Uptown investing

A spate of office conversions mean more people are calling the inner-city home. But do they make good investments?

PORTFOLIO POINT: The increasing supply of inner-city apartments, including office conversions, may be tempting for investors. But the usual rules still apply.

Is the term central business district becoming a misnomer? With the reinvigoration of our city centres and the steady rise of CBD residential properties, they are becoming less the predominant preserve of office space.

Perhaps the most high-profile incarnation of this trend is the current array of planned reassignments and replacements for residential purposes of former office buildings in Sydney’s Circular Quay precinct. For instance, Gold Fields House in Alfred Street is being converted to luxury apartments, while the Sir Stamford Hotel and Amatil Building, both on Macquarie Street, are scheduled to be replaced by apartment towers.

Nerida Conisbee, national director of research at Colliers International, believes Sydney’s residential market fundamentals support this trend. “Buildings with views to the Harbour have global appeal. People want to live in the Sydney CBD and there’s not much supply with these views, so that’s fuelling demand for conversions. In the case of Gold Fields House, its location and views will garner huge apartment prices,” she said.

I asked whether Sydney’s relatively high office vacancy rate – 9.6% compared to 7.9% nationally, according to last week’s Property Council of Australia’s Office Market Report – was also a factor in the push for reassignments from commercial to residential by owners.

“Sydney’s high office vacancy rate is a short term-problem. It may go up a little bit more this year but it’s not catastrophic,” she said. “Once the global economy picks up, which it should do in the next 12 to 24 months, we’ll see improved rates of office utilisation in that city. In fact, there is a danger that once Sydney picks up, there will be a shortage of office space as, apart from the Barangaroo development to the west of Circular Quay, the Sydney CBD doesn’t have a lot of development options.”

I must say that while I certainly agree that there is a supply shortage of luxury apartments with uncompromised views in Sydney’s CBD, and increasing numbers of people want to live and work in Sydney, I’m less confident than Nerida that the global economy will pick up in this timeframe given the severe challenges in Europe and the US, so Sydney’s office market may have to wait longer for its boost.

More generally, Nerida cites a push by governments to regenerate city centres as a driver of CBD living. “Effectively, local government in all our capital cities have policies in place to get people living in our cities because it revitalises the area, provides the ability to have a night-time economy, and it is a good use of otherwise obsolete buildings, especially if they are well located.” This is quite correct and upgrading and consolidation of good infrastructure is a key indicator of governments enacting this agenda.

She points to the City of Melbourne Postcode 3000 project in the 1990s and the Victorian government’s Melbourne 2030 planning strategies as early and successful examples of government interventions that have reversed the hollowing out of our cities and increased the tax base.

“This push has had a huge impact on the vibrancy of the Melbourne CBD. If you look at Melbourne of say 20 years ago, the town cleared out after 5pm and you had a dead city. At the weekend you would have had some people coming into the city for shopping. But now, Melbourne at 10pm is still vibrant and at weekends it is busy.”

I asked Nerida for her thoughts about the qualities investors should look for when considering purchasing an apartment in a reassigned building. She quite correctly cites that ultimately, it comes down to the location. “

For example, Gold Fields House’s views are pretty unbeatable and it is very difficult to find those sorts of assets anywhere else,” she said. “Being close to all the amenities is also vital. Some of the more popular buildings are adjacent or close to the retail end of the CBD, where the bulk of cafes, bars and restaurants are. Many buildings also have historical features that are very attractive to investors.”

I would add that ensuring that any existing spectacular views cannot be built out is also vital. This makes the selection process somewhat more complicated.

For all the upbeat vibe around CBD revitalisation, not all office-to-residential reassignments are successful, due to the lack of sufficient surrounding lifestyle amenities. “There was an example of this in the mid-1990s at the former Melbourne stock exchange building at 357 Collins Street,” says Nerida. “The then developer, MaxiCity, planned to do a residential conversion but the building was situated in core office territory and consequently they couldn’t get the project off the ground. It’s now being refurbished as offices by Australand.”

A nascent trend aimed at maximising the return in high land-value cities such as Hong Kong is multi-use buildings. They contain retail at ground level, offices in the middle floors, with the upper floors dedicated to quality apartments and penthouses. We may find this trend is reflected in future re-assignments in cities such as Sydney and Melbourne.

There are a number of existing reassigned buildings that are highly coveted and tightly held. In Melbourne, good examples of reassignments include the old BP building on St Kilda Road, now called the Domain; and Panorama – a former post office – in Carlton. In Sydney, exceptional developments such as Gold Fields House at Circular Quay will also probably do well.

Don’t let a handful of success stories compromise your sound investment radar, however. Most residential investment opportunities in our CBDs do not exhibit the required qualities for success. Rather, most high-rise apartments are in unremarkable buildings with compromised views either now or in the future, containing small one or two-bedroom cookie cutter apartments, and often with poor finishes and a lack of acoustic privacy. These apartments have no scarcity value and consequently struggle to record capital growth in the secondary market.

Over coming decades our CBDs will inevitably be called home by many more thousands of people – and that’s a good thing. But – with the exception of a few buildings – most will remain residential investment no-go areas.

Property Q&A

This week:

  • I’m thinking of investing in Brisbane.
  • Burleigh Heads’ prospects.
  • One investment property or two?
  • Where to buy in Adelaide?

Brisbane investment

I’m considering buying an investment property in Brisbane. I am interested in how far out I should go and whether I go north or south. Originally from Melbourne, I feel that the affordability in Brisbane is outstanding as far as distance from the city and would like to buy a property with, say, 500 square metres of land so I can consider dual occupancy or development in five to 10 years. I am considering an 8 kilometre radius. There is a divide here in Brisbane about north vs south as far as growth and liveability. What do you make of this and how far out of the city is good value for growth?

Meighan Hetherington at Property Pursuit in Brisbane says there is no clear-cut divide between north and south Brisbane in terms of liveability and capital growth and I agree. Rather, liveability is determined by access to amenities such as transport routes and proximity to schools, shops, parks and healthcare.

Tread carefully when considering buying a property that you might redevelop in five to 10 years. First, investing to redevelop is not for the faint-hearted: getting it right requires superb timing, substantial effort, cash flow, independent advice and planning. Second, are you confident you will still want to undertake a development in five to 10 years? It is possible that you will change your plans in the interim.

It may be better to buy something that is optimal for your needs today rather than speculate on what might be right on such a long time horizon. It is likely you may need to pay a premium to buy the sort of property you are looking for as a range of state and Brisbane City planning restrictions rules and overlays restrict you and other competing budding developers to a relative small pool of properties.

In light of current high building costs and the stable property market, it may be difficult to make a commercial return on your investment, given you’ll need to factor in a 20% plus margin to make the project worthwhile.

In terms of locations, up to about 10 kilometres from the Brisbane CBD is about the limit for investing.

Burleigh Heads

My wife and I have owned and rented out an investment property high on Burleigh Heads for the past 10 years. The ageing house on this land has ocean and inland "views to die for”. It is the worst house in the street but it has performed remarkably well. Is this the exception to your reasoning about investing close to the centre of our major cities? Surely, when the land itself is so scarce (there are few hills beside the ocean at the Gold Coast) then it is an investment that should be held long term. Despite the Brisbane establishment’s belief that all things good happen in "the river city", the freeway traffic tells a different tale as does the growth of the Gold Coast Airport, the extension of the rail line to Robina, etc. I would be interested in your views of this area and its relationship to the Brisbane property market.

I’m delighted that your investment has been so successful. It is likely that your exceptional views and Burleigh Heads location has served you well to date and underpinned your capital growth. The question is whether you can expect similar growth in the future.

The Gold Coast property market has fallen by double-digit percentages in 2011 and residential sales are down around 60% since the 2007 peak. The market has struggled because the Gold Coast is reeling from the impact of the strong dollar on in-bound and domestic tourism, 10% unemployment, and a 22% office vacancy rate according to last week’s Property Council of Australia’s Office Market Report.

Despite some of the welcome infrastructure being built in the Gold Coast, I believe it may take several years for the area to recover from its excess supply of property and to adapt economically to a high-dollar world. In such an environment, even quality property like yours may do well just to maintain its value.

At the risk of sounding like the Brisbane establishment, the prospects for the Queensland’s capital city are far more robust than that of the Gold Coast given its deeper and more diverse economic base.

One or two?

I have an investment property in Burnley, Melbourne and am looking to invest in another property in the inner suburbs. My budget is around $750,000-800,000. I have been approached by people from a development company who suggest it’s better to invest in two $400,000 properties rather than one $800,000. However, the properties they are proposing are 20-25 kilometres from the Melbourne CBD, at Greenvale Lakes. The numbers they have put together assume 8% annual capital gain over 10 years, which obviously makes their proposition sound good. I know this is not a correct comparison, as I believe capital gain in inner Melbourne suburbs would be higher than outer suburbs. Do you agree?

You are certainly asking the right questions in terms of determining the relative merits of a new property in an outer suburb versus buying something in an inner suburb, and I sense a healthy scepticism on your part about the developer’s offer. You are right to be wary.

Armed with a spreadsheet and generous assumptions, it is very easy to come up with attractive projections for capital growth. It would be wise to challenge the developer on what those assumptions are and his track record on previous developments such as growth in capital values over seven to 10 years.

According to Australian Property Monitors, Greenvale recorded capital growth of 6.8% pa over the past 10 years. That might sound reasonably attractive, but be aware that the data is likely to be misleading. As a suburb that has seen many new developments in recent years, the composition of housing stock has changed significantly. The houses sold in 2011 were, on average, much larger, better-equipped and therefore more expensive than those sold in 2001.

This phenomenon of new development sales at prices well above the established housing stock can skew the median values of a suburb upwards as it only considers properties sold, not the whole housing stock. Frankly, I doubt one will see such levels of capital return that far from Melbourne’s centre consistently over the next 10 years and I am confident that inner city suburb growth levels will exceed that of Greenvale Lakes.

I question the advice of buying two $400,000 properties. While buying two lower-priced properties rather than one more expensive one can provide diversity, there is too much unnecessary compromise at the $400,000 level. You will be better using your full capacity to buy one gem. I suspect the developer is serving his own needs by promoting diversity at the expense of quality in this instance. More generally, the advice you are being provided is clearly not impartial. You are being “sold” a product, so be aware of this important factor.

Adelaide

You cite inner-city two-bedroom houses in Adelaide as a reasonable investment prospect. Are there any suburbs in particular you would recommend in the current market?

As a relatively small capital city with finite demand, the investment-grade zone in Adelaide is limited. The most compelling investment prospects are to be found in an arc stretching from just beyond the CBD and the parklands to about six kilometres out on the south and east and three kilometres out on the northwest side. Investors should focus their search in areas such as Unley, Goodwood, Maylands, North Adelaide and Thebarton and certainly avoid new developments in areas such as Port Adelaide.

Monique Sasson Wakelin is managing 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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