Back on the buying trail

PORTFOLIO POINT: Whether upgrading or adding to the portfolio, be clear about your primary reason for re-entering the property market.

The property investor who buys just one dwelling and holds it over a lifetime is a rare breed indeed. The opportunity to add to their portfolio or upgrade their existing dwelling becomes increasingly appealing as many property investors find the costs of holding a property fall significantly over time.

Their rental and other sources of income are rising at the same time the value of the debt falls in real terms. The rental growth may even be sufficient to make the investment property cash flow neutral or even positive.

Naturally, many investors use the improvement in their financial capacity to buy a second investment property, building their retirement nest egg and making the investment more tax-efficient at the same time.

For home owners in their late 30s and 40s, the decision to re-enter the property market is often driven by a need for more space for a growing family. They frequently trade up to a bigger house using equity built up in the first home and a rise in family income around the same time.

In some cases home owners seek more bang for their buck around this time as children grow up and sacrifice proximity to the city centre for a bigger house further out, while others decide to sit tight and instead use their equity and growing purchasing power to buy their first investment property, as part of a goal to secure their retirement.

The criteria for when and what to buy a second time around are, effectively, the same as buying the first property (or third or fourth, for that matter).

Be clear about the primary reason for re-entering the market and be willing to accept the opportunity cost this places on you. Is it for lifestyle reasons or for investment purposes? If you need a bigger house to accommodate the teenage years then great, go for it.

But be aware that the process of upgrading often moves home owners out of investment-grade property (such as two-bedroom houses in inner suburbs) into property where there is less competition and hence lower capital growth prospects. So your rate of capital growth – in percentage terms – can be slower.

If your real aim is to build more financial assets, then consider whether you’d be better off buying an investment property rather than upgrading the home. As discussed in my recent column Home or investment?, buying an investment property rather than a home generally makes financial sense if you are disciplined enough to stick with investment grade property in the inner suburbs of our major capital cities.

Assessing property decisions in this dispassionate way can be especially helpful for those who are struggling to choose between their lifestyle and financial objectives to make an informed choice. They’d love a bigger home, but would also like to retire early. Working out the relative whole-of-life costs of buying a bigger home compared to the benefits of an investment property allows a person to understand the real price they will be paying for that desired extra bedroom.

Incidentally, for those who are committed to upgrading their home, this may be a good time to do so. The slowing market has generally had a bigger negative impact on the more expensive three and four-bedroom properties above $1 million, where prices are more vulnerable to a fall in sentiment than in the mainstream. Consequently, the price differential between two-bedroom houses and apartments on one side and three bedroom houses on other has narrowed. Once the market returns to an upward part of the cycle, this differential will likely widen again. So consider making the leap now.

Returning to the central question of when to buy a second time: Once you have answered the purpose test, it is then a case of confirming that you are in a financial situation to take the plunge. You’ll want to talk to your lender to assess your current level of equity, your salary and rental income, debts and living expenses.

For the second-time investor, the other main consideration is spreading risk through diversification. Owners who have invested in, say, a two-bedroom 1960s to 1970s style unit in a particular suburb the first time round, shouldn’t buy the same style of property in the same or similar suburb just because they’re familiar with it. Rather, to avoid over-exposure to any localised fluctuations in value, they should consider a different style of unit in a different area or, depending on their finance, a house, again in a different but equally well-performing location.

For some who have successfully bought their second investment property, there is the question of whether to keep on accruing. It may indeed be a feasible and wise option, but remember that quality always trumps quantity, and it is the amount of equity that has been built that matters, not the number of properties owned.

So while glossy investment magazines and tabloid property inserts may feature individuals who have bought their 20th investment property, it is far better to avoid those cheap, low-growth assets and to remain disciplined, and to buy intermittently and well.

Property Q&A

This week:

Buying in Brisbane.
Bank valuations.
My apartment has lost value.
The land value component.

Brisbane on a budget

We are looking to move to Brisbane soon and have a budget of $700,000, and $400,000 of this will be part of the mortgage. We have family living in St Lucia and would like to live within 10 minutes’ drive from them. Do you suggest we buy a two or three-bedroom townhouse in St Lucia, somewhere close to the CBD, or go further out and buy a house in, say, Indooroopilly? We would like to live there for between three and five years then move to a larger place and either sell or rent out the property.

Three-to-five years is a relatively brief time frame to hold property, and it would be costly in terms of transaction fees to sell and buy again after such a short time. Therefore, it may be prudent to try and decide what your lifestyle needs are for the next seven-to-10 years, and plan accordingly.

Alternatively, if you envisage that the property will be leased after three-to-five years, apply investment criteria when you first buy, even if it means compromising your lifestyle requirements in the short term.

Both St Lucia and Indooroopilly offer attractive opportunities for home buyers and investors. St Lucia is generally more pricey, given its slightly closer proximity to the CBD. With a median house value of about $900,000, I’m afraid you may struggle to find a two-bedroom house in your range. Indooroopilly’s median price for a house is about $600,000, so your prospects look more promising there.

St Lucia has better capital growth prospects than Indooroopilly, so if you intend to prioritise your investment strategy, you might consider buying an older style apartment in St Lucia to live in for, say, three years, then it rent out, with a view to buying your dream home in another part of St Lucia in a few years (assuming you still want to live there). Given you are new to Brisbane, this approach has the added advantage of not creating huge costs should you realise after a few months that Brisbane is not for you. You can retain the unit as an investment property and live elsewhere.

Bank valuations

I would like to know how some investors are able to get the bank to use a valuation price that is higher than the purchase price when getting a loan and therefore creating instant equity.

Such a scenario is actually a rare event, and can be the result of some fudging of documentation to mislead the lender. Most banks depend on sworn valuations and, given that a valuer has to be willing to stand by it in court, they tend to be on the conservative side. As such, it is very rare that a valuer would be willing to post a figure above the sale price. There would need to be compelling evidence that the sale price was below the market price.

It might occur where the sale is at “mates rates” between family members, or where it could be shown that the transaction was a distressed sale. Occasionally in a very strong upwards phase of the market, when prices might jump $10,000 or more in a few weeks, it is possible that the valuer might factor this in.

Unfortunately, given their conservative nature, a valuer is more likely to decide that a new owner has paid too much for a property. In these instances, the buyer often finds they have to have a bigger deposit to settle the transaction.

Apartment's performance

In March 2010 I bought a two-bedroom apartment in Hawthorn, Melbourne, for $455,000, or $480,000 with costs. The block has only 15 apartments that lack uniqueness but is well located with excellent proximity to transport, schools, universities and shops. In June 2011 I saw one apartment from the block sold for $378,000 – an almost 15% decrease in the price I paid. This has really shaken my confidence. I was thinking I would not sell for more than 10 years and I will experience many property cycles, but this low price has me wondering whether I should cut my losses early.

Paying $455,000 for a two-bedroom apartment in March 2010 does seem a bit on the low side for Hawthorn, one of Melbourne’s most prestigious suburbs, which suggests to me that the property is not quite investment-grade – as you hint in your question.

If so, your property is less likely to show resilience than other parts of Hawthorn when conditions soften, as they have in recent months.

Saying that, it may well be the case that the apartment that sold in June may be quite different from yours. In any one block, there are often between one and four units that you would avoid, due to problems such as lack of views, a poor aspect, security, noise and light issues. Further, the vendor may have been under pressure to sell, or the transaction may not have been at arms’ length. Your situation is illustrative that it can be dangerous to put too much weight on one comparison.

Also avoid placing too much weight on events in a 12-month period and instead see your investment in a seven-to-10 year time frame. If I think back to 1993, there was a flat in Hawthorn that sold for $78,000. In the next year, 1994, other flats in the block sold for around $65,000. Now they are all worth $400,000–450,000!

Land value

I have often wondered about the capital gains performance of multi apartment blocks (having minimal inherent land value component) as opposed to apartment blocks with high inherent land component. It seems to me the larger the block, the less the capital gain. In the area that I operate you can buy a 25 square metre unit in a block of 70 units (you will own one-70th of the land), which means in effect that the $159,000 you pay for the property, most of it will be depreciating from day one – the property will conceivably be worth less ongoing, as the value of the land increasing will never compensate the building depreciating.

I couldn’t have put it better. You’ve hit the nail on the head. The driving influence for ongoing capital growth is the land value. For houses, the land component should represent 70–90% of the property’s value. And, ideally for units and apartments, the land component value should still represent 50–70% of the total value.

In large complexes, one is unlikely to see sustained capital growth unless the land value is already very high to begin with, such that the notional land value associated with each apartment is a high proportion of the total price. These sorts of apartments are rarities, which is why investors should buy units in established and smaller blocks.

Monique Sasson Wakelin is managing director of Wakelin Property Advisory, an independent firm specialising in acquiring residential property for investors.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Do you have a question for Monique? Send an email to monique@eurekareport.com.au