The case for residential

There has been some negative comment about investing in residential property in recent weeks. It peaked with an interview we published last week with Simon Ibbotsen of Standard & Poor’s. The interview between Ibbotsen and Michael Pascoe was widely read and though Ibbotsen argued his case as a director of asset allocation at S&P, he ignored some of the more important issues, which will always draw retail investors to residential property.

I have received several letters from subscribers who are concerned about the points Ibbotsen raised – specifically that residential yields on property are so weak they do not justify investment in this area, particularly when compared with the strong yields of the sharemarket.

Today's lead letter is a good example of the type of correspondence I have received and my answer, I hope, will serve as a general response to Ibbotsen or any other critic of residential property investment.

Residential as an investment

I keep reading reports of low returns on investment properties and how they’re not very good investments. However, as low-medium income earners, my husband and I like the concept of someone else paying for our retirement; that is, the tenants pay most of the mortgage via rent and we only have to top it up and pay expenses. The negative gearing gives us the opportunity to direct funds into the next investment. Our aim is to own a number of investment properties by the time we retire, to generate income or roll into something else. I don’t know of any other way where someone else pays for your investments.

Your line of thinking on the subject is why so many people on your income level opt for investment property as a means of building future wealth. However, the key issue to bear in mind is that residential investment property is a growth strategy and not a yield-driven asset class. It’s the growth that underpins the income stream that helps pay for the investment.

The first consideration in achieving your desired outcome is to get your asset selection right rather than concentrating solely on rental yields. With a properly located, high-growth asset, the demand as a rental property will essentially take care of the rental yield. Even a good quality one-bedroom apartment in the right location will enjoy high demand.

The rental income will contribute considerably towards your holding costs, and the negative gearing benefits will also provide an important contribution in this regard. What you need to concentrate on is the long-term capital growth and the build-up of equity. It is the equity build-up that provides the leverage for you to buy subsequent investment properties. When you are nearing retirement, you will have a number of options.

You can use the income from investment properties to replace a wage or salary, choose to sell one property to settle any debt on the others or even live in it yourself if you wish to. If you have any concerns, seek some independent investment property advice so you know what you can buy for the money you have available and what the best strategy will be for your future financial independence.

This week I also deal with:

· Retirement villages
· Allowing investment property transfers to a SMSF
· Staying away from main roads

Retirement villages

As someone starting a property portfolio, are retirement villages a viable option to be looked at for capital growth? I understand rental yield and return on investment is reasonably higher than your standard residential property. However, I am not sure of the longer-term growth and return from this segment of the market.

The retirement village market is a complex one. Check very carefully on what basis you would be buying in to any retirement facility because the way they are managed varies considerably. Some are strata titled, which means you could own a unit with its own title and then rent it out. However, there is likely to be a management fee. Others are not strata titled, so you would be reliant on the operator of the village to ensure the unit was occupied and, again, there would be a management fee associated with this.

The more likely scenario with these villages is that an individual pays to enter the village and the overall management fee is then deferred until they either move out or are deceased and the fee is then taken from the estate. Given the terms and conditions that normally apply to such properties, it has been our experience that they do not show good capital growth. Issues such as the ability to increase the rental level also need to be taken into account. Also, they are not the kinds of investments that deliver optimal performance because of the limited options for rental and resale. The locations and often the building styles are not suited to growth and there is little scarcity value. You also have very little control over the asset.

Transfers to SMSFs

Has there been any comment from Government regarding a change of attitude to the issue of allowing for the in specie transfer of residential investment property to self-managed superannuation funds (SMSFs)?

Unfortunately not. But, I fully intend to keep calling for this to happen. One of the arguments against in specie transfers of residential investment property into an SMSF has been that it would provide great potential for “rorts”, such as holiday homes being placed in funds. However, there are already clear tax rulings on what constitutes a genuine investment property that could be applied in such cases.

If the Federal Government thinks the issue of residential property transfers will go away on June 30 – the deadline for the $1 million super top-up – then it should think again! There are other provisions that allow for ongoing substantial transfers of cash in any given three-year period after that date.

Main roads

Is a property on a main road, but in the right inner-urban area, likely to make a good investment? The property we are looking at is not on an extra busy road, but it is a thoroughfare and it seems to be used a lot by people getting to the nearby shopping area. I’m not exactly sure what constitutes a road or street that is too busy.

You may notice that properties on main, or constantly busy roads have a lower price tag than those in the quieter side streets. Those on main or even thoroughfare type roads don’t offer the same level of quiet, safety and general quality of life. Another important issue is parking. If a property on a busy road doesn’t have off-street parking, then it can be a major turn-off for tenants or future prospective buyers. Properties located in these areas, as a general rule, don’t show as quick or consistent a growth rate as their quieter neighbours.

Carry out your own observations in regard to traffic levels. For instance, the property may be on a commuter route that means constant, daily traffic flow with little let-up at weekends as people access a nearby shopping precinct. Properties located near busy restaurant or shopping strips can also present a parking nightmare, particularly at weekends.

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.

Monique Wakelin is co-founder of Wakelin Property Advisory, www.wakelin.com.au, a Melbourne-based independent property acquisition and advisory company, and co-author of Streets Ahead: How to Make Money from Residential Property.

Do you have a property question for Monique Wakelin? Send an email to monique@eurekareport.com.au