Time for a Spring clean

Reviewing your property portfolio regularly will help uncover the weak performers.

PORTFOLIO POINT: Reviewing your property portfolio on a regular basis will help you keep on top of the performance numbers.

Spring is traditionally the time for the new broom; when we sweep out the detritus of winter and fling open the doors and windows on a fresh start.

So it’s an opportune time to take a long, hard look at the standing of one’s investment property portfolio, identify weaknesses and prime oneself to take action if necessary to rectify any shortcomings.

There are two main challenges in this process for most property investors. The first is access to the tools to undertake a meaningful analysis of their portfolio. The second relates to fundamental human failings – inertia and the unwillingness to acknowledge and correct our past errors.

Despite niggling suspicions that something isn’t quite right with the performance of one or more of their properties, investors often refuse to acknowledge and/or address a problem that has possibly cost them tens of thousands of dollars already and may go on to cost hundreds of thousands of dollars unless acted upon.

To illustrate the challenge more deeply and to provide a roadmap to solving them, let’s look at a hypothetical investor who owns their own home and three investment properties.

Our investor has not let the grass grow under their feet over the last 20 years, as you can see from table 1. They purchased their first property in 1995 in the leafy Melbourne eastern suburb of Hawthorn. Using the amassed equity in the home and in subsequent investment properties, the investor then bought houses in well regarded inner suburbs in Brisbane, Melbourne and Sydney.

Table 1

On paper, all three investment properties seem promising. In each instance the investor has chosen classical architecture styles and a level of accommodation – two bedrooms – that is in high demand by the pool of renters. They’ve also chosen areas where supply is scarce, is proximate to the CBD and blessed with a high degree of amenity – so future resale prospects are strong.

However, one of these properties is an under-performer, but this is only possible to detect through further fact finding and analysis.

Step one: ascertain current capital value

Step one requires establishing the present capital values of these properties. The best way to do this is to identify comparable properties that have sold in recent weeks or months. When the market is buoyant and turnover is high, this can be a relatively straightforward affair. But it becomes more difficult if sales volumes are low in the target vicinity, and may require you to cast your net over a longer timeframe and wider area. It is also possible to purchase this information from data providers. Be careful to try and compare like with like, or to adjust valuations for differences in characteristics between your property and a comparable one. Admittedly, whilst this is adjustment process is routine stuff to a valuer or a property investment advisor, it is easier said than done for the lay person.

Step two: Assess capital growth achieved and rental yield

Once you have settled on a current value, you can calculate the annualised capital growth and rental yield – there are a number of simple calculators on the web for this purpose. The benchmark for an investment grade property is long-term annualised growth of 7% or more a year and a gross rental yield of between 3.5 and 4.5% (note that the optimal range for rental yield varies a little between capital cities).

After undertaking their calculations (see table 2), our hypothetical investor is pleased to see that the Brisbane investment property has met this benchmark. Unfortunately, neither the Flemington or Glebe properties have met the benchmark for capital growth, and the Flemington property is also showing a suspiciously high rental yield that is well in excess of the target band.

Table 2

Step three: assess other assets and non-rental income

A review of your overall financial resources will help you decide if you are in a position to invest again, whether it is another property or something from a different asset class.

Step four: review your loan structure

Speak to your lender or mortgage broker to establish if your loan structure is working effectively for you. This is not just about securing a lower interest rate – although that is a very worthwhile part of the assessment. It’s also about fees and charges, structure and flexibility. You may find that you want to consider whether the loan should be fixed or variable and whether it has sufficient other features such as an offset account.

Step five: reassess the performance of your property manager

It’s important to review the performance of your property manager from time to time and to discuss with them matters such as the current level of rent and whether the return might be enhanced by cosmetic improvements to the property. Consider whether you have had any concerns about how the property has been managed and ask the property manager to address these issues.

Step six: review your insurances

It is vital that you have insurances such as buildings, contents, public liability and landlord protection insurance in place and it may be wise to have an income protection policy as well. These insurances may need to be adjusted from time to time to take account of changes in circumstances such as the building’s value or your income.

Step seven: review your tax benefits

Check with your accountant that you are taking full advantage of gearing provisions and that you are claiming appropriately for depreciable items and holding and maintenance costs.

Sell or hold?

So what should our investor do next? Clearly, the Brisbane property is performing to expectations. The Sydney property meets the rental yield benchmark but has averaged capital growth of just 4.8%. However, the property has only been owned for three-and-a-half year, during a period of variable capital growth right across the market, so this isn’t really a surprise. Generally, reviews of capital performance over short time frames should be informative, rather than directive.

The greater concern is the Flemington property bought in 2004. Its annual capital growth of 4.8% is the same as the Glebe property. But such a low rate of growth over eight years represents significant underperformance over a period that delivered a strong run for property in Melbourne – especially given Flemington is a highly sought after suburb. In this instance, a closer inspection reveals the cause. The property is located on a street which suffers from inconsistent architectural styles and the presence of some warehouses and a garage. The owner was hoping that the process of gentrification would see the industrial properties turned into residences, but this has not happened to date.

In light of its high rental yield and compromised location, it may well be the case that the Flemington property will continue to underperform top quality investment property, and its disposal may be the best course of action.

Although residential property investment is a relatively passive process once you’ve purchased the asset and chosen a property manager, there are a myriad of factors that can subsequently affect performance.

A regular portfolio review is a vital health check for all property investors, and a necessary discipline to attain the objective of financial independence.

Property Q&A

This week:

  • Should I sell my Canberra home on moving to Melbourne?
  • Is my Toowoomba property worth keeping?
  • Should I buy an investment property at Gracemere?
  • What are the best options on my Hoppers Crossing investment?

Should I sell my Canberra home on moving to Melbourne?

We are going to move to Melbourne and want to buy a home there. I have a house in Canberra with four bedrooms, rumpus and double garage worth $640,000 with no mortgage. I am not sure which one is the best approach: Option 1 is to sell the Canberra house and buy a house in Melbourne, or Option 2 is to rent out the Canberra house. We could refinance and redraw 85% of the value of the Canberra property to buy a house in Melbourne.

Is this a permanent move to Melbourne? If not or if you’re unsure, it may be best to rent in Melbourne to begin with and hold off selling the Canberra residence. If you’re unfamiliar with Melbourne this period also gives you a chance to assess close up which suburbs most appeal to you before you buy.

Turning to whether you should rent out the Canberra property in the longer term if Melbourne is to be permanent; it may have been a good home to you but does it objectively represent a good investment property? In light of your description of the house’s comparatively modest price for Canberra given the number of bedrooms, I suspect the property is quite far out from the heart of the city, which may stymie capital growth. You may want to ask an independent property advisor to assess the property.

There are also tax implications to consider. Check this with your accountant, but it is likely that the interest on any loan raised to buy a home in Melbourne will not be tax deductible. Further, you’ll have to pay tax on the rental income from Canberra and you’ll lose the capital gain tax free status on the Canberra property.

More fundamentally, although the Canberra property market has performed well in recent years, it remains a small city that is heavily dependent on one industry – the business of government. The long-term prospects for investment property are better in larger cities with a more diverse range of industry such as Sydney or Melbourne. Consequently, should you become a permanent Melbourne resident, my preference would be to sell the Canberra house, buy a home in Melbourne, possibly with a view to investing in a large city down the track.

Is my Toowoomba property worth keeping?

My family is considering moving from Toowoomba to Brisbane. We currently own a house in Toowoomba which would make an attractive rental property as it is in a good location and is low maintenance. I understand the rental vacancy rate in Toowoomba is consistently quite low and is predicted to remain this way in the future due to gas and mining development in the nearby Surat Basin. I am wondering whether to hold onto the Toowoomba property as a rental (thus avoiding costs of disposal and purchase of another investment property), even though it does not meet your usual investment criteria (i.e. it’s not in a capital city). We would look to also buy a house in Brisbane, which would meet the investment criteria as much as possible, although its primary purpose would be as a family home.

This is a similar situation to the first question in terms of the potential taxation drawbacks around changing your principal place of residence, but once again please consult your accountant to check your circumstances.

Putting taxation issues to one side, I would be wary of maintaining ownership of a property in Toowoomba for investment purposes after you moved to Brisbane. As we have seen from the news in recent weeks, mining booms don’t go on forever, and when they do end, those regions that are heavily reliant on this sector are affected disproportionately.

Should I buy an investment property at Gracemere?

I would love to know your thoughts on buying an investment property at Gracemere, Queensland, about 8 kilometres out of Rockhampton. The property is selling for around $375,000 with a weekly rent of $600. I've been told that property values will increase by 18% over the next couple of years.

My advice would be to be very sceptical about any claims made about the likelihood of capital growth for this property, especially those made by the vendor’s agent, a developer or anyone who stands to benefit from the sale!

The property has a gross rental yield of over 8%, which tells me this is a high-income, low capital growth property, consistent with there being little or no scarcity value to this asset.

Whilst the high yield may be tempting, don’t be beguiled by it. Once you factor in holding costs (interest payments, management and maintenance costs) the net return will be modest – especially as you can’t anticipate much in the way of capital growth, the real driver of wealth creation in property investment. Furthermore, high-yield properties tend to require owners to spend significant sums of money on renovation every few years in order to maintain the property to a standard that justifies the rental level.

I recommend that you take your investment budget and consider buying an older-style unit in a key, established market, say, in an inner suburb of Brisbane.

What are the best options on my Hoppers Crossing investment?

I own an investment property in Hoppers Crossing, Victoria on an 800m2 block. It’s brick veneer, with three bedrooms plus a study. Should I strata title into two blocks, sell the backyard off, or use equity to buy another property? Property is walking distance to the Plaza, trains, schools, parks, etc.

Hoppers Crossing is around 20 kilometres south-west of Melbourne, along the Princes Highway to Geelong. In recent years this region has seen substantial population growth. I understand that you may see an opportunity to take advantage of this population growth, but also be mindful that you are also competing with a large pipeline of housing development, so capital growth may be muted.

Your more adventurous options – subdividing and building or selling off land – takes you into the realm of property development, which can be a very profitable exercise but usually requires significant time and money to get right and is not without risk. It is also crucial that professional advice is sought from your accountant, an independent property advisor and architect throughout the process. A feasibility study must be undertaken to establish the costs and potential added value of each option. I also suggest that you consider two other scenarios: one, leveraging the equity in the property to buy another investment property; and two, selling this property and buying another property. In each case the aim would be to invest closer into Melbourne in order to benefit from the higher propensity for capital growth.

It may turn out that the rewards for development do not justify the effort and risk and that a more passive approach involving buying elsewhere is the way to go.

Monique Sasson Wakelin is a co-founder and director of Wakelin Property Advisory, an independent firm specialising in acquiring residential property for investors. Monique can be found on Twitter: @WakelinProperty.

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

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