Inside the property club

PORTFOLIO POINT: It takes more than money and negotiating skills to get into the off-market networks, where some of the most sought-after properties change hands.

Some of the best property investment opportunities are not splashed across real estate pages or pushed by ambitious agents. Nor do they have billboards out the front or appear in the online classifieds.

These particular properties are only available to investors with access to a considerable amount of equity and, unfortunately, it’s not a case of what you know but who you know.

I’m talking about the about off-market property networks, where some of Australia’s most expensive pieces of real estate change hands. But aspiring property owners take note: you will require more than just a strong capital position and negotiating skills to get results.

If you are unfamiliar with off-market networks, you need to understand how this market works as well as the subtle and not-so-subtle nuances of negotiating within this special environment. The relative scarcity of top-end property means savvy investors need to ensure they are comparing as many properties as possible, and in order to do that you’ll need to access to this world.

One of the things to note is that opportunities in off-market networks tend to open up when markets tighten.

Vendors may be reluctant to go through a highly public auction process if they perceive there is a high risk of failure or if they require privacy and want a confidential sale. This is especially the case where the seller has a public profile and having an open house just won’t do!

Similarly, when the top sector of the market is flat, dealing privately through a reputable agent can be a way for a vendor to achieve a reasonable price sooner rather than waiting for the typical four-week auction period plus a settlement time of 60 days or more.

Richard Jellis, director of Jellis Craig based in Melbourne’s east, says dealing off the market can also save vendors an advertising campaign worth tens of thousands of dollars. “Agents actually don’t love making a living from secret off-market sales but it can make for very happy vendors and buyers,” he says.

“The speed with which an agreed transaction can occur is definitely an attraction for both parties. A buyer tired of missing out at auctions may like all the characteristics of a property but won’t have to wait four or five weeks to compete with other bidders at a hot auction.

“Equally, many vendors don’t want to live in a fishbowl for weeks on end – particularly if family matters likes births, deaths, marriages, divorces or an interstate move are motivating the sale.”

There is a key proviso for investors wanting to buy a property using off-market networks that participants simply must acknowledge. Like most networks, off-market property networks only operate on the reputation and mutual trust of those involved. That means an investor must have the financial capacity to buy the properties available through the network and have a reputation for following through on commitments.

“Agents will work to match the right property with a buyer in an off-market transaction if they have met the buyer in person, established their credentials, found the buyer willing to attend a private inspection and are sure that the investor is very clear about what they are looking for,” Jellis says.

Investors who make firm but fair offers on properties through an off-market network gain respect and are likely to be contacted again. But an investor who makes offers clearly below market values, or refuses to accept a fair price, is likely to find they are ostracised by the network very quickly.

Most importantly, any buyer who reneges on a deal is unlikely to be approached again.

The usual entry point for investors to off-market networks is to register their interest with three to four top agencies in their targeted areas, communicating to the agents what their key investment requirements and price brackets are, usually $1.5 million and above.

Gavin Hegney, director of Perth-based Hegney Property Group, has watched for years as buyers and their advisers tried different ways to access off-market property sales. “I’ve seen hand-written letters addressed to a property owner, even mass-mailings to owners in highly sought-after streets and specific requests made to buyer’s advocates with proven contacts in industry networks. Good agents are always aware of the off-market matching opportunities,” Hegney says.

Rich Harvey, of Sydney-based buyer advisory firm Propertybuyer, says agents tend to work through buyer advisory firms. “In my experience, agents would rather work though buyer’s advocates on off-market sales because both parties are realistic about current market values and key requirements like due diligence, timing and privacy,” he says.

Once an appropriate match has been found, negotiations may have a different pace and intensity to other sale types. Hegney says off-market transactions can be easier than private sales. “Negotiations can run their course without agents bombarding the buyers with news of more interest. Buyers don’t want to have to deal with a Dutch auction and vendors don’t have to deal with people who are not genuine buyers,” he says.

While having greater access to more transactions of higher priced, investment-grade property is in an investor’s interest and membership of off-market networks is important, this should never become equated with wasting time or money on sub-investment-grade property.

For example, it’s important that investors are able to distinguish between glib flattery from an agent keen to off-load a sub-standard property that has failed to sell and has been languishing on the market for weeks or months, and a rare invitation to inspect a top-notch opportunity weeks before the competition is invited.

Good research, regardless of the method of sale, independent advice and a firm grasp on market fundamentals must always be the cornerstone of an investment strategy, particularly when it comes to higher-priced property.

Property Q&A

This week:

• What does investment-grade mean?
• We want a Melbourne investment.
• Where can I find property investment software?
• What are Phillip Island’s prospects?

Investment grade

In several of your recent columns, you have used the term “investment-grade property”. What exactly is an investment-grade property and how will I know one when I see one?

An investment-grade property is a residential property that consistently exhibits above-market capital growth over time. The underlying reason for this performance is two-fold:

• These property types are not being built any more and are therefore finite in supply.
• Buyer demand for these properties consistently outstrips supply.

The result is that investment-grade properties have scarcity value and this drives the value up over time. Scarcity value doesn’t mean these properties are unusual – they mostly have quite conventional building styles and floor plans for their period. But because more buyers want these properties than there are properties available, they experience above-market rises in capital growth and rental return over time.

An investment-grade property can be either a house or an apartment, but they are nearly always established rather than brand new. New properties built in the modern style are not as popular with all buyer and tenant types. They often have limited scarcity value, as other newly built properties of a similar style come on to the market relatively frequently.

Good examples of properties with scarcity value include Victorian and Edwardian single-fronted, two-bedroom houses and well-positioned apartments in period or older-style buildings. Investment-grade properties are located in high-demand, high land-value locations in the inner-ring and some select middle-ring suburbs of our major cities.

Melbourne investment

We live in Sydney and have nearly paid off our home in Jannali, in the southern suburbs. Recently we have been thinking about purchasing an investment property in Melbourne. What suburbs should we look at? We have a budget of $700,000.

I usually recommend inner and middle-ring suburbs of Melbourne. Property in these areas is more tightly held and has all the location factors demanded by the different buyers and tenants. This maximises the investor’s opportunity for capital growth and increasing rental returns.

I recommend you start your search in a two to 12 kilometre radius of the city, excluding the CBD, Docklands, St Kilda Road and Southbank. With a budget of $700,000, you may be able to find a small two-bedroom cottage in the inner-northwestern suburbs. But with this budget, you will have to be very selective because many houses in this section of Melbourne now sell for between $700,000 and $800,000.

Your other option is to look at apartments. With a budget of $700,000, you will be able to afford a top-quality investment apartment in the inner-bayside, inner-southeast and inner-eastern suburbs. Stick to low-rise complexes of fewer than 20 apartments in quiet residential streets, close to transport, shops, schools and recreational facilities. You should also ensure your apartment is well-positioned in the block and has an allocated car space.

I suggest you visit Melbourne and take some time to get to know the local market before you continue your search for a property that ticks all the boxes.

Keeping track

I have great software for keeping records of my share trading but I have been unable to source any software for keeping records of my property investment and expenses. Do you know of any software that does, or do I have to keep on making up a spreadsheet for each property, which makes it difficult to compare the progress of one property to another?

There are some property investment software packages on the market that appear to be reasonably comprehensive. If you do purchase property software, then at a minimum it should be able to provide you with reports on:

• Capital growth.
• Internal rate of return.
• Before-tax and after-tax cash flows.
• Land tax.
• Growth in equity under different interest rate and capital growth scenarios.
• Rental returns.
• Depreciation allowances and schedules.
• Deductible expenses.
• Cash flow comparisons under different loan types.
• Portfolio aggregation reports.
• Comparisons between different properties in your portfolio.

While some investors may find the reports generated by these software packages useful, to my mind it’s probably easier to capture all your investment expenses on a spreadsheet and forward it to your accountant. Your accountant can then advise you on the tax and income implications of your investment.

By far the most important aspect of any property investment is the property’s capital growth. You can monitor this by estimating the current value of your property at each anniversary of your purchase and estimating its growth for the year. To estimate the current market price, review recent sales of comparable properties in your area and make an honest assessment of your property’s current market price on that basis, or arrange an independent appraisal of your property’s value.

You should use simple benchmarks to measure the capital growth performance of your investment. Generally speaking, quality investment-grade property will outperform inflation by anywhere between 5% and 7% over the life of the investment. But I caution you to remember that the change in your property’s value in any single year may be above or below the market’s average. But over the course of three to five years or more, your property should be outpacing the overall market.

Phillip Island

I am looking at buying land and building a holiday home on Phillip Island, about 120 kilometres southeast of Melbourne. Can you tell me what capital growth prospects I can expect over a five-year period?

Phillip Island is a unique place with magnificent ocean and bay beaches, making it popular with families and water sports fanatics, particularly sailors and surfers. It’s a great place for a beach holiday in summer – and even winter if you are one of those Victorians who love the ocean beach on a winter’s day.

In terms of capital growth, there are a couple of factors you should be particularly aware of. First, one of the more interesting factors about Phillip Island is that the local council has very tight restrictions on the subdivision of land on the island. While this provision is designed to protect the atmosphere of the local community, it can also accelerate property price growth when demand is running strong. That said, these instances are few and far between and overall growth on the island has been poor for years.

Although there are still some agricultural properties on Phillip Island, the vast majority of properties owned there are holiday homes and not the owner’s primary residence. If any of these owners get into financial trouble, the first thing they will look at selling is the holiday house rather than their family home. That’s why during economic downturns, we tend to see many For Sale signs spring up in coastal areas. Indeed, this was the case in many parts of the South Gippsland coast during the first half of 2009.

My experience of Phillip Island property values is that they tend to lag other coastal areas close to Melbourne and that this market can fall very quickly – faster than many other coastal areas. For this reason, I would think that property values on Phillip Island are likely to exhibit more variability than other coastal areas close to Melbourne, which is something you may want to take into account in your plans.

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

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 Wakelin? Send an email to monique@eurekareport.com.au.