Question Mark: Quarterly Review

KEY POINTS

• Residential property is sending mixed signals.
• Three months into 2006, the residential market is performing very much as we expected.
• It is a mixed bag for capital growth

Sydney’s median house price declined by 5% during 2005; a much-needed cooling-off period after house prices became unsustainable during the last boom.

Recent figures from Australian Property Monitors show that Sydney house prices increased by 0.1% between June and December 2005, to $518,000. This is an early indication that the Sydney market is over the correction and the sun will gradually come out during the remainder of 2006. However, it may be slow going until homebuyers and investors regain confidence.

The Melbourne market is finding its feet after two or three years of sluggish growth. The median house price increased by 2% in 2005, to $348,500. Significantly, about half this growth came in the final quarter, indicating a more significant increase in buyer confidence in late 2005.

We believe the Melbourne market will continue slowly gathering momentum during 2006, with a faster pace as we head into 2007. Now is a good time to buy and put yourself in the driver’s seat to reap the benefits of a whole growth cycle, rather than holding off until prices have already taken off.

A notable exception will be the CBD/Docklands apartment sector, in which there has been a sharp decline in building activity as developers wait for buyers to soak up the oversupply. I suggest you think very carefully before buying in these areas, which are not likely to produce good capital or rental growth for some time.

The Brisbane market’s fortunes continue to be strongly linked with the Sydney market. Since Sydney prices came off the boil, fewer Sydneysiders have travelled north in search of cheaper housing. As a result, the Brisbane median house price rose by a relatively modest 2.6% during 2005.

Certain sectors will fare worse than others. The CBD/Southbank apartment market, which is only 30% owner-occupied, will continue to suffer the fallout of oversupply from the recent building boom. Outer-suburban housing estates, which boomed during the Sydney homebuyer exodus, will also experience an oversupply relative to demand.

The Perth median house value rose by a whopping 18.5% during 2005; an increase fuelled largely by the continuing rises in resource prices and the associated home-building boom. Perth has certainly had a good run but with increases like we saw in 2005, it’s unlikely the market can continue spiralling for too much longer. I believe Perth is closer to the end of its housing boom than it is to the start.

Adelaide’s median house price grew by 2.1% during 2005. Virtually all this growth occurred between January and September, showing a fall-off during the last quarter. Without the benefits of a Perth-like resource-fuelled housing boom, we expect these subdued conditions to continue in 2006.

Rentals tighten. Vacancy rates in most major capital cities tightened substantially from December 2004 to September 2005, with decreases ranging from 0.5% to 1.5%. This was due partly to the widespread investor withdrawal, and partly to hesitation among would-be first homebuyers waiting to see if the market would cool any further.

However, the most recent figures from the Real Estate Institute of Australia for the December quarter of 2005 show that vacancy rates barely moved since the previous quarter. What’s more, the Bureau of Statistics says the nation’s total home loan commitments rose by 2.8% in December 2005 '” the sixth consecutive monthly increase. First homebuyers also increased as a percentage of loans for owner occupied properties.

These factors combined suggest that first home buyers are beginning to dip their toes into the property market once again, and that vacancy rates are unlikely to fall much further in the foreseeable future.

If you haven’t reviewed your rent levels already, now may be a good time, before rent levels stabilise further and market tolerance drops.

The exception is Sydney, where vacancy rates dropped only 0.2% during calendar 2005. In keeping with tradition, the Sydney property market began its correction some time before Melbourne and Brisbane, and the stability in vacancy rates reflects this.

The top end of the market is extremely strong, for a couple of reasons. First, high-quality property in blue-chip locations is usually purchased as a long-term family home, so these areas are always tightly held. Second, people at this end of the market ($2 million-plus in Sydney and $1 million-plus Melbourne) usually earn their money from business interests. The sharemarket’s current dream run gives them more purchasing power.

Strong competition means some top-end property in Sydney and Melbourne has achieved growth of 10–20% in the past two or three years '” even when the wider market was sluggish. One property in the Melbourne dress circle suburb of Toorak recently sold for $830,000 more than the reserve, as seven bidders pushed the price to $6.63 million.

We expect this trend to continue for the remainder of 2006, or as long as the sharemarket keeps climbing.

Entry level. The lower end of the market is somewhat softer than the top end, as first homebuyers and investors are yet to enter the market in large enough numbers to create a significant shift in prices. However, recent CommSec figures showing an increase in the proportion of home loans taken out by first homebuyers indicate that the outlook should strengthen during the remainder of 2006. It won’t be a flood, but a slow trickle that will build momentum.

Generally speaking, investors at the lower end of the market hold back until they see what homebuyers are doing. Now is a good time for first homebuyers to enter the market, before investors return in large numbers, drive up the level of competition and put pressure on prices.

New apartments feel the sting; established properties fare better. The high-rise sector continues to suffer the fallout from oversupply and lack of investor activity. According to CommSec, national building approvals for multi-unit developments fell by 5.2% in January '” 23.2% lower than last year. By contrast, approvals for detached houses, which have a much higher level of owner occupation, fell just 0.4% in January; 6.9% lower than 12 months earlier.

Within this overall picture, there is a clear difference in residential building activity between states. Approvals in NSW and Qld are down by about 21%, indicating that the oversupply will take some time to correct. In Victoria the situation is somewhat brighter; with a drop of around 4%.

As mentioned earlier, Perth and surrounds continue their boom status; CommSec says WA is set to build more detached houses in 2006 than NSW, which has more than three times the population.

Commercial property. Unlike the residential sector, the commercial market is running hot pretty much across the board. The commercial market marches to a different beat from the residential market; while lifestyle considerations dominate the residential market, it is business confidence that drives the commercial market.

When business is good and confidence is high, companies are out in force looking for commercial premises to lease or buy. However, early indicators are that the current run of confidence is coming to an end.

Commercial property trusts are increasing their gearing levels; some are geared as high as 50%. Higher gearing means more money to invest, which in turn brings higher property prices, forcing rental yields down. Higher gearing levels also expose commercial investors to greater risk.

What’s more, CommSec figures show a 20% increase in commercial building approvals during January 2006 compared to the same time last year; an indication that supply may soon overtake demand and begin to soften prices.

The construction boom in direct commercial property is reflected in the listed trust sector. According to the ASX, the market capitalisation of listed property trusts increased from $85.3 billion to $104.4 billion in the year to February 2006, an increase of 22.4%.

Super swell. All the indicators are that now is not the time to be chasing the market in the commercial sector. Paradoxically, more investors than ever are entering the commercial market looking for higher income streams, primarily through superannuation.

According to Access Economics and the Association of Superannuation Funds of Australia, Australians held $531 billion in super in 2003. This figure increased to $650 billion in 2005.

The Australian Prudential Regulation Authority says that about 7% of our super money is invested into direct and indirect property. In 2003, this represented $37 billion; climbing to $45 billion in 2005. That’s an extra $8 billion going into the commercial property sector over two years. Gear that up to 50%, and it becomes $16 billion.

These additional funds have contributed to an overheated market which is headed for a cooling phase '” and over at the big end of town the key players know it. They’ve have made their hay and are now selling out while the sun is still shining. The likes of Marc Besen, Ralph Sarich and Kevin Seymour have begun offloading shopping centres and office blocks for a handsome profit.

While we’re certainly not suggesting you should sell your commercial property holdings lock, stock and barrel, it’s worth taking a tip from the big boys and adopting a more measured approach.

THIS WEEK I have selected four questions from subscribers, covering heritage overlays, setting a realistic selling price, some basic advice on property investment, and “capitalising” mortgage insurance.

HERITAGE OVERLAY

We have lived in our house in Melbourne’s inner suburbs since 1968. All the kids have now left home and we are tossing up what we should do next. The house is getting old and requires a lot of maintenance to bring it up to scratch.

We’re exploring the idea of knocking the house down and building a couple of units. We haven’t approached the local council about this yet, but we suspect we may have problems. The certificate of title states that the block has a single dwelling covenant. The house is also in a heritage overlay area.

Does that mean our house is heritage listed? What are the implications of the covenant and the heritage listing? Will they stop our redevelopment plans?

The fact your house is in a heritage overlay area does not mean the house itself is heritage listed. Heritage overlays mean that the local council believes your street as a whole has heritage value, and that they want to keep the streetscape as consistent as possible

This might not stop you knocking down the house, but may make it difficult to get a permit to build two units that don’t blend in with the street’s overall architectural character.

The single dwelling covenant will also create a considerable headache. Getting the covenant lifted is possible, but is difficult and costly, and requires a planning permit from your local council.

If these obstacles prove too much, I suggest you consider selling the property at a realistic price that reflects the house’s state of repair, and downsizing to more suitable accommodation.

SELLING PRICE

I own a two bedroom investment apartment in Sydney’s inner west. I’ve had it on the market for more than six months at $415,000. I’ve had a couple of offers but knocked them back because they were way below my asking price.

I know negotiation is supposed to be a process of give and take but I’ve put a lot of work into the property and I genuinely believe it’s worth what I’m asking. I don’t see why I should accept something far lower. Can you give me any tips?

I’m going to be quite direct: even if you’ve put a substantial amount of your own money into a property, there can be a big difference between what you believe the property is worth, and its true market value.

When you’re deciding on an asking price, it’s essential to put aside your attachment to the property and look at what the market might be prepared to pay. To do this, spend time researching recent sale prices (the past six months) achieved by properties in the immediately surrounding streets and suburbs.

To be really useful, these “comparables” should also be of a similar size (land size and number of bedrooms), architectural style (period/contemporary) and level of renovation (full/partial/unrenovated).

If, after doing this research, you still believe your price is realistic, look at other factors that may be at play. For example, is the property in an area where you’re competing with a lot of other vendors?

If so, it may be a case of waiting until more buyers come looking in the area and demand increases. Alternatively, if you’re keen to sell soon, you may have to lower the asking price to meet what the current market is prepared to pay.

PROPERTY INVESTMENT 101

I’d like to buy my first investment property. I’ve heard that now is a good time to buy but I’m pretty much a novice. In particular, what are the advantages of paying interest-only, compared with principal and interest? Also, what other costs can I expect besides the deposit and loan repayments? Are they tax deductible?

Taking out an interest-only loan is generally the best way to go when you’re buying an investment property. The monthly repayments maximise your cash flow because they are lower than for principal and interest loans. This narrows the gap between your repayments and your rental income; minimising your out-of-pocket holding costs.

Investment properties have a range of purchasing and holding costs. First, there’s stamp duty on the value of the property, which is payable on settlement. This varies from state to state but can be quite substantial, so check with your bank or solicitor about the amount that will apply in your case.

Once you’ve purchased, we recommend engaging a professional property manager to find and screen tenants, collect the rent, look after the day-to-day running of the property, and look after your interests in the event of any disputes. They will charge an initial letting fee, advertising costs and an ongoing management fee which is negotiable but generally about 7% of the rental amount.

If you’re buying a unit that’s part of a body corporate, you’ll have to make regular payments to cover the manager’s fees, building insurance, maintenance and repairs. You may also have to pay occasional levies to fund major works, so it’s wise to keep some cash in reserve for these unexpected expenses.

It’s highly advisable to take out landlord protection insurance to cover you for events including rent and malicious damage to contents.

Generally speaking, all these expenses should be tax deductible, however, speak with your accountant to check what applies in your case.

MORTGAGE INSURANCE

I’m looking various home loans and I need to borrow more than 80% of the property’s value, so I have to pay mortgage insurance. A couple of lenders say I can “capitalise” the mortgage insurance on to the loan amount. I’m not sure exactly what this involves. Can you enlighten me?

Anyone borrowing more than 80% of a property’s purchase price has to pay a mortgage insurance premium. This protects the lender '” not you, the borrower '” in the event that you are unable to make your loan repayments.

“Capitalising” means borrowing a certain amount above 80%, and borrowing the mortgage insurance premium on top of your loan amount.

The vast majority of lenders will cap your borrowings at 95% of the purchase price plus mortgage insurance, meaning you’re effectively borrowing 97%. They set this limit because the insurance premium can sometimes be more than 2% of the purchase price.

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

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