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Australian Housing Market :Great Australian Dream


Assessment Details and Submission Guidelines
Course NameMaster of Professional Accounting
Unit CodeMA514
Unit TitleBusiness Finance
Assessment TitleReport (individual)
Unit Learning Outcomes covered in this assessment
  • b. Demonstrate knowledge of time value of money (TVM) concepts and techniques, capital market theories, and methods of financing businesses, and critically apply the concepts to evaluate economic and investment decisions, including the valuation of bonds and shares and the assessment of capital budgeting decisions. 
  • c. Demonstrate strong conceptual corporate finance knowledge to analyse and interpret advances in theory for professional practice. 
  • e. Communicate relevant high level finance knowledge with other professionals.
Word limit2000

Assignment Description

Students are required to undertake research and conduct analytic work following given instructions in the areas of business finance covered in learning materials from week 1 to week 10 inclusive. Through this assignment, students should identify the main issues related to the realization of “Great Australian Dream”, and provide a workable financial plan to realize the “Great Australian Dream”. Students are strongly advised to reference professional websites, journal articles and text books in this assignment. 

The Case 

You are supposed to be a financial adviser, providing professional financial consultancy to your clients. One of your clients is a young technical migrant who has just completed her postgraduate degree and found a job in Sydney/Melbourne with an entry salary of $80000/year. She wishes to purchase a house to realise her “Australian Dream”, for which she has saved $50000.  Ideally, the purchase should happen within 10 years. However, she knows that Sydney/Melbourne housing price is very high. She is not sure how she can afford to purchase a house in Sydney/Melbourne. Your task now is to work out a financial plan for her that can guide her to her target. 

Required: 

This assignment is to be completed individually and is to be submitted in Week 10.

100 mark

#Key tasks to be completed

1
Forecast the housing price in Sydney/Melbourne

2

Forecast the income development

3Predict the net income of your client
4

Determine the upfront payments and purchase costs, depending on the proportion of the upfront payment 


5

Work out the financial plan showing how to realize the “Australian Dream” for your client.

6Risk assessment of the financial plan

7
Report detailing the financial plan 

8Final Submission of Complete Assignment




You are required to do the following:

  1. Investigate the historical housing price data for Sydney or Melbourne and make an appropriate forecast of the housing price for the next 20 years. Clearly state the assumptions you make in order to obtain the forecasts of housing price and justify your assumptions by providing convincing arguments.                             Historical housing price data are available on the ABS website. 10 Marks


  1. Investigate the historical income data for Sydney or Melbourne and make an appropriate forecast of the income of your client for the next 10 years. Clearly state the assumptions you make in order to obtain the forecast and justify your assumptions by providing supportive arguments. 10 Marks


  1. Calculate the nett income of your client, given that she is single and does not have dependent. You can use the ATO tax Calculator to determine the nett income. Make a realistic assumption on the monthly expense of your client and determine the capacity of monthly repayment of your client. Find out the most favourite current home loan rate, and determine the maximum amount your client can borrow at the best rate.

10 Marks

  1. Usually, a bank will finance only up to 80% of the property value, i.e. the buyer needs to pay upfront 20% of the property value. Alternatively, if the upfront payment is less than 20% buyer needs to pay mortgage insurance. When purchasing a property you need also to consider the stamp duty that is associate with property purchase. You can determine the amount of stamp duty with online stamp duty calculator. What is the house price your client can afford now?    10 Marks

 

  1. If the current financial situation of your client cannot afford a house, please work out a financial plan that will guide your client to realize her “Australian Dream”, where you need to consider how your client can invest her savings to achieve the target of upfront payment plus stamp duty.  You need to provide a plan with 20% upfront payment and an alternative plan of 5% upfront payment plus mortgage insurance. Here you need to consider that the property price is changing following your answer in task 1 and hence the saving target is changing with time, and the income of your client is also changing with time following your answer in task 2. Use an excel table to show how the target will be achieved and when the house purchase can take place.  30 Marks


  1. Since current interest rate is at its historically low. In the coming years, the mortgage rate may increase to 7% and stay at the level for several years before it goes down again. Assuming that the mortgage rate will increase to 7% in the third year after purchasing the house, what is the impact of the increased interest rate on your financial plan? Show the impact on the excel table of your financial plan. Can your client withstand this increase in interest rate? How would you advise your client to manage this risk?

20 Marks

  1. Based on your analysis above, write a report with financial plan to your client detailing what are the assumptions underlying this financial plan, when the “Austrian Dream” can come true, and what are the potential risks entailed by the assumptions and how the risk is managed in the financial plan. 

10 Marks   



Answer

Australian Housing Market

Executive Summary

The Australian economy is poised for growth as seen by the macroeconomic indicators, such as growing GDP, both in absolute and per capita terms, controlled inflation (it is showing signs of picking up), unemployment is declining and the positive trade balance. Further, the economy has been strengthened by better trade relations with almost all trading partners.

However, it seems that the wage and inflationary pressures are setting in and government has its eyes on this. Further, the housing market went through a heated cycle of increases. This is a tricky market as indebtedness levels are high. If after the sky rocket increase in housing prices as witnessed, there is a sudden and steep decline in prices, it may cause turmoil in the market something similar to what happened in the United States in 2007-2008. Further, given the high indebtedness level in the sector, it will further create problems of defaults.

Hence, the sector is receiving continued attention from the RBA and government so as to keep this on track. Through government intervention by various policies, the housing market has started to cool down a little bit now (RBA, 2018).

The following pages present analysis of a person’s financial state who has just started working with a salary of $80,000 per annum and is looking to purchase a house in Australia to realise the ‘Great Australian Dream’. Through a series of forecasts regarding housing prices in Australia (Sydney or Melbourne). Further, the person’s savings have been calculated by deducting forecasted expenses from forecasted income and the same has been discounted at a discount rate of 10% to calculate present value of the funds. At the same time, the housing prices have been forecasted by averaging the house price indices in eight major cities of Australia. This data is available for three categories of housing, residential property, established property and attached dwellings. Further, the data is available on quarterly basis. The data has been averaged to arrive at consolidated indices and then the same has been forecasted over a period of 10 year horizon. After this, the accumulated savings of the person have been analysed against the house prices to see if the situation is conducive for realizing the ‘Great Australian Dream’. 

Given the positive interest rate environment where interest rates are at an all-time low of around 3.7%, and housing loans are easily available, this seems possible in Year 3 where accumulated savings are sufficient to pay 20% of the house value in form of upfront amount and undertake a housing loan for the remaining 80% of the house value. 

However, the economic environment is always fraught with risks and forecasts are full of assumptions which may or may not turn out to be true. Hence, the person is advised to invest the savings such that a corpus is formed for purchasing the house as well as there is a cushion to meet unforeseen uncertainties. This will also provide a hedge against risks such as increased house prices, change in job or wages scenario, increased expenses, changed interest rate environment etc. 

1. Australian Housing Market Prices Forecast

The following graph depicts the historical housing market prices for a decade form 2008 till 2018 (ABS, 2018):

historical housing market prices form 2008 till 2018

Source: Australian Bureau of Statistics, 2018

It can be seen that the housing market presents a cyclical trend in the market. It seems that the latest peak came around 2017 and now the prices are on a downward trend. This is also in-line with the forecast provided by the same website for the Australian housing market prices as follows (ABS, 2018):

Australian housing market prices

Source: Australian Bureau of Statistics, 2018

Basis data above, the price index in Australian housing market can be forecasted. The forecast and related assumptions are available in excel spread sheet.



The forecast for the Australian economy as presented by ABS (2018) can be depicted as follows:

OverviewActualQ2/18Q3/18Q4/18Q1/192020
GDP Growth Rate0.400.70.80.90.80.8percent
Unemployment Rate5.605.55.55.55.45.6percent
Inflation Rate1.902.22.32.22.32.5percent
Interest Rate1.501.51.51.7523percent
Balance of Trade1527.003006002000487-500AUD Million
Government Debt to GDP






41.9040.740.740.736.532.9percent

2. Income forecast

It is already mentioned that a job of $80,000 has been secured. Hence, this is the income flow which will be further increased. The assumed increment rate is 7%. This is based on the economic forecast as discussed above. The forecast mentions GDP will grow at a rate of *%. Keeping this mind and still taking a conservative view, annual increment of 7% has been assumed. Since 10 years is a very long time frame, the realistic scenario is not possible to predict accurately as many changes in job scenario are possible.

For example, the person may change jobs and get an immediate jump in the salary. Or, the company may go bankrupt and person may be out of job. Or, there may be economic downturn and person may not receive any increment. 

However, for purpose of our analysis, we have assumed that the same job and same increment rate will continue for the period.

3. Net Income forecast

The spread sheet provides a break up of possible expenses for the person. The expenses have been assumed on annual basis (Australian Trade and Investment Commission, 2018). Further the increment rate has been assumed at 2.5% which is the inflation rate forecast.

The expenses also include rent component which will be there till a house is purchased. It is assumed that rent will increase at 5% per year. For housing calculations, rent will be excluded from respective components.

The tax has been calculated basis current slabs and ignoring levies and surcharges.

The housing loan rate seems to be around 3.5-4% in the current environment.

4. Affordability

Given the savings excluding rent and further assuming that the bank will provide 80% of the house property value and the person will put in 20% of the value up front, the person can currently afford a house worth around $155,000 which translates to a housing loan of $124,000 and upfront payment of $31,000. This will swipe away all the savings for Year 0 but after that, the person will need to pay only EMI.

However, if the house selected is not in the budget, then the person can opt for insurance and pay less than 20% upfront payment.

5. House Purchase

If we assume a price of $305,000 for the house selected by the person, the upfront payment comes to $61,000 in Year 0 which is not affordable as of now.

However, if the person keeps saving and accumulate funds, we can compare the accumulated funds through present value concept and see if the person can buy house anywhere within 10 year horizon.

It can be presented as follows (calculations in spread sheet):


From above table, it is clear that at given assumptions, the accumulated savings of the person will be sufficient to initiate a house purchase in year 3. This is assuming that the house price will be around $342,317 and the 20% upfront will come to $68,463 where accumulated savings of $82,958 exceed this upfront payment enabling the person to take a house loan.

6. Increase in Mortgage Rate

Using a loan amortization schedule and assuming 3.7% loan for 30 years, EMI came to around $1,261 per month. After three years of payment at increased interest rate of 7% and loan amount outstanding of $258,037 for remaining 27 years, the increased EMI came to $1,775 per month. This comes to a total annual payment of around $21,300 which can be managed by the person.


The interest rate risk can be managed by investing remaining savings in instruments such as interest risk hedge or, even traditional instruments of savings.

7. Recommendation

 Seeing above analysis, it is best for the client to accumulate savings at the assumed rates and then purchase a house in Year 3 by taking out a house loan. Till then, rental accommodations can be used.

To increase the savings further, these can be invested in low risk investments so as to increase the corpus and cover for unforseen events or change in underlying assumptions which have been discussed above in relevant sections.

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