Buyer grants' good news/bad news

Property investors love to see a strengthening market but rising prices invariably run in tandem with deteriorating affordability. It raises the question: at what point does good news become bad news?

When we dig a little deeper into balancing the drivers of capital growth with maintaining affordability, we find considerably more than inflation and interest rates at play. According to the Australian Bureau of Statistics’ Australian Social Trends 2006, until the late 1990s supply effectively kept pace with population growth and much of that supply came from the new housing sector. By 2001, demand for established property, particularly in the inner suburbs, accelerated strongly. At the same time, land available for new housing developments in the outer urban suburbs began to dry up. The majority of the housing demand '” 62% '” was in the capital cities. House prices rose at unprecedented rates from about mid-2000 to mid-2003 and interest rates and inflation remained low.

Prices then began to moderate and, with the exception of a resources boom-driven market such as Perth, have remained stable or grown very modestly. The relationship between supply and demand is therefore an equally powerful influence on price movements.

But a further factor contributing to price pressure (and one not usually taken into account) is ongoing Government incentives through first home buyer grants. At the time these grants were first introduced, it was supposedly a pre-emptive strike against the potentially inflationary effect of the introduction of GST. Today, the grants are more to do with affordability and its influence on politics. Although the grants might be perceived as relief for first home buyers, they are also contributing to artificial pricing pressure.

In spite of being election winners, grants actually feed the very problem they are ostensibly designed to solve '” low affordability '” because these grants are almost immediately factored into market prices.

In order to maintain an equilibrium between a satisfactory investment performance and reasonable affordability, inflation must be kept firmly under control through proactive economic and monetary policy management. We also need to see greater acceptance by investors that just like any asset class, property is cyclical and, yes, in some years, performance will be better than others. Finally, we need to stop feeding the raging inferno of low affordability with widespread cash handouts to first homebuyers.

Investors like increases, but when they go above a certain level due to rising inflation and higher interest rates, falling affordability can drive prospective buyers away from the market and cause values to correct. It is the degree of correction that impacts most on the marketplace. In the late 1980s and early 1990s the rapid rise in inflation and interest rates going to double-digit figures became a substantial economic problem. However, the steady economic management over the past decade has led to the market stabilising, rather than falling dramatically.

The current policy of small interest rate rises is more likely to safeguard the longer-term stability of the property market rather than undermine it. That more stable market actually makes it easier for investors to distinguish between top-notch and second-rate investment property, which relies too much on inflation to drive capital growth. Undoubtedly, as a basic commodity, rapidly rising property values can create inflationary pressure. A badly performing property may well depend largely on inflation to go up in value. If inflation suddenly dropped, this “miraculous” capital growth rate would all but disappear. Well selected property will grow in value because ongoing demand will outweigh supply, not because of the artificial effects of inflation. The rub for investors is to understand that top-performing investments are not reliant on inflation for capital growth to occur.

This week I have selected the following questions from subscribers.

Paddington pain

I have a one-bedroom unit in Paddington, Sydney, which I bought in 2000. The location is pretty good and it is a nice “young” trendy suburb. I have had three agents manage the unit. The latest tenants moved in on June 10, 2006, and the agent signed the agreement with the tenants. A short time later, I gave the agents notice and took the management of the unit back. However, I forgot to ask for a copy of the tenancy agreement and my calls to the agent have not had a response. The tenants are miffed because I wanted to put the rent up as I was under the impression the agreement was for six months, not 12. They won’t give me a copy of the agreement either. What are my options other than selling? I don’t seem to have much luck with properties, although I did have one perfect tenant with this current property.

First, if you feel you are being unfairly dealt with by an agent in this instance, call the Real Estate Institute of NSW. You are legally entitled to and should have a copy of the lease as the owner. Normally, a managing agent would keep a copy of the lease agreement, give one to the landlord and one to the tenants. In a previous Eureka column (click here) we have looked in detail at the advantages of appointing an agent to manage a tenanted property rather than taking on the onerous and time consuming task yourself.

Ask the REINSW to give you a checklist for managing agents because a professional company should be fully accountable to you and deliver value for money. Before appointing anyone, shop around and ask each prospective agent to detail the services they offer, including their tenant selection processes and ask them to provide references. A professionally managed property should deliver happy tenants and a happy landlord and the agent’s cost is worth the peace of mind and can ultimately save you a lot of time and money in lost rents and disputes. Don’t despair, if your property is well located and showing good capital gain it is worth persisting with a search for the right agent.

Renovation value

We are keen to buy an investment property in an inner urban suburb of Melbourne. Several of the single-fronted properties we have looked at are structurally good, but need a fair bit of modernising. A few of them still have outside laundry and loo. Would this level of renovation be overdoing things and would it take too long or rising values to cover the costs?

The type of properties you describe often need a bit more than cosmetic sprucing up with a coat of paint or new carpet. Many single-fronted properties need a new kitchen and bathroom and other lifestyle enhancing improvements such as built-in wardrobes and storage. Don’t be put off by the outside laundry and toilet as it’s not expensive to install these facilities inside. But make very sure the property is structurally sound. This is where it’s worth getting a full building inspection as this will tell you whether you can bring the laundry and toilet inside fairly easily and inexpensively by using existing plumbing.

Don’t go over board with appliances and other fittings. Good serviceable kitchen equipment will add value, so don’t be tempted by expensive European appliances. If there are major structural problems, such as rewiring, restumping or the like, then beware of “the renovator’s delight”: these can swallow up an awful lot of money on structural work before you can get around to any cosmetic, lifestyle-enhancing improvements and will not add to the capital value.

What tenants want

Can you describe the type of investment properties that are the most attractive to tenants over the long term? I understand the inner suburbs advice you give to investors, but we could only afford a modest property in these areas and were wondering whether such a property would take longer to rent out than something more upmarket.

The opposite is usually the case. An upmarket property with an elaborate garden, swimming pool or tennis court is much more limited on the rental market. Unless such a property attracts a corporate tenant prepared to pay top dollar, it would be out of reach for the average tenant. Don’t be put off by one and two-bedroom apartments and small houses.

The factors that underpin rental demand are different from those affecting buyer demand. The latest Australian Bureau of Statsitics’ Australian Social Trends Report tells us that renting is more common among young, childless couples, single parents, singles or groups of singles. The most popular properties are attractive, but low maintenance and in clean, neat order, as opposed to luxurious. Tenants also favour neutral décor, good storage and basic heating and cooling. They will also look for close proximity to public transport, shopping, leisure and educational facilities. Properties with one to three bedrooms will be the easiest to rent.

The right insurance

We are in a dispute with our insurance company over a damage claim we lodged in regard to our investment property. We assumed building insurance would cover structural damage, but the company says it is not prepared to pay for something that was done by our previous tenants. We had the tenants evicted because of the amount of damage they were causing. We don’t feel like going through this again, but nor do we want to spend a small fortune on insurance.

It would be standard for an investor to have building and contents insurance to cover unforseen events such as fire or storm damage or burglary and many people assume this is enough cover. You must also have public liability in the event that someone is injured or killed on your property. Landlord’s insurance is highly recommended as a separate policy. The premiums are very reasonable and will usually cover not only malicious damage, but the rental shortfall if the tenant leaves the property owing rent. Do your homework and check with an insurer who has a working knowledge of property related insurances and shop around for the best forms of cover for the best price. Always check what the exclusions are in any policy and make sure your policies accurately reflect the value of your property and contents.

Monique Wakelin is co-founder of Wakelin Property Advisory, www.wakelin.com.au, a Melbourne-based independent property acquisition and advisory company, and co-author of Streets Ahead: How to Make Money from Residential Property.

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