drive must come from within.
You can educate them, guide them, and encourage them, but the reality is that some children will be highly motivated, while others won’t be interested at all.
Property is a significant commitment, so it doesn’t make sense to push your child into the market unless they are genuinely keen to do so.
Your level of support should align with their level of enthusiasm.
If they’re highly motivated, saving aggressively, and doing everything they can to buy property, then help them as much as possible.
But if their interest is only lukewarm, it’s wise to match that energy.
They must be willing to make an emotional and financial contribution, otherwise they have no skin in the game.
The challenge is that you won’t always know when, or even if, your child will want to enter the property market.
However, of course, you should put yourself in a position to be able to help them when they are ready, which is the subject of this blog.
You buy now, they buy later
Over the past few years, I’ve written a lot about how Melbourne apartments have underperformed.
According to REIA data shown in the chart below, apartment values (i.e., all dwellings other than houses) in Melbourne have been stagnant for the past 7 years.
In fact, it’s my observation that older-style, investment-grade apartments have remained relatively flat for closer to 10 years.
There’s strong evidence that investment-grade apartments are now intrinsically undervalued.
Over the past decade, land values have certainly risen significantly, yet apartment prices haven’t followed suit.
Additionally, construction costs have surged with many developers reporting that it now costs over 30% more to build an apartment compared to pre-COVID levels.
The ‘cost to replace’ these older-style apartments is much higher than their current market values.
In addition, the supply of new apartments remains very low.
As the chart below highlights, both Sydney and Brisbane have experienced similar flat cycles in the past, and these periods of stagnation are always followed by a growth cycle.
It’s only a matter of time before Melbourne follows suit.
It is my thesis that Melbourne property, and specifically Melbourne investment-grade apartments, will enter a growth cycle in the coming years.
This makes them an attractive investment opportunity.
It also highlights the affordability challenges our children will likely face.
That is, apartments are likely to cost significantly more in 10 years than they do today.
First-home buyers tend to be attracted to apartments due to their affordability relative to houses.
Here’s the strategy…
If you’d like to be able to help your children enter the property market in the future, buying an apartment now could be a smart strategy.
I suggest buying a 2-bedroom apartment, as these are better suited for those who work from home and for two renters to share the same apartment.
Investment-grade apartments are typically built before the 1980s (older-style), located in blue-chip suburbs on quiet streets, with only a small number of apartments in the block.
To ensure you purchase the right property, I recommend engaging a reputable buyer’s agent.
In Melbourne, you will need a budget of around $650,000 to $750,000.
For instance, if you buy a 2-bedroom apartment for $700,000 that rents for $550 per week, I estimate the after-tax holding costs would be approximately $16,000 per year.
Assuming rental income gradually increases and an average interest rate of 6.5% p.a., the total after-tax cost to hold the property for 10 years could be about $135,000.
If the property grows at an average (conservative) rate of 6.5% p.a., its value could rise to $1.3 million in 10 years.
Average capital growth rates in growth cycles tend to exceed 6.5% p.a. If the average growth rate is 8% p.a., the property could be worth more than $1.5m in 10 years.
At that point, you could sell it to your child for $905,000, which is the original purchase price of $700,000, plus purchasing costs of $60,000, plus an estimated $145,000 for capital gains tax (CGT).
Your child would also need to pay a stamp duty of around $75,000, bringing their total acquisition cost to about $980,000 – approximately 75% of the property’s market value at the time.
CGT and stamp duty are levied on the market value of the property, not the sales price.
Effectively, this approach means you have gifted your child $135,000 (the after-tax holding costs).
If you’re not comfortable with this level of financial support, you could include that amount in the sale price, selling the property to your child for $1.04 million.
In this case, you will be fully reimbursed.
Plan B
Keep in mind that your child would need to have enough income to be able to borrow $980,000.
If they can’t borrow that much right away, you might consider selling them a portion of the property now and the rest later when their financial position improves.
If you take this route, it’s important to think about what happens to this arrangement in the event of your death.
You could leave your remaining share of the property to your child in your will, but if the share you leave exceeds their entitlement, you’ll need to make alternative arrangements.
If you’ve helped one child but not the others, it may be worth including an offset clause in your will to ensure your estate is divided equally among all your children.
Be aware that parents and children co-owning property together can become complicated from a borrowing perspective, so you’ll need to obtain professional mortgage broking advice.
If, after 10 years or whatever your timeline is, your child isn’t able or doesn’t want to buy the property, you could continue to hold it as a personal investment or sell it to realise the capital gain.
What if you have more than one child?
Of course, you could buy multiple properties – one for each child.
However, if you choose this option, you’ll need to think about how to equalise your financial support, as the financial outcomes are likely to differ between them – no two properties are likely to perform identically.
If your children are close in age, you might consider selling the property to them as equal co-owners.
Siblings co-owning property can work well, but it’s important to recognise that these arrangements often have a limited lifespan and can sometimes complicate family and personal relationships.
Avoid factoring in private use
Sometimes, clients suggest buying property near a university their child might attend or make similar decisions based on personal preferences.
My recommendation is to set aside any lifestyle or personal considerations and focus solely on purchasing the highest-quality investment within your budget.
Financial outcomes should be your top priority to ensure this strategy delivers the best possible results.
You first
I would recommend only contemplating an arrangement like the one I’ve described above if you are confident that your own financial plan is secure.
Only once your own financial future is secure would it be appropriate to start using some of your financial resources and, borrowing capacity to help mitigate the risk of your children being priced out of the property market.
Otherwise, it is probably best to limit your support to providing a family guarantee.
