Good property stands firm

PORTFOLIO POINT: Metropolitan investment-grade property has proved resilient in the past year, despite the headwinds. I’m expecting an improvement in 2012.

Those glum property bears who hoped 2011 would deliver the reputation-making property crash must be so disappointed. Early in 2011, they surely thought that conditions were right for vindication: record prices following strong 2009 and early 2010 growth; a jump in mortgage interest rates in November 2010; economic-sapping natural disasters in January 2011; an unpopular federal government perpetually teetering on collapse; heightened volatility on stockmarkets; and, worst of all, a deepening sense of economic crisis overseas.

With such portents of doom married with their own gloomy efforts over the year to make their predictions self-fulfilling, the fall in property prices of about 5% that we are likely to record across metropolitan capitals over 2011 must feel like a grown-up receiving an iPod Shuffle for Christmas rather than the iPad 2 they’d hoped Santa would bring – OK but not really what they wanted.

No doubt they be will out again, rewriting history about 2011 and wailing about how bad 2012 is going to be.

For the record, I should declare that I stuck my neck out in January 2011 and expected the national metropolitan market to grow by 4%. I certainly underestimated the economic impact of the natural disasters on the economy and the flow-on into property-buying sentiment. I also – like everyone else – underestimated how severe the stockmarket would become: the ASX is looking at a 15% fall for the year.

But the real story of 2011 – which most commentators will miss – has been the resilience of metropolitan investment-grade property despite all the economic headwinds and negative hype we have faced over the past 12 months.

This year has offered an instructive lesson about why investment-grade property is an asset for all seasons and should be part of every diversified portfolio; it’s both a shelter in challenging times as well as a growth asset in good times. It has certainly not displayed the heart-thumping volatility and falls seen in other sectors.

In addition, the extended period of mild softening in prices from mid-2010 and through 2011 means that conditions are set reasonably fair for 2012. Barring environmental or economic calamities (surely it isn’t too much to assume that European leaders will desist from self-immolation in 2012), I anticipate that a modest recovery should arrive in 2012.

Most importantly, it will be the progress of the economy that will chart the course of the property market and interest rates in particular, given the fact that the property market benefits disproportionately in comparison to other sectors from lower interest rates. It may well be that, just as there was a tendency in 2011 to underestimate the drag on the economy of the natural disasters, the consensus view has become overly pessimistic.

Indeed, the Reserve Bank is predicting GDP growth of 4% in mid-2012 but few people appear to believe it. If this growth does occur without inflation rearing its ugly head, the confidence it generates may power reasonable property price growth.

This boost for property may be compounded by positive feedback loops. Good GDP numbers may see unemployment increase by less than the small rise currently predicted by many economists over 2012, which in turn may encourage the government to loosen its current restrictive grip on immigration quotas – all positives for the property market and property investors.

Speaking of government, I suspect that the recent small increase in the federal government’s parliamentary majority is likely to ease the sense of disarray at the top felt by the electorate, even if the government doesn’t become any more popular. This may have a positive impact on consumer confidence. (Of course, a week – let alone a year – is famously a long time in politics, so it is possible the government will lurch back into crisis and unnerve everyone including property investors all over again).

Supply is just as important as demand in determining prices. A number of property commentators argue that several property markets are suffering from over-supply, and are therefore likely to struggle in 2012. I agree that this is certainly the case for the capital city fringes and inner-city high-rise apartment markets. But there is an elementary error in an argument – as some prominent commentators are postulating for Melbourne, for example – that whole cities will struggle because of oversupply in fringe markets. These analysts are treating cities as homogeneous markets rather than a series of different ones. So expect multi-speed property markets across the nation next year.

I expect 2012 will see demand again outstrip supply across key areas within our capital cities, with asset values exhibiting modest positive capital growth at around 2–5% in 2012, effectively providing a year of stabilisation rather than stellar growth. This will be a happy state of affairs for we need further improvements in affordability.

Incidentally, I noticed that just a few days ago economist Steve Keen predicted another 10% fall in prices across the nation in 2012. Unless economic disaster strikes from left field, Steve will get it wrong for the umpteenth year.

Tune-in in January to read my city-by-city forecast. This is my last column for 2011. I wish all Eureka Report subscribers a wonderful holiday season. Thank you all for your feedback and diverse and insightful questions throughout 2011. It’s a great privilege to write for you each week.

Property Q&A

This week

• Should I buy the block next door?
• Can we renovate within the DIY fund?
• How do I tap home equity?
• Should we buy a beach house?

Neighbour’s block

My next door neighbour is planning to sell his inner suburban block at some point. The house itself has little or perhaps negative value, but being next door the land is worth quite a bit to us. In this situation is making a pre-auction offer sensible? Any tips?

I would be interested to know why you are attracted to the property. Is it as an investment property? Or is it for lifestyle reasons such as wanting to extend your garden? Or do you wish to control the adjoining land to prevent undesirable development? If you’re looking to buy the optimal investment property, you may be at risk of placing too much weight on convenience at the expense of smart investing.

By all means buy next door for lifestyle reasons. In this instance the property is probably worth more to you than anyone else. But you don’t want the vendor’s agent to know that! Find a third party to act on your behalf in order to protect your interests. To be very clear: anonymity will be your most valuable weapon under these circumstances.

Rather than making a pre-auction offer and possibly risk paying more than you would at the auction, it may be better get your representative to register interest in the property. This will give you some leverage in the negotiations before and/or after auction day. This way, you can be confident that should another party try to make an offer beforehand you will be given the opportunity to counter-offer.

On auction day, use your representative to bid and ensure you hold the highest bid should the property be passed in. The representative will also conduct post-auction negotiations on your behalf, if required. You can then show your face and surprise everyone at the contract signing!

DIY renovations

We have recently renovated two properties cosmetically in Melbourne and Geelong that we have owned for many years. We found the exercise creative and reasonably rewarding given the current financial circumstances. We are retirees with practical business backgrounds and would like to explore how to do more cosmetic renovation projects using renovators/builders to do the work, but are mindful of the pitfalls of moving into the realm of council approvals. Our budget would be to buy below $300,000, spend $20,000–40,000, and turn over the property in, say, three or four months with a 20% plus annual return. As a self-managed super fund (SMSF) project, there is no CGT, making it attractive, particularly if we can do between two and four per year using the same contractors. What wisdoms would you have us explore to follow this “What if?”

The rules about renovating properties within an SMSF are under review by the tax office. At the moment, you aren’t allowed to “improve” a property held within a self-managed super fund but you can do maintenance work. This will change if draft rules are applied. Under the proposed new rules, improvements to properties will be allowed using cash within the SMSF, whilst borrowings will be permitted for maintenance work.

You will need to speak to your accountant about whether your proposed work would be considered maintenance or improvements, and to advise you if and when the new ATO ruling is adopted, plus advise you of any other associated tax issues.

Putting aside the superannuation aspect of this question, effectively becoming a full-time redeveloper is not for the faint-hearted and should only be pursued after much due diligence. To avoid costly mistakes you should seek the advice of a team of professionals: a property adviser to help ascertain the right property; an architect or surveyor to guide you on appropriate renovations; a good builder; and a lawyer and an accountant to consider the legal and tax issues.

You should also consider complementing this strategy of buying and improving properties and on-selling them with a couple of passive, buy and hold options as a safety net.

Tapping home equity

How do I tap the equity in my home to invest? If the investment goes poorly, is my home at risk?

Using some of the equity in your home or another asset conservatively in order to buy your first investment property is a tried and tested approach and remains a valid strategy in today’s market.

Your bank or a mortgage broker can provide specific advice, but there are two important principles.

• Don’t over-borrow. Ensure you have sufficient cash flow and reserve funds to pay the monthly costs. In the current environment, keep your total borrowings secured against each property at or below 70–80% of its current value, which will safeguard you against changes in property prices and interest rates over time.
• Ensure you always buy quality assets in the inner-urban parts of our capital cities that are far more resilient in bad times as well as being top performers in good times. This greatly reduces the likelihood of negative equity.

Also, should there be a financial problem with the investment property, the bank will generally seek to sell the investment property first. It is very rare that banks will sell a primary residence if there are other assets and reasonable equity in them.

Beach house

We’re off to the beach this summer and I know my partner will be tempted by all those holiday houses for sale. Remind me why I should say no!

You’ll have your work cut out this year as prices are down in many prime coastal areas around the country, and your partner may find the price tags very tempting. If you want to buy purely for lifestyle reasons, saying yes may be the right answer if you can afford it and feel you’ll make good use of it.

However, notwithstanding today’s prices, holiday homes should not be bought as investments. Indeed, the current softness in this market perfectly illustrates that holiday homes often fare poorly under weaker conditions. A holiday home is a discretionary purchase and is one of the first things off-loaded if a financial crunch is reached. Consequently, they often exhibit volatile and inconsistent capital growth.

Many prospective buyers are attracted to the idea of using the holiday home a few times in the year and leasing it out at other times. Often they end up using the property at the times of highest potential return, such as the summer holidays, which severely reduces the income stream and may raise questions at the tax office!

Managing agent’s fees will also be much higher than for traditional investment properties, to reflect the increased workload of servicing the needs of short-stay guests.

Holiday homes need to be furnished and frequent turnover of guests, combined with the coast’s often inclement weather in winter, leads to high wear and tear and maintenance costs.

One way to forestall your partner is to suggest renting a property in the area for the whole year. That trial period should reveal whether you will use and enjoy it enough and the locality is as suitable as you had hoped. You can then make an informed choice about whether and what to buy.

Monique Sasson Wakelin is managing director of Wakelin Property Advisory, an independent firm specialising in acquiring residential property for investors. Monique can be found on Twitter @WakelinProperty.

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