Question Mark

WHETHER TO SUBDIVIDE

Q: My partner and I have an investment property on a large block of land. We’re thinking of subdividing it and building a separate unit at the back, then selling it for a profit. What do you think of this as an investment strategy?

The effectiveness of subdividing as an investment comes down to the level of risk you’re prepared to take on. There are three key risks:

• Building costs. Is your construction budget realistic? More often than not, small-scale residential developments take longer than anticipated because it’s harder to find skilled labour. If a tradesperson has the choice of a small job or a much bigger one, they’re usually going to go where the most money is!
• Holding costs. You may lose rental income on the property at the front of the block while construction is going on, because relatively few tenants would be happy to stay there amongst the noise and dust. What’s more, most investors have to borrow significant funds to undertake residential developments. This means you could be paying interest on the property under construction but not receiving any rent to offset it. If you still have a mortgage over the property at the front of the block, you’re bleeding even more money. All of these factors will eat into your profit on selling, considerably reducing the effectiveness of the investment.
• Market value. Land size plays a role in determining what price your property will achieve when the time comes to sell. If you subdivide, the value of the property at the front of the block will be worth less than it was before, because it no longer has the full block of land.

I’m not saying that subdividing per se is a poor investment choice, but it’s essential to understand the risks.

LOW-DOC LOANS

Q: I’d like to buy an investment property for long-term security. I’ve been running my own business for 18 months and although things are going well, I’ve already been knocked back by one lender because I don’t have a long enough trading history. I’m not sure where to go from here.

Traditionally, owners of new businesses found it hard to get a traditional home loan because lenders saw them as too high a risk. However, an ever more competitive lending environment has led to development of 'low-doc’ loans. A 'low-doc’ loan may be particularly suited to you as a newly self-employed borrower because you don’t have to provide proof of income.

The onus is on you to be honest about the personal income you derive from the business. If you overstate your personal income and borrow more than you can afford to repay, the lender may be able to repossess the property.

To reduce their risk, lenders will generally only allow you to borrow up to 80% of the property’s value for a low-doc loan. You may also be charged a higher interest rate and higher fees than a lower risk borrower such as a PAYG earner.

When determining borrowing capacity, most lenders average out your past two years’ trading income. Most businesses tend to run at a loss in the first year because of start-up costs. In your situation, if you do not wish to have a low-doc loan , it may be a better option to wait until you can provide lenders with proof of a solid three years’ trading. You may then be able to apply for a conventional home loan at the same rates as your PAYG counterparts.

TIMING A PURCHASE

Q: I’d like to take the plunge and buy an investment property but I wonder whether it’s worth waiting until prices come down a bit more. The market seems to have been flat for a while '” do you think it’s reached the bottom?

With the exception of Perth, the market began to slow in most major capital cities in 2003. I believe the market has reached the bottom, but we still have a good 12 months to go until we see any upturn. This period provides a good opportunity to research properties in your desired area and price range, without feeling the pressure to buy.

The aim of buying residential investment property is to hold it for the long term, at least 7–10 years. If you buy while prices are still flat, you’ll reap the benefits of a full cycle of growth.

COMMERCIAL PROPERTY

Q: I’ve got quite a lot of equity in my home and I think the time has come to be more adventurous. I’m considering buying a small commercial property. What should I be on the lookout for?

Commercial property can make a great investment, provided that it’s primarily cashflow you’re after. Yields for commercial property are currently around 7 to 9 per cent, compared with around 3 to 5 per cent for residential property.

Just as the yields are higher, so are the risks. The value of commercial property is tied to its rental return. If the property isn’t tenanted, the value of the property may decrease.

Vacancy is also a major risk factor. It is preferable to buy a commercial property with a sound long-term lease. If you buy a vacant property, it may take much longer to lease than a residential property '” sometimes as long as 12 months '” simply because it has a more specialised use.

Long periods without rent can create cashflow if you’ve borrowed to fund the purchase of the asset.

You should also negotiate the lease so that tenant pays all outgoings such as Body Corporate fees and council rates.