Home buyers' homework

PORTFOLIO POINT: A little due diligence before the sale might save some heartache later.

With a good supply of properties available in the market and improving affordability, these are better times for investors looking to buy residential property.

During calm periods there can be a tendency to buy quickly, to pre-empt the subsequent rush when the market picks up again. While I support decisiveness in property investment decision-making, investors must do their “due diligence” before buying a property – be it at auction or by private sale.

Not only should a prospective property tick all the investment boxes, but you need to ensure there are no structural or legal issues – which are often not immediately apparent – that could jeopardise the investment’s outlook.

It is vital that a building and pest pre-purchase inspection is undertaken on houses (they are mandatory in the ACT), as there are several potential defects that are difficult for the lay person to identify, such as termite or borer infestations, a faulty roof, or cracked slab footing.

Some of these problems can cost tens of thousands of dollars to rectify and require a building to be vacant for weeks to effect repairs. These problems may be so troublesome that, in many instances, they make the investment proposition untenable.

However, building inspection reports do not always give you an unambiguous steer on whether to buy or cut and run. Often the outcome is a more nuanced “maybe”, and further consideration is required. Most established properties, particularly older-style properties, have some problems that need to be addressed.

Peter Alexander from Safe Homes Inspections says the results of a building inspection allow investors to identify and prioritise the range of problems. “It answers the questions: What do I have to fix straight away? What do I have to fix in the medium term that might otherwise cause further deterioration of the property and thus the value of the property? What’s there that I can fix further down the track and at my leisure? And the most important question of all: What’s it going to cost me?”

Armed with this knowledge, a buyer can potentially minimise their additional costs by structuring a remediation timetable that addresses serious problems immediately and schedules other repairs when the property is vacant during periods of tenant turnover.

The knowledge of defects provided by the building inspection may also provide leverage at the negotiation table for a buyer when a property is sold by private treaty or has been passed in at auction. Further, arriving at a price that factors in cost of improvements is only prudent.

That all said, investors must never expect a property to be perfect, especially when it comes to Victorian, Edwardian or Art Deco styles. There is a happy medium between trading off some relatively minor issues with the building in favour of the high scarcity value conferred by classic architecture.

Close attention should also be paid to the proposed contract of sale and the associated disclosure documents, which are prescribed by state law to enable relatively transparent and informed negotiations.

Sadly, many buyers pay scant regard to these documents. Andrew Lord of Lord Commercial Lawyers says “99.9% of contracts” are signed by purchasers without them having the document checked. “It’s astounding, given we are typically talking about transactions worth many hundreds of thousands of dollars.”

These documents provide a wealth of information some of which, if picked up before the contract is signed, may influence the decision to invest, or aid in the negotiation process.

The content of these disclosure documents may vary from state to state but tends to include: details of the title; charges on the property – such as rates and body corporate fees; land tax levels; building permits – whether they have or have not been obtained; orders issued by the roads authority; zoning information such as heritage overlays; whether the property is accessible via road; whether utilities are connected; the existence of any heritage or environmental orders; whether the property is leased; whether there are any easements or registered or unregistered right of ways; or any caveats.

Andrew Lord urges prospective buyers to look carefully at the “special conditions” in the vendor disclosure obligations. “Sometimes, when there are known defects in the property, the owner will place a note in the special conditions listing the defects stating that, 'notwithstanding these defects, you agree to proceed with the contract.’ Unfortunately, a serious issue can be buried within pages of trivial special conditions.”

Also check whether the special conditions include a clause about penalty interest rates should you not settle on time. “Some contracts have quite high penalty rates, of up to 24% a year,” says Lord. “On a $700,000 loan this can equate to thousands of dollars a week.”

A thorough inspection of body corporate meeting minutes is especially critical for apartment buyers, Lord says. “Minutes from recent meetings should be included in the disclosure documents, but occasionally they are left out, so you want to ensure you have a complete set.”

The minutes allow buyers to check whether there are any recently passed resolutions that might create a financial impost, Lord says. “In an older block, a resolution might say that the roof needs to be replaced and that a levy of $15,000 will be struck on each apartment owner.”

The typical way lawyers are used in property transactions today is actually somewhat perverse. Rather than having lawyers check contracts before they are signed, most buyers only engage them for the conveyancing process – the act of transferring property title from one person to another – after signatures have dried on the contract. The lawyer may well pick up the problems at this juncture, but it is now the new owner’s problems, not the vendor’s.

Given the enormous costs involved in purchasing property, it is understandable that buyers look for ways to make savings. However, it is definitely a case of “penny-wise, pound foolish” for investors to shun building inspectors and legal advisers.

The contract negotiation phase is also the opportunity to make the terms and conditions more favourable to the buyer. Seeking a longer settlement period helps reduce the risk of needing bridging finance if you are in the process of selling another property.

It’s also a very good idea try to add a clause to the contract to allow you to show tenants through the property prior to settlement, which can result in you earning rent from day one of ownership – which is not a bad way to start your new investment journey!

Property Q&A

This week:

• Should I buy in Kirribilli?
• Thinking of Mornington.
• Restrictions on a rural block.
• What are Perth's prospects?

Kirribilli life

I am returning to Sydney after five years in Canberra. What are your thoughts about buying an apartment/townhouse to live in somewhere between Waverton and Kirribilli? I anticipate living there for at least 20 years. My budget is about $1 million. Also, I know you don’t normally recommend high-rise buildings, but what about those with views of the harbour?

Waverton and Kirribilli are sound areas to reside and invest in, being close to the CBD and North Sydney but you will need to be very selective in what you buy in these areas.

Most properties in Kirribilli are south-facing so look for an apartment with a large balcony and windows to let in plenty of light; some apartments can get a bit dark in the winter months. While the older Art Deco blocks of up to 20 apartments look charming, and you can rub shoulders with the Prime Minister’s residence, there are some unrenovated blocks that may still have issues with fire orders from council.

Investigate the body corporate minutes to make sure there are no special levies coming. The larger high-rise blocks get some excellent harbour views, but because there are so many apartments, the proportional land component is very low.

Even if you don’t actually own a slab of land, it still drives the price growth. So the smaller the number of units in a block, the more you benefit from the underlying value of the land going up. That said, generally high-rise is more accepted in this area due to high-density living and harbour views. And given your purchase is primarily for lifestyle, my usual reservations about high-rise investments are less of an issue. But do your research. There are some high-quality high-rise blocks in the area, but there are also some to avoid for their ongoing maintenance issues.

Mornington values

I'm considering buying a property in Mornington, Victoria. It sits well beyond the end of the Frankston train line, which services the rest of the coast, and I'm wondering whether there a noticeable drop off in property values after the end of train lines?

Being about 70 kilometres south of Melbourne’s CBD, Mornington is clearly not a prime residential investment area. But if your motivation is primarily lifestyle, with capital growth as a secondary consideration, then Mornington is worth considering. Proximity to a railway station is always a plus, however, and Frankston is only a 15 minute drive away so it is possible for people to park and commute.

The ability to commute to the CBD is not a determining factor for house prices in Mornington. The Eastlink tollway puts a vast area of Melbourne’s east within commuting distance, and makes Mornington an attractive alternative to the sprawl of the eastern suburbs. Further, demand for housing in Mornington is also driven by those looking for holiday homes.

That being beyond the end of a rail line does not always equate to a fall in property prices is neatly illustrated by relative prices in Frankston and Mornington. The median house price in Frankston is about $360,000; in Mornington it is $500,000.

Rural block

If I buy a block of land and am later told I can’t build on it by the local fire authority, what can I do? And what if a vendor doesn’t disclose that they knew the fire people wouldn’t let me build? Will the current focus on insurance issues and flooding/fire zones mean getting a mortgage is more difficult or will it have a negligible impact? And what will it mean for property investing/developing in general?

If you have undertaken the appropriate “due diligence” before you buy, as I’ve highlighted in today’s column, then fire-related building restrictions should come to light. However, even if you have been diligent, it is still possible that this scenario could occur due to someone’s oversight or a lack of disclosure.

In this scenario, I recommend you obtain legal advice. The general principle is that a vendor is obliged to disclose to the buyer any issue – other than that relating to the state of existing structures – that they know about at the time of the transaction. A failure to disclose could lead to the contract being judged void, and/or damages being sought. However, if changes occur after the sale – say a change in fire authority guidelines – then caveat emptor: buyer beware!

The spate of fires and flooding we have seen in recent years is clearly putting upward pressure on insurance costs and, by making some people think twice about the desirability of living in fire or flood-prone areas, will reduce demand for such areas, particularly in the first few years after a major incident.

I believe recent disasters will see more caution among property investors, and greater attention to whether an area is vulnerable. Even putting aside the fire threat, rural properties do not make good investments and should be avoided.

Perth suburbs

Can you provide your forecast for the future of the inner Perth suburbs in the short term? I have three investment properties in the south eastern suburbs – being Cannington, Queens Park and Gosnells. I am due to retire in two or three years and am not sure whether to sell before then or wait until I have actually retired.

At the beginning of the year I tipped Perth to win the capital growth silver medal (after Sydney) in 2011. I based this forecast on the West Australian capital’s property market reaping a boost from the resumption of the mining boom after the GFC, with a likely increase in demand for property from home-owners and renters.

To date in 2011, the market in Perth has been slow. It appears that there is a significant lag from the point that a new mining initiative is announced through to the extraction phase. Further, the main benefit to Perth only happens if and when the various capital work is contracted to workshops in the city. Increasingly, much of this work goes interstate or overseas, although Premier Colin Barnett is putting pressure on miners to make more use of local companies.

That said, it is probably only a matter of time before the effects of the mining boom flow into the Perth property market.

Cannington, Queens Park and Gosnells contain a range of properties and location types. By and large, at about 10 kilometres (Cannington and Queens Park) to 20 kilometres (Gosnells) from the CBD, they may not represent prime investment areas, and you cannot expect to see the levels of capital growth associated with areas in the two-to-eight kilometres out from the CBD.

If your primary need is to retire debt to coincide with your retirement it may be better to hold off selling until you are about to retire; that is, in the months leading up to retirement rather than two to three years out as it is likely prices will improve somewhat. If you would like to maintain some investment exposure in the residential sector you may like to consider a cash purchase in an inner suburban location post-retirement.

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