Make the most of a rising market

PORTFOLIO POINT: Smart buyers are adjusting their tactics to deal with a strong property market in which the gap is widening between prices quoted and achieved.

More evidence has arrived that the property market is moving upwards. RP Data’s latest report shows that prices in all capital cities except Perth are on the move, led by Melbourne and Sydney. Investors should now be able to observe the next sure sign of a market gathering momentum: the outcry when buyers discover a widening gap between quotes and actual selling prices.

This difference, called misquoting, originated with agents trying to attract the widest range of potential buyers by removing price as a barrier. It’s a controversial practice, which has long been a sore point with buyers, finding themselves priced out of the market for a property they believed was well within their price range.

In 2009, prices have lifted suddenly, beyond the expectations of many agents and vendors. Market supply is about 35% lower than last year, while demand from buyers is rebounding thanks to lower interest rates and a more benign economic outlook.

In this environment, agents have to balance their experience of recent sales, both successful and unsuccessful, with the need to keep vendors grounded and buyers motivated in a market that could yet prove fickle. It’s not an easy task.

When the price achieved for a property is high, it only adds to the resentment that an increasing number of unsuccessful buyers feel. At this point misquoting and calls for governments “to do something” permeate the media, the property industry and consumer groups. Tactics that make the price ambiguous and focus buyers’ minds on the property are evident in both the auction system, which predominates in Melbourne and Sydney, and private treaty sales, which dominate in all other capital cities.

With an auction, the agent’s primary goal is to allow the market to decide the true value of a property. Removing price as a barrier through a low quote is designed to attract potential buyers who otherwise would have excluded themselves because of the price, but instead go on to inspect, up their budget and bid, helping to maximise the property’s market value.

For sales by private treaty, agents take the opposite approach. They over-quote. Negotiating with one buyer at a time, agents cannot rely on bidders competing openly to drive the price up. In their discrete negotiations with buyers, agents have only one objective: to gain an acceptable price offer from a buyer wanting to pay the minimum possible. Quoting a higher asking price is used to lift the buyers’ minimum offer to within the range the vendor is willing to sell. Agents use over-quoting to rebalance the negotiating power and generate these offers.

There is legalisation in most states restricting real estate agents from quoting a price they “have knowledge” the vendor will not accept, which in practice means an agent quoting a price from a previous written offer, which the vendor has flatly rejected. Although well-intentioned, these regulations do not cover verbal offers before auctions and leave ample room for the agents to circumvent restrictions or substitute one tactic with another.

One proposal suggests misquoting could be stamped out by publishing the reserve price. Although it sounds appealing, this would disadvantage vendors. Imagine for instance, if a vendor sees a neighbouring property sell for much more than had been expected – shouldn’t they be allowed to adjust their expectations? Are they locked in to selling at a price set one, two or four weeks before escalating market conditions became obvious?

And what happens if a poor auction ensues? Can the vendor now sell for a lesser price? If they did, would this behaviour be perceived as misleading? These problems expose the shortfalls of a published reserve; to be effective, the legislation would have to tie the vendor’s hand while they are trying to sell their property.

Ultimately, these are privately held assets and no amount of legislation can force a vendor to sell at a price they don’t want to accept without fundamentally changing the way a free market works. But governments should look to introduce more balance between the rights of vendors and buyers, a sweet spot that allows for the art of negotiation without lulling so many into believing they have a realistic chance of buying a property they can’t afford.

If quoted ranges had to include the reserve price and could be updated regularly to reflect market conditions and interest in the property, we could begin to see a more equitable balance providing reasonable and reliable information to buyers without compromising the vendor’s right to privacy or the right to sell their property at their desired price.

Even if there is no change to the status quo, it’s important to recognise that no amount of agent positioning can push a sales price above the demand-supply equation.

In the meantime, successful investors must come to terms with misquoting as just another factor to be managed. Instead, investors should get out and see as many properties similar to the type they are proposing to buy and monitor weekly sales and auction results, comparing one week’s results against subsequent weeks to see what prices are being achieved. Moreover, well-informed buyers who understand the market’s dynamics and what a property is likely to fetch don’t have to rely on a quoted range.

Well-informed investors also know not to succumb to the bargain-hunting mindset.

Properties that seem like a bargain today are those not rising in a surging market – hardly a description of a bright investment opportunity. Just as Warren Buffet once said, “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price”, I say it’s far better to buy a property that has all the characteristics that drive capital growth over the long term than to pay a bargain price for a property that doesn’t achieve above-market growth.

Strange as is may seem, it’s these growth characteristics that will prove far more rewarding over time, while the price paid on a top-performing property will seem irrelevant in 10 or 15 years.

For all its opaqueness, investors should accept that forewarned is forearmed. It’s at times like this that the skill and resolve of a shrewd buyer is tested! And if a better system of quoting can be developed, then it’s incumbent on the industry to do so.

Property Q&A

This week:

• Sydney or the bush.
• A big new estate.
• Brisbane showplace.
• A home from home.

Heading for the hills

After months of looking to buy in Sydney (which is just out of my budget), I recently found a small house for sale in regional NSW. I want to rent it out and pay it off faster before moving in later. Will this work as an investment if more and more people cannot afford to buy in Sydney and seek other options?

It seems from your question that you would like to combine investment performance with your future lifestyle. Unless you intend to move into the property within two to five years, I suggest you avoid combining the two objectives. Although it can prove frustrating to buy a property in an urban area where prices just seem to go up, the experience of the past 20 years has been the further away you get from larger centres, the lower the capital growth from investment property.

Regional centres can provide a good investment stepping-stone, but if it is growth you are seeking, stick to the larger centres and make sure the asset selection is spot-on. The economies of the larger centres such as Gosford or Wollongong are more diversified and property there will perform consistently over the longer term. In mid-sized regional centres, such as Bathurst or Maitland, you will find period homes with relatively higher land values and architectural scarcity, but you should not expect the same investment outcomes as in the larger centres. In smaller centres, you will find lower-priced property that might seem like bargains but a more fragile the economic base increases the likelihood of adverse capital growth.

Spoilt for choice

I am looking to make my first investment purchase: a townhouse in Melbourne’s inner-north in a new development with 90 other dwellings. The purchase price is going to be $580,000–600,000, with two bedrooms, two bathrooms and a study. I love the area, which is near shops, parks and schools. Is this a good investment?

The general area you have chosen is perfectly suitable for investment. The revival of local streetscapes and shopping strips and the relative affordability of Melbourne’s inner north – compared to the inner-east and south-east – are some of the factors behind impressive recent sales in the area. But just because you love the area doesn’t mean you will love the investment performance of the property you are looking at.

The first factor you need to consider is that with 90 other dwellings being built in the complex, there is likely to be plenty of competition should you wish to sell your townhouse in the first five years or rent it out. It’s this competition that means your property will lack scarcity value, and price improvement and capital growth will be suppressed.

One benefit of buying off the plan is that you will make some savings on stamp duty, but this will be outweighed by the cost you pay to be in a new development. Developers typically make a 20% margin on their projects, which is incorporated into the price. You should also consider the notional land value of your investment, which you can calculate by taking the price of the land the development is built on and dividing it by the number of units. You should aim for a notional land value of at least 40%. All in all, I think you would be better served by investing in an established compact house in the same area or a two bedroom apartment closer to the CBD.

High rise in boom city

I was wondering what you think of an investment of the proposed apartments Lend Lease is planning to build at the Brisbane Exhibition Centre?

The RNA Showgrounds redevelopment is an interesting mixed-use development in the centre of Brisbane, but as a residential investor you are likely to wait for two or three years before being able to occupy and lease your apartment. I don’t mean to disappoint you but I am just not a fan of high-rise apartments or units in large complexes bought off the plan. They are usually not good at creating value for investors because they are rarely a scarce asset and don’t have consistent demand from a wide profile of home buyers, investors or renters.

The market has recovered in Brisbane, but only six months ago I was hearing stories of three-bedroom apartments being offered for the same price as two-bedroom apartments in the same development 12 months previously. This exposes the inherent volatility in this type of investment. More high-rise developments are planned for the Brisbane city area, so in the future prospective purchasers will be presented with more new and near-new apartments competing on price in the secondary resale market.

Unfortunately, they will attract more bargain-hunters who think they’re making a good investment on the basis of purchase price alone, always a dangerous assumption. In turn, they are likely to be equally disappointed with their property’s growth performance. Some high rise apartments are worthy investments, but they’re few and far between.

A home away from home

I want to invest in a three-bedroom house in inner bayside Melbourne. We don’t want an apartment because we believe that land content is what determines a property’s value. We we’re regularly in Melbourne, so overnight stays make security paramount. We expect to pay $600,000 to $1 million. Off the plan is fine because I hate paying stamp duty!

What’s not clear from your letter is whether this house is for primarily for investment or as a place to stay when you’re in Melbourne. If you want a house for your overnight stays, that’s fine, but I don’t think you should confuse this with an investment property, which is bought to make capital growth and rental returns.

Nobody likes stamp duty, but how do you feel about paying a developer’s margin of 20%? Do your sums: I think you’ll find the stamp duty is the lesser of two evils. No one likes paying stamp duty or developer’s margins and while you will pay one or the other it’s important to choose the higher growth option to mitigate the expense.

The key determinants of your property’s capital growth will be the relative scarcity of the asset you buy. Your preferred areas are fine, provided you find a house in a quiet residential street near public transport, schools, shops and parks. With up to $1 million, you should be able to find a reasonably scarce architectural style in a quiet, consistent streetscape close to the beach and cafes.

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.