Question Mark: High-Rise Blues

The investment outlook for high-rise apartments is looking very sorry indeed. The latest figures from the Bureau of Statistics show that building approvals for new units have fallen by more than 20% over the past 12 months.

Finding and purchasing land, obtaining finance and construction permits, and completing a new building can take 12 to 18 months. This means there’s a significant time lag between a period of strong investor demand for new apartments and the properties coming on to the market.

The sharp reduction in approvals reflects the supply overhang of new apartments left after investors deserted the market when prices climbed beyond their tolerance level during the last property boom. To put the 20% drop in apartment approvals in perspective, it's almost three times worse than the fall of 7.8% registered for total private dwelling approvals over the same period, the year to June 30.

If you want local evidence of this oversupply take the “drive by” test. I recently drove past Melbourne’s Docklands precinct at 8 o’clock on a Sunday evening '” a time you would imagine most people would be home and apartment blocks would be a blaze of lights.

Not so. To my amazement, it appeared lights were on in only about 10% of the apartments. Where were all the tenants?

I suspect many of the apartments are vacant, being held by developers for sale when prices pick up in the high-rise sector. The last thing any developer wants to do is reduce the price for brand new apartments.

I believe the softness in new apartment approvals is likely to continue until the supply is soaked up.

The slump in new apartment approvals, compared with an improving overall trend for private dwellings, underlines the volatile nature of new apartment sector. It is driven by the involvement of developers, which varies considerably according to how much profit they believe they can derive from a particular location or development.

This stands in sharp contrast to established apartments and houses, where activity and prices are driven by the demand of investors and homebuyers in the open market.

If you are looking at the new apartment sector, I suggest you wait until building approvals begin to increase. This will indicate that the excess supply has been taken up and that the supply and demand curve is swinging back in favour of the developers.

Remember: building approvals and developer activity may surge quickly, but it is likely to be short-lived. Once the next crop of apartments springs up, it might not take long for the sector to move back into oversupply.

This translates to a poor outlook for investors seeking capital growth from new apartments; a situation I believe will continue for some years to come.

Correction

Finally, I’d like to correct an answer I gave to one reader’s question last week. I said:

“The tax office allows you to rent out your main residence (family home) for a maximum of six years without being subject to capital gains tax if you sell, provided that you don’t buy another home to live in during this period.

This six-year period can be used in an unbroken stretch, or a little at a time.

Let’s say, for example, that you move out of your home for three years, move back for two years, then move out for another four years before selling it.”

This is not correct. In fact, if you move back into your main residence, then move out again, the tax office allows you to claim the main residence exemption for another period of up to six years, provided you don’t buy another home to live in.

Investing overseas

I read last week’s question from a reader asking about investment property in Dubai. You seemed to be quite sceptical about buying in the Middle East. Are you sceptical about investing anywhere overseas? After all, nobody seems to be too sceptical about Australian property trusts pouring our savings into offshore markets.

There is a big difference between investing directly in overseas property, and investing via a property trust.

I am not sceptical about buying overseas as such, but I am extremely sceptical about individual investors buying direct property in a market they know nothing about.

As an individual investor, you shoulder 100% of the risk yourself. The stakes are considerably higher than if you invest in a property trust, where the risk is spread out among hundreds or thousands of investors. Trusts also invest in a wide range of properties in different locations, which further spreads risk. And you can invest across several trusts with different volatility levels; diluting your risk even more.

When you invest in an international property trust, part of your fee goes towards paying the fund managers for their expertise in researching the relevant markets and selecting suitable assets.

As an individual investing in direct property, the onus is squarely on you to do this research. This means finding reliable information about recent sales results for properties of comparable size and style in the immediately surrounding streets and suburbs of the city you’re considering.

It’s definitely a case of buyer beware. If you’re being “advised” to purchase a particular overseas property from someone who’s being paid a commission to sell it, think twice before taking their recommendation at face value.

A letter from the taxman

I bought an investment property in March 2005. I recently received a letter from the tax office telling me to be careful about what expenses I claim for the 2005-06 financial year. Apparently they sent me the letter because I’m a new investor who declared rental income and claimed related expenses for the first time last financial year.

I’m not too worried because my records are in pretty good shape, but I’m a bit concerned that I’ve received this letter and it means I’m likely to be audited '” a hassle I don’t need. What do you make of it?

The tax office identified rental property as one of its key areas of interest last year, and has done so again for the 2005-06 tax year. This is because taxpayers have declared more rental income and claimed substantially more rental expenses in the past few years.

The amount of declared rental income rose by 12% last year, while the amount of expenses rose by almost 20%. The percentage of taxpayers reporting losses on rental properties also increased.

While I believe these increases can be attributed to the last property boom rather than questionable claims by investors, I have no problem with the tax office taking a closer interest.

It is particularly keen to make sure that claims for expenses associated with rental property are legitimate. Common mistakes include (among other things):

• Claiming capital works as repairs.
• Claiming the interest on private borrowings as well as income-producing borrowings.
• Claiming deductions for a property that’s only available for rent part of the year, such as a holiday home.

Having said all this, the fact the tax office has written doesn’t mean you’re more likely to be audited. The the same letter has gone to 100,000 other first-time investors to ensure they understand their responsibilities. Tax officials say they don’t usually seek more information from individual taxpayers where gross rent and deductions are line with the norm.

On another note, the tax office is cracking down on under-reporting of capital gains. Despite a 53% increase in capital gains reported for the 2003-04 tax year, the tax office says many investors continue to under-report capital gains on property and shares. It is working more closely with land titles and state revenue offices to match tax returns with official property transaction records.

Ultimately it all boils down to honesty. If you’ve kept good records, declared all your rental income and/or capital gains, and claimed legitimate expenses, you shouldn’t have a problem.

Your accountant will be able to provide more information.

A better offer

I have an investment property in north Queensland. The carpets were flooded during a recent storm, and my tenants were forced to move out. I’ve installed new carpets but the tenants haven’t come back.

I had been letting the property for $295 a week before the storm, and it has been back on the rental market for five weeks. The property manager said he was having trouble finding a tenant and I should drop the rent to $290. I was a bit annoyed but agreed.

I contacted another property manager for a second opinion. She said I should be able to get at least $350 a week. Now I’m in a bit of a spot because the first agent signed a tenant up at $290 a week, and the second agent has someone ready to sign at $350. Am I obliged to accept the first offer?

When you appointed the first agent, you would have signed an authority form giving them the right to act on your behalf in managing the property.

Once you sign an authority with one agent, it’s illegal for any other agent to act for you. You must terminate the first agreement in writing and then sign another one with the new agent.

This means that, even though the second agent can get more rent for your property, they have no legal right to act on your behalf. The first agent has signed up a tenant at $290 a week, so you’re bound to lease the property through that agent, at that rental level.

I suggest you call the first agent immediately, instruct her not to accept the tenant’s offer of $290, and inform her about the offer for $350. Try to get the contact details of the tenant who is prepared to pay $350 and ask your current agent to sign them up. It may be a bit difficult to extract this information from the second agent, but it will be best for your hip pocket in the long run.

A change of title

I have been with my current partner for two years and we have been living together for the past year. We live in a property in Melbourne that I bought four years ago. The title is only in my name and I want to add my partner to the title and the loan. However, we’re concerned that if we add his name to the title he will have to pay stamp duty.

People living together in a de facto relationship in Victoria can add their partner to the title without having to pay stamp duty. You will however, be required to complete a statutory declaration stating that you are in a de facto relationship.

Your will also incur some minor associated costs for property conveyancing and loan restructuring. These costs shouldn’t amount to much more than $1000.

Mark Armstrong is Director of Property Planning Australia, an integrated property advisory and mortgage sourcing service. He
also writes for Australian Property Investor magazine.

You can email any questions regarding property to Mark Armstrong right here, by clicking questionmark@eurekareport.com.au