Inner Melbourne the hot spot

• Prices in inner urban Melbourne are rising steadily and it’s only the beginning of the cyclical upturn '¦
• Sydney is showing signs of following suit in certain sectors, while others remain stagnant '¦
• Perth’s phenomenal housing market upsurge off the back of the resources boom is predicted to soften over the next year '¦
• And, the other capital cities have shown small, but steady price increases in the year to March.

Can all these commentaries make sense, and at the same time? Yes, Australia's residential property market has well and truly become a multi-layered, multi-speed market – and the different driving forces that apply from city to city, suburb to suburb and even street to street are showing up like never before.

What's more, as we approach the halfway mark of 2007, that multi-speed market has not only become embedded but it is throwing up unique performances that could leave the less observant market player nonplussed. It is, therefore, appropriate for me to revisit the national market on behalf of investors.

Victoria

In Victoria, the inner-urban precinct, where the most intense investor activity is taking place, is a prime example of how specific influences are setting the pace, so let’s zero in and unravel what those drivers are. The sought-after property investment zones – two to 12 kilometres from major CBDs – have taken on a life of their own. Sections of this market are being dynamically driven upward in specific price brackets and some of the figures being realised are surprising even seasoned market players.

Interestingly, the Melbourne inner-urban high demand end has led the push ahead of the usual market leader, Sydney, and at this point it is only at the beginning of its upturn. But, take note, there are increasing signs that inner-urban Sydney is about to follow a similar upward pattern, but without some of Melbourne’s specific catalysts. One of those catalysts is an influx of savvy interstate investors to Melbourne capitalising on a cheaper entry point than may be possible in Perth or Sydney and doing it before the southern capital ups its ante across the rest of the year.(See today's column from Peter Kelaher on the hot spots in Sydney's Lower North Shore).

In some of Melbourne's most sought-after inner city suburbs, such as Albert Park, Middle Park, Carlton and Elwood, we are seeing increases of 15–20% in property priced between $300,000 and $900,000. For properties between $500,000 and $750,000, the main drivers are coming from a combination of first home buyers, who are purchasing primarily for investment purposes, and using the right growth and investment selection criteria; and seasoned investors, who are targeting properties within specific price points and localities that are proven performers.

Investors, including the interstaters, are concentrating on properties that are priced below their actual financial capacity. But, they are prepared to spend whatever it takes to acquire them at this early stage of the upward trend, in anticipation of further growth over time. This buying competition is having a dramatic “pull up” effect in lower and middle-priced property in the $300,000 to $800,000 range. In Melbourne, it has become increasingly difficult to buy a prime one-bedroom apartment with excellent capital growth prospects for under $300,000. Two-bedroom apartments that meet the selection criteria are ranging from $350,000 to $450,000. Prime investment property in the $500,000 to $750,000 bracket is showing growth of about 15%, especially in the inner-east.

When we hit the owner-occupier $800,000 to $1.5 million zone, it is white-hot because supply is nowhere near meeting demand. The market is turning a little slower from $1.5 million plus because there is a smaller number of properties and buyers in that price range. Melbourne’s across-the-board median price is still listed at $400,000, a misleading figure for anyone looking for a house in inner urban precincts.

But, yet again, when we take a closer look, the multi-layered market is revealed. The REIV tells us that the inner urban – two to 12 kilometres from the CBD – median is now $491,000, with middle-ring suburbs (12 to 20 kilometres) standing at $368,000 and the outer ring (20 kilometres-plus) on $300,000. Sydney still remains the most expensive city with a median price of $523,600, followed by Perth at $450,000. Adelaide and Hobart are the cheapest capitals at $290,000. Canberra’s median is $398,000, Darwin’s is $370,000 and Brisbane’s is $339,000.

Western Australia

If we head west, a different scenario is unfolding with the West Australian Government predicting a softening of that state’s housing market over the next 12 months. In the year to March, Perth’s prices rocketed yet again, by 32.1%, and affordability has become a major issue. The State Government this week took the classic, publicly popular budgetary move of drastically slashing stamp duty for first home buyers. They will be exempt from stamp duty on houses worth up to $500,000 with a phasing-out scale up to $600,000. The cuts will stimulate this market sector – which has effectively been at a standstill while West Australians waited to see what the state budget would deliver.

There is likely to be a lag time of several months before larger numbers of first home buyers enter the market. However, the Perth median price is $450,000 and the stamp duty cuts – like first home buyer grants – will almost immediately be factored into property prices. With a saving of more than $20,000 on a $500,000 property, the temptation could in fact be for first home buyers to swamp the market between $500,000 and $600,000 and beyond, which in turn may create the sort of owner/occupier versus investor competition we have already seen in the Melbourne market.

Fuelling the investor fire is the fact that rental vacancy rates in the inner urban zones and CBDs have dropped even further, to below 1% in Adelaide and in the inner-urban high demand areas of Melbourne; while the other capital cities range from 1% in Perth, 1.5% in Sydney, 1.5% in Brisbane, 1.6% for Canberra and 2.3% in Hobart to 4.6% in Darwin. But, keep in mind that such broad statistics do not offer a complete picture of any single suburb.

The Real Estate Institute of NSW says there is a “no vacancy” sign up anywhere in the inner-urban zone of Sydney, but there are varying levels of availability in other suburban areas.

The demand for rental properties in Sydney is climbing quite dramatically and this will be a factor in the recovery of that market. In Sydney, low affordability has caused a rise in rents over the past year of up to 26%, according to the NSW Department of Housing. Sydney’s inner urban zone has seen median weekly rents for a one-bedroom apartment climb 6.3% to $340 a week and a two-bedroom apartment is a median $410 a week – up 7.9%.

The rental increases were not confined to inner suburbs, with middle and outer areas showing increases of $20–25 a week. However, the Sydney market is reporting that up to 90% of property purchases are by owner-occupiers at this point. But, even if there is renewed investor activity in the next few months, it will take some time before enough rental properties filter on to the market to make a dramatic short-term difference to rental vacancies and rent levels around the nation.

The future of market movements will also hinge on the outcome of the federal election in the short to medium term. The economic pundits appear to be ruling out any interest rate rises between now and the election. However, the inflationary impact of the Federal Government’s budgetary tax cuts remain to be seen. But, for the time being, it appears that higher demand on the eastern seaboard will see moderate growth continue, particularly in areas where underlying demand exceeds supply.

Property Q & A

This week I have selected subscriber queries on:

• Residential property’s prospects.
• Whether to buy or rent property, or buy shares?
• An investment property for our son.
• Depreciation allowances.

Residential’s prospects

Why are you always talking up the prospects of residential property in Australia? You have never expressed any negative sentiment. The expensive suburbs of all capital cities have not outperformed the outer suburbs in the past 30 years.The OECD and The Economist magazine have both issued warnings about the property bubble in Australia. I note you suggest property investors aim for long-term capital growth of 5–7% above inflation. This may have happened in the past, but it is absurd to expect it from here on.

It is not a case of talking property up or talking it down, but giving investors a factual account of what is occurring in the marketplace. The property market moves in cycles and, like any asset class, moves through downturns and upturns. Property prices, particularly in the sought-after investment precincts, are determined by much more than wages growth and inflation.

Rents do not in fact determine the ongoing growth potential of residential property. It is the demand from owner-occupiers that determines the level of ongoing growth. The major driving force – and long-term staying power and consistent compounding capital growth – for any properly selected investment property equally hinges on the ratio of supply and demand.

I have also often said that not all property is good property in investment terms, so the selection criteria are crucial. Outer-suburban property is more volatile, reacting to economic activity and changes to monetary policy, and feels the squeeze when interest rates rise or wages fail to keep pace. There is no comparison between investing in residential property and what superannuation can deliver. It is not a case of one or the other.

The majority of Australian property investors fall into the “average” earning capacity – less than $80,000 a year, according to the latest figures from the Australian Bureau of Statistics. Properly selected residential investment property will continue to perform ahead of inflation. And yes, there are “rubbish” property investments. They’re the ones I often warn against, including cheap outer-urban properties with no scarcity value or real growth prospects, speculative new developments sold on hype and unsustainable guarantees, or those in poorly chosen locations, but with a high price tag. The list could go on and on.

At Eureka Report we pride ourselves on educating investors, to the best of our ability, about correct, non-speculative asset selection and keeping them abreast of market movements, including the bursting of any bubbles. We don’t presume to suggest what asset class they should choose. I personally always advocate a diversified approach to investing and would never suggest that residential property is the only way to go.

Buying, renting or equities?

I have a daughter who is single and living in Brisbane. She is a young professional. She is considering three options: buying a unit to live in; buying an affordable unit to rent further out of Brisbane and building up equity and using negative gearing while renting where she likes closer to the city; or buying shares while renting a place close to the city and using the shares to create wealth. What should she do?

This is a very common scenario among today’s young professionals, where they want to live in a certain convenient, lifestyle-oriented location, but can’t afford the buy-in price. She may be particularly interested to read my Eureka Report column from February 21, Owner/renter investors, in which I discussed the growing trend that we called the renting investor. This involves renting in a chosen location, but buying a good capital growth investment that will produce good equity build-up. The cost of renting is generally less – about 3–4% of a property’s value – than the cost of paying a mortgage, which will take a greater percentage of her income with the mortgage rate around 7%.

This way investors can have the best of both worlds and let capital growth do its work over several years. We are seeing an increasing number of first home buyers selecting properties on investment criteria, taking advantage of first home buyer grants to boost their spending power, moving into the property as owner-occupiers for the required period of time and then renting it out. Be wary of the “more affordable further out of Brisbane” option, as the key to successful property investment is to view it as a longer-term growth oriented asset and to achieve this you must get your asset selection right. Your final question raises the argument of whether shares or property make the better investment. It is not an argument I subscribe to! Both asset classes are very worthwhile.

An investment for our son

Our son is very keen to get into the right part of the market now before prices rise further, but he also wants to travel and live it up a bit before settling down and he hasn’t been working long enough to save a decent deposit. He will continue to live at home for a while yet. We are considering using some of the equity from one of our investment properties as a deposit to get him started. Should we add that property to our portfolio or leave it as a stand-alone investment for our son?

The first important point is the fact that you have recognised the value of your son having time on his side to allow for capital growth and equity build-up in an investment property. He can start off modestly with something like a well located, properly selected one-bedroom unit that provides that growth, but won’t drain your equity. You are to be congratulated for educating your son about the importance of starting the journey to financial security from a young age. You clearly have the knowledge in regard to property management and financially managing repayments and ongoing costs from your own experience in the property market to steer him in the right direction.

Consult your accountant or financial adviser as to the most effective structure of holding the property, but also about the best method of financing the deposit. He may be able to take advantage of the first home buyer grants to help cover entry costs such as stamp duty, so check your options in that regard.

Depreciation allowances

What sort of items should I look at in an investment property that would qualify for depreciation allowances? A few of the properties I have been looking at would need upgrades soon to some appliances, such as ovens or heaters.

Do yourself a favour and ask your accountant or tax adviser to outline what depreciation allowances will cover. It is a very long list and can vary depending on the type of property. The basic rule is that land appreciates in value while buildings, fixtures and fittings depreciate. Investors can claim depreciation on certain kinds of construction expenditure and on a range of items such as floor and window coverings, heaters, air conditioners and stoves.

The list of what you can’t depreciate is almost as long as the list for what you can. The allowable depreciation rates vary from item to item. The number of years over which you can claim depreciation on an item also varies. There are quantity surveyors aplenty who will visit your property and draw up a depreciation schedule for you. It’s a good idea to revisit the schedule every three to five years, subject to advice from your accountant.

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.

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