Middle-ring: the comfort zone

PORTFOLIO POINT: Big family homes in middle ring suburbs are a nice place to live, but you probably wouldn’t want to invest there.

Australia is beginning the year with residential property markets well and truly on the rise. As investors renew their interest, speculation is growing over what will emerge as the next property investment winner. Much of this speculation centres on what we might call the “big upmarket family house” located in select precincts of upmarket middle to outer suburbs of our major cities.

These properties are the homes of affluent families, including many executives and self-made business owners. They’re large three or four-bedroom houses from the 1960s or 1970s with spacious entertainment areas, backyards and patios, and sometimes a pool or tennis court.

In Sydney, you’ll find these houses right across the upper north shore in suburbs such as Westleigh, Pennant Hills, Normanhurst, Turramurra, with Pennant Hills Road as a boundary. In Melbourne, they can be found to the east of Elgar and Warrigal Roads, in suburbs such as Wheelers Hill, Warrandyte, Glen Waverley and Donvale. Hallett Cove in Adelaide or Aspley in Brisbane are other good examples.

Like most middle to outer suburbs, these precincts are filled with quiet, tree-lined streets, but they differentiate themselves from neighbouring suburbs with good public transport and freeway access, better public high schools and private schools and more leisure facilities than most middle-outer suburban areas.
In Sydney and Melbourne you could expect to pay anywhere between $700,000 and $I.8 million for the right house in these areas. It’s a much more affordable way for affluent families to achieve a spacious lifestyle for much less than it would cost in the inner-ring suburbs

The question for investors is: Should I be investing my hard-earned money in these locations and property types?

When the market is buoyant these properties ride the wave and their values increase faster than the market average. But if the market enters a serious downturn, these properties get hit just as hard as any other. They’re reactive rather than resilient and it’s when the market rebounds the investment difference becomes apparent.

The effect can be seen when we compare the price movements of typical inner suburbs with typical middle-outer suburbs that are home to many of the upmarket family houses. We’ve used Melbourne data in this example because it’s the most up-to-date. We found that December quarter 2009 median prices for typical inner suburbs increased 18.1% on average compared to a 13.9% for typical middle to outer suburbs. The five year difference is even more compelling, with price growth up to 50% higher in the inner suburbs.

Similarly, rental return from these lifestyle properties is also not optimal from an investment point of view. The reason is simple: three and four-bedroom houses appeal to traditional families, not the professional couples, singles, empty nesters, mature singles and others who make up that diverse group we call the “tenant pool”.

Nearly every demographic type rents apartments and small houses in the inner suburbs at some point in their lives. The reverse is true of the big middle to outer suburban house: they’re exclusively for families who typically prefer to buy rather than rent. This makes for a relatively small pool of tenants, skewing demand and lower yields and higher rental vacancy rates.

The effect on vacancy rates can be seen in Real Estate Institute of NSW’s 2009 figures. Sydney middle suburbs, 10–15 kilometres from the CBD, led the rise – up 1.5–2.3%, while inner suburbs barely moved – up only 0.2–1.5%.

The manager of Jellis Craig’s property management division in Melbourne, Susy Lawson, highlighted how tight the inner urban rental market is, saying: “In the inner suburbs we operate in, a presentable two-bedroom house for rent will receive applications within hours of going online and we’ll be inundated within a couple of days. But the response for larger three and four-bedroom houses is more price-driven because the demand is lower.”

I asked Rich Harvey, managing director of Property Buyer in Sydney, about the upmarket family house market. He said: “I do think that some middle-ring suburbs can be considered for investment. In some middle-ring suburbs, near new employment centres and business parks, high owner-occupancy rates may mean less property for sale and price gains can be above the market’s average. The downside, however, is there’s a much smaller market to sell to and risks aplenty for investors in these areas.”

Meighan Hetherington, of Brisbane-based Property Pursuit, advises clients against buying investment properties more than 12 kilometres from Brisbane’s CBD. “People here are pretty city-centric and for Brisbane, 12 kilometres is a long way to drive every day,” she says. “We don’t have the employment centres spread out, which means rental returns and future saleability are affected when properties are too far from the CBD.

“Properties just inside that 12 kilometre boundary need to be looked at carefully, particularly if they are not close to major transport links. Some suburbs not on a train line, like Aspley, should be avoided in favour of better-performing properties for similar prices closer to the CBD. But even then you can’t just rely on how close it is; you have to research the demographic mix, the property types and all of the infrastructure and facilities before making a decision.”

And there’s the rub. While a rising market lifts all boats, true investment grade properties float higher than most.

So my advice is quite simple. If you’re thinking of buying a large family home, don’t mind being a bit further away from the centre and these precincts appeals to you, the upmarket family house may be just what you’re looking for.

But if you’re investing purely for financial gain there are faster growing opportunities elsewhere.

Property Q&A

This week:

• Should we keep our Mosman unit?
• Buying US property.
• Inner and outer growth prospects.
• Housing affordability.

Mosman unit

We own a two-bedroom unit in a complex of nine in Mosman, which we purchased seven years ago. It has only recently returned to the price we paid for it at the height of the last Sydney property boom and our rental return is running at about 4%. Do you think we should hang on to it for a while longer?

It’s a little surprising that an apartment in a low-rise complex on Sydney’s lower north shore has not performed better in growth terms; while the rental return is a little low for inner Sydney where many investment properties achieve 4.5%.

The Sydney property market did have an impressive run up to 2003 and has bounced around a little since then. Underlying these results are reductions in house prices in some outer west and southwest areas, while unit and house prices in areas like the lower north shore and the eastern suburbs have performed relatively well. The only thing I can conclude from your result is that there are other factors holding back the capital growth of your property. For example, did you buy it off the plan or brand new? This often goes hand in hand with an inflated purchase price, which is in line with your no-growth experience.

Before you make any decisions about what you should do with this asset, I think you need to get some professional assistance. Find an independent qualified residential property adviser who has at least five or 10 years’ experience working on the lower north shore. Have them assess your property, taking into account all of the factors that drive capital growth and rental return. Their report should include scarcity value in light of the location and style of building, current market value, capital growth since your purchase, potential for capital growth over the next one, three and five years, market rent and a recommendation to hold or sell your unit.

It’s quite important you undertake this process to ensure the assumptions you are working from are valid. If the asset is not investment quality then it’s time to get out of this investment and look to re-invest somewhere else with better potential.

US property

Do you have any advice on how to buy property in US?

I’ll give you the same advice as I would to investors purchasing interstate: ensure you research the market thoroughly, set your budget and understand that only about 5% of residential properties for sale at any one time are right for investment.

The first thing you should recognise is America’s economic situation is a lot more fragile than Australia’s. It has an unemployment rate of 10% and federal debt approaching 100% of GDP for the first time since the midpoint of World War Two.

You should remember that you won’t be buying property in “America”. Rather you will be investing in one of more than 300 metropolitan markets spread across six time zones and 50 states! Each of these markets has different characteristics and profiles and therefore propensity to growth. Property market growth is typically a function of the underlying supply/demand balance and the broader economic and financial picture and these factors are not particularly positive across most US cities. Property prices have fallen by an average of 26% over the past three years and falls of this scale should be a powerful warning to investors: Don’t expect prices to bounce back quickly!

Investors in US property should make themselves familiar with the local building codes and owners’ liability for injury to tenants. And then there the tax situation. Across most US cities, property owners face sales taxes and an annual land tax bill from both the state and local authorities (city, county or both).

In short, there’s no need to seek greener pastures when prospects at home are so bright.

Near and far

I understand your arguments for buying the best you can afford close to major CBDs but that seems to be completely at odds with other research, which suggests that the outlying growth areas consistently provide higher capital growth because they provide affordable housing, which will always be in high demand. Do you believe the research is flawed?

In a word, yes. Affordable housing does not equate with a good investment opportunity.

When we examine the average median price improvement of suburbs across major Australian capital cities over seven or 10 years, the highest growth areas are closer to the CBD. Affordable housing is in high demand, but only from first-home buyers, who make up just 20% of the market over the cycle. If an area is in high demand and supply is limited then it will quickly become unaffordable, as high demand drives prices up. But what tends to happen to first-home buyer areas when supply is exhausted is that new estates spring up further out, dampening price growth for the previous crop of new homes coming onto the resale market.

On some occasions, such as in Sydney in 2003, there are short one-year busts when price growth in outer suburbs outstrips growth closer in. Price improvement in these areas often comes off a low base and is driven mainly by first-home buyers being pushed outwards from their preferred areas. It is not a signal that these areas have been magically transformed into prime investment areas.

Some organisations with a vested interest in selling units in new developments in the outer areas will exploit these peaks to project these suburbs as high-growth. But longer-term data over the past 35 years shows conclusively that high-growth suburbs are clustered close to metropolitan centres. This is because these locations are in demand from all types of buyers and tenants. If you’re an investor, I would focus my search on proven prime areas only.

Affordability

I agree with your contention last week that “for an affordability study to be both meaningful and useful, it needs to be divided into two tranches: affordability for first-home buyers and affordability for upgraders”, but surely each of the cities in the surveys have both types of buyers. In Sydney, median house prices are over nine times earnings. Compare this with Dallas Fort Worth’s 2.7 times earnings. Plain common sense tells me there's something very wrong with the Australian housing market!

Actually, I have to both agree and disagree.

The affordability difference demonstrated by Demographia’s income to house prices comparator shows that there is something intrinsically wrong with the Dallas-Fort Worth property market. The authors drew this comparison, but I would point out that Sydney and Dallas are relatively similar Western world cities in terms of population size. The Demographia comparison tells me that all the factors that underpin a strong and growing property market are positive in Sydney, but few if any are positive in Dallas. While this makes it more expensive for first-home buyers to get into the market in Sydney, many property holders in Dallas must be wondering how the biggest financial transaction of their lives went so wrong.

The real issue for Sydney first-home buyers is the inability of state and federal governments to plan for the building of housing alternatives that actually meet the needs of the changing demographics. All we seem to be able to build is new house and land estates far away from any infrastructure and cramped, cookie-cutter high-rise apartment towers that nobody wants to live in over the long term. Until some meaningful alternatives are planned for Sydney’s established suburbs, I expect housing affordability for first-home buyers to continue to deteriorate.

It very important for property investors to not equate “affordable” with fabulous investment opportunity. By definition, and perhaps paradoxically, it’s the very factors that push property prices up that confer the best investment potential. First-home buyers on a limited budget have two choices: they can either search for the dream home in the outer suburbs and begin building equity through active debt reduction; or they can purchase a property that is not their ideal home but located in a high land value and high-growth area. With either strategy, the goal is to grow owner’s equity in order to buy a high-quality property in a desired location later on.

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.