Property babble

PORTFOLIO POINT: Property is taking a breather after posting strong gains. The question now is about when growth will resume.

You may have thought it impossible, but the shrillness of the media debate about property prices has edged up another notch in recent weeks.

'Bubble Bursts', screams Melbourne’s Herald Sun. 'Capital House Prices Slide', yells The Australian Financial Review. And 'Property Investors Get Sinking Feeling', intones The Australian.

Proponents of the property bubble scenario, perhaps sensing the market’s softer mood, have seized the offensive, delivering a raft of commentary citing softer market data as the evidence that a sizeable decline is on the way.

Judging from my mailbag, I can see there is uncertainty among investors about the prospects for property. Such an outcome could be considered a measure of success for those commentators, many of whom are staking their reputation on prices slumping.

But what is really happening and does the reality match up with those doom-laden headlines?

Let’s look at the data, for which Australian residential property watchers are spoilt for choice. There is the ABS’s Eight Capital Cities House Price Index, and offerings from commercial providers Australian Property Monitors, RP Data-Rismark and Residex.

It is telling that when you look at the national or weighted average of capital cities numbers for quarterly and annual growth coming out of these surveys, they all fall within a tight range and tell a sober – if unexciting – story:

The four surveys more or less measure the same parameter over the same timeframe; averaging their results gives a pretty good guide to the state of the market.

You can see from the table that at a national level property prices have eased back around 1.2% in the last quarter. And over the past 12 months prices have risen 0.6%.

The real story behind these numbers is the resilience of the Australian property market in the face of global and national adversity, be it economic, environmental or natural disasters.

After peaking around May 2010, prices have clung to nearly all their recent capital growth despite several interest rate rises, the removal of the national First-Home Owner’s Boost, rising petrol prices, an increase in the consumer savings ratio and much scare-mongering by the “bubble brigade”.

I asked Cameron Kusher, research analyst at RP Data, for his view of the market.

“The market has slowed down. Values are holding up better in Sydney and Melbourne, with Brisbane, Perth and Canberra doing less well. There are a lot of listings and the stock is taking longer to shift. There aren’t many first-home buyers or investors out there, which is making it hard for aspiring upgraders to sell their current property. Rental yields have started to improve across Australia’s capital cities – outside of Melbourne. Over time that may attract some investors back to the market.”

Kusher is relatively sanguine about the prospects for the market. “While the market has definitely softened, with fewer transactions and lower activity, I expect these falls will be relatively contained, largely because I don’t see which factors not already in play would cause people to sell for significantly less than today’s prices.

“Unemployment is low, the economy is doing reasonably well – and very well relative to the rest of the world. If people can’t sell at today’s prices, most will just take their property off the market and try again at some other time.”

So far from the train-wreck scenario portrayed by doomsayers, the typical capital city residential property market is experiencing a modest softening in prices, that’s all. After a strong run up in prices in 2009 and early 2010 off the back of falling interest rates and the First-Home Owner’s Boost, the market is taking a breather.

Importantly, this is exactly what property commentators such as myself said would happen at the start of the year (see Property’s Year of Affordability). Rather than focusing on capital falls, the crucial question for investors is how long property prices will remain in this holding pattern before capital growth resumes.

Personally, I’ll be content – and not surprised – should property prices trade in the current range for the rest of the year and into early 2012. Strong supply and more balanced demand will make this year a good time to buy.

You’ll still have to pay a fair price to secure a quality property, but unlike the recent past, you’re less likely to have to endure the heartache of an arduous search effort with several misses before you buy successfully.

Surely, all that has to be good news for investors and first-home buyers alike.

And, just quietly, provided my cat Isabella does not cost me a small fortune with her extravagant culinary preferences, this is the year I’ll be adding to my own portfolio too.

Property Q&A

This week:

• Negative gearing (1&2).
• Buying a serviced apartment.
• Should I sell a Mornington unit?

Negative gearing (1)

With regard to your recent article on negative gearing (see Pity the maligned property investor), I am an accountant and have had clients who have never sold their rental properties but have in fact increased the number of properties from one to maybe five. Don't you think this might alter your argument slightly? My main gripe is that interest should be deductible for landlords and home owners alike. It sounds as though you only represent landlords though.

There is no doubt that owning a multiple-property investment portfolio probably changes the outcomes from the original scenario. Note that once equity builds up, the negative gearing benefits diminish and income grows, and that income becomes subject to income tax. Imposts like land tax and capital gains tax remain in the mix.

An individual who holds off selling their investment property for many years will reap negative gearing benefits for longer – albeit with a diminishing impact – but one day they will eventually sell. The tax office will then be a major beneficiary of the capital growth of the property, and over the lifetime of the property holding, our multiple investor will be an even greater net contributor to the Treasury.

It is true that homeowners can’t deduct interest payments, but they are also exempt from CGT. There is a clear distinction between passively consuming the benefits of a property as a homeowner, and building wealth through property investment as a means of self-financing retirement rather than relying on government welfare.

Negative gearing (2)

Over some time I have been aware of your continued defence of negative gearing which, I would submit, is not inconsistent with your involvement in the property sector. Would you please let me have your justifications for the amount claimable as tax deductions to be in excess of the rental return from a negatively geared property? It would seem it is entered into purely as a means of reducing taxable income so as to enable the claimant's tax burden to be in part transferred to the general body of taxpayers?

First, I defend property investors, not negative gearing! If our entire tax system can be remodelled in a viable and equitable fashion, then I’m all for it.

There is a perception in some quarters that property investment is unlike other forms of investment and that it is costless and risk-free. As such – in the eyes of those who hold this view – it does not merit the taxation treatment other forms of investments or business operations receive, such as netting off those losses against other income, be it in the same year or future years.

However, property investment is not risk-free. Moreover, it is definitely not costless. A negatively geared property investor chooses to plough several thousand dollars – even after taking into account interest deductions – of their own money into the investment every year for several years. They are forgoing income and consumption today for a return later. That is the action of a responsible citizen, investing for the future. Quite appropriately, negative gearing provisions reduce the tax they pay in the years when their net income is reduced by their investment losses, and sees them pay substantial capital gains tax when they realise the assets.

The principal reason for becoming a property investor should never be about reducing tax. It is always about accumulating wealth to self-fund retirement as opposed to being reliant on welfare after giving up work – something governments have made it clear they cannot and will not fund for most people. The optimal property investment strategy is buying quality property that will deliver sustained capital growth. That it is also tax efficient is a welcome bonus for those who take a calculated risk, but it is not the main game.

Serviced apartment

I’m considering an investment in a serviced apartment in South Yarra, Melbourne. It is a three-year-old fully furnished two-bedroom apartment with car park and storage cage, that is leased to Quest until 2017 with 3 x 5 years renewal options. The guaranteed net rent is 6%, and the owner pays council rates and water tax. The developer is selling for mid $500,000s. I like the location of the apartment and I think rental returns are good. It is going to be a pure investment for me and I will be interested to know your views. Is this a worthwhile investment or something an investor should stay clear of? What are the other pitfalls that I should be aware of?

Be cautious of the serviced apartment industry and these units as investments. Over the economic cycle it is common for the industry to overestimate demand, leading to a glut of supply.

Units are often overpriced for what they are. Too frequently locations are poor – even if the suburb is blue-chip, they tend to be sited on busy main roads, and the building styles are usually nondescript and lacking in scarcity value.

Ultimately long-term leases are a two-edged sword. When you come to sell, it is imperative you capture the owner-occupier market to maximise the unit’s potential resale price. Owner-occupiers are of course looking for properties with vacant possession. Consequently, a serviced apartment has a very limited resale market – you can only sell it to another investor, which is effectively only 15% of total market. This is a severe disadvantage.

Body corporate and management fees for serviced apartments tend to be very high. Further, individual investors may have little control over their unit. In many instances the service company can commission works without individual owners’ approval or consultation.

No doubt a major attraction to prospective buyers of serviced apartments is the potential for guaranteed rental returns. For many buyers, it allays a powerful fear: will I be able to rent the property out to a secure and relatively long-term tenant? Buying a serviced apartment is likely to be a costly way to deal with these concerns. It is far better to focus on securing a good quality property in a desirable location that will always attract a suitable tenant market and rent, and generate a superior market-driven return. Therefore, asset selection is key.

Mornington unit

My elderly mother owns a unit in Mornington, Victoria, but it is now vacant as my mother has moved to a nursing home. The family is considering selling the property, either on the open market or I could purchase for my own investment portfolio. The unit was bought in 1997 for $167,000 and is now valued at $435,000, with a rental return of $1200 per calendar month. The unit would need repainting and new carpets before being rented. Should I do the latter or invest in a unit closer to Melbourne, rather than 50 kilometres away from the CBD?

I imagine the unit has some emotional value to you, due to your mother living there for many years. However, looking forward as an investor, it is incumbent on you to consider the property dispassionately.

The capital growth track record of this unit since 1997 equates to under 7% per year, which significantly underperforms investment-grade property over that time frame. An equivalent investment-grade property, bought for $167,000 in 1997, should be worth somewhere in the region of $700,000 to $900,000 today.

The lengthy holding period across several economic and investment cycles gives us pretty compelling evidence that this unit will always be a laggard. I recommend you sell the property and invest within a 2–12 kilometre radius of the Melbourne CBD, rather than 50 kilometres out in Mornington.

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