Watch out for postcode blind alleys

The property market is turning … but don’t take the raw data on face value.

PORTFOLIO POINT: There’s a lot more to the property market than the information from commercial data providers suggests. Don’t be led down a residential blind alley.

Following the 25 basis point cash rate cut earlier this month by the Reserve Bank, there’s a definite spring in the step of real estate practitioners.

Their relief is understandable; it’s been two years of hard slog for most of them, as they sought to win business and sell property into a declining market with few interested buyers.

I believe that their renewed optimism may actually be justified.  Property prices are down around 10% across capital cities from the March 2010 peak but are now stabilising and perhaps showing some initial, tentative growth in recent weeks. Rents remain firm and the cash rate has come down 150 basis points since November last year. Consequently the gap between the percentage return from property investment – the rental yield – versus the funding cost – interest rates – is narrowing.  If this trend continues, there will be a ‘tipping point’, when a critical mass of investors and prospective home buyers recognise the opportunity and demand picks up.

I sense that tipping point may be close. Whilst I usually shy away from making interest rate predictions, it’s increasingly clear that the Reserve Bank is signalling another rate cut before year’s end. Last week’s deteriorating employment numbers have probably settled the case for a 25 basis point cut on Melbourne Cup day and possibly another 25 basis point cut in December.

Now whilst these developments are undoubtedly good news for the property market, home buyers and investors must be on their guard.  There are many very hungry industry participants out there who are desperate to make up for barren times. In particular, developers will be marketing hard to unload off-the-plan stock in our fringe suburbs and CBD high-rise apartment sectors that have failed to sell, mostly because they’re either too far flung, they’re over-priced or both.

Those selling these questionable assets will be banking on lulling a new cohort of investors and home buyers who are unaware of the poor proposition they face.  They are also hoping that the optimism of a rising market will see people suspend their scepticism.

Unfortunately, the cause of buyers is not helped by an upsurge in commentary and reports that intentionally, or unwittingly, send the wrong message about where and what to invest in.

I have a great deal of respect and time for the commercial data providers, RP Data, Australian Property Monitors and SQM Research amongst others.  But, very occasionally, they do release some curious information. For instance, take the report released in late August by RP Data that listed the suburbs where paying off a mortgage was cheaper than renting. The story was a great success from a PR perspective – it received substantial exposure across the media.  But it was – to my mind – at best a pretty meaningless piece of analysis and, at worst, something that could lead buyers to make bad decisions.  In essence, the report highlighted that it was occasionally cheaper to buy than rent in a number of regional areas and fringe suburbs.

Now RP Data did not provide a recommendation on whether these suburbs were a good place to buy for investment or lifestyle reasons; they simply let us have their data and findings. But, unsurprisingly, most of the media jumped to the most obvious conclusion, heralding these suburbs as places to buy because they were cheap. Arrgh! The real conclusion to draw should have been to avoid investing in these places. The locations were cheap and the rents high because there was no long-term buyer demand there.

Along a similar vein, SQM Research recently published its Housing Boom and Bust report, which flagged the top 20 fastest income growth suburbs as potential future hot spots. Now, this is an interesting theory, but that’s all it is. It’s encouraging investors to speculate on the next big thing rather than buy tried and tested assets.

Sadly, experience shows that suburbs with seemingly great potential invariably take far longer than expected to ‘take off’ in terms of accelerating capital growth, and investors would have been better of sticking with blue-chip locations. This inside knowledge is the difference between desktop research and day-to-day experience in the market itself.

But there are other factors aside from interest rate movements and empirical research that can easily confuse and destabilise investors at an early point in a cycle turn. We’ve recently had the Home Buyer & Property Investor Show in Melbourne, an event that winds across the country over the course of a year.  Whilst there are some speakers at these events who present very worthwhile speeches and whom I respect, there are others talking up so-called hotspots in middle and outer suburbs and even extolling the virtues of small regional towns as booming investment locations. The latter pepper their presentations with charts full of carefully selected and edited data that ostensibly demonstrate why Frankston or Blacktown is the next great investment opportunity.

The rise of the internet has seen a plethora of data and analyses available to property investors.  Used judiciously, this intelligence can be the property investor’s friend and will come in very useful for those wishing to capitalise on a market recovery that has been fuelled by the falling cash rate.

But we all need to be wily about the conclusions we draw, especially when the information in media, seminars and blogs supports vested interests. Today’s property investment landscape is much more about putting the pieces of the jigsaw together just right, rather than drawing conclusions from just one or two elements that are bound to steer you up a thousand blind alleys if they are taken at face value.

Property Q&A

This week:

  • What is the outlook on Sydney property and where should I invest?
  • Will Catalina dilute house prices in Mindarie?
  • What is wrong with positive gearing?
  • What is the investment potential of Freshwater?

What is the outlook on Sydney property and where should I invest?

I’m planning to buy an investment property in Sydney with a budget of $450,000-$500,000, preferably in the inner east. I would appreciate your advice on the suburbs I should start investing my time in researching and your view on Sydney’s property market in the next one to two years.

I’m quite optimistic about the prospects for the Sydney residential market in the next year or two. Indeed, Sydney is ahead of most other capital cities in the property cycle in that there is consistent evidence of reasonable price growth over the last three to six months.

A factor supporting further price growth in Sydney is the strong growth in rental prices, which are up 4% over the September quarter, according to Australian Property Monitors.

With a $450,000 to $500,000 budget you will need to focus on one bedroom apartments. In fact you’ll be challenged to find an investment grade apartment – one that sits in a small, established apartment block on a quiet residential street – for this sum of money in the eastern suburbs, but take a look at Rose Bay or Potts Point.

You’ll have more choice focusing on the inner west, in suburbs such as Newtown, Enmore, Camperdown and Dulwich Hill.

Be aware that notwithstanding your reference to one-to-two years, if you do invest, your holding period should be at least five-to-seven years and preferably seven-to-10 years.

Will Catalina dilute house prices in Mindarie?

We have been looking to buy a house in the northern Perth suburb of Mindarie, which has a population of around 6500.  Nearby there is a new sub-division being built called Catalina, which will supposedly cater for over 7,000 people when all stages are fully finished (which could take 10 years).  The block sizes will apparently be much smaller than those in Mindarie, and the location is inferior. But wouldn’t all the new land available dilute the prices of homes in the adjoining suburbs?  The local agents are all adamant that it will boost prices in Mindarie but their views have an obvious conflict of interest.

Yes, you’re correct; the placement of thousands of homes in Catalina will undoubtedly dilute demand for housing in Mindarie. But you will still see better performance in Mindarie than in Catalina if you are going for an older house with a greater land component in Mindarie versus an off-the-plan house on a smaller block in Catalina.

If you’re buying in Mindarie to set up a home and are drawn to it for its attractive lifestyle offerings, and you’re willing to accept lower capital growth because of the neighbouring development, then go ahead.

But if your main objective is investment, I would discourage you from investing in a location 35 kilometres from Perth’s CBD. Consider much closer-in areas such as Mount Lawley and Inglewood.

What is wrong with positive gearing?

Why is it not a good plan to be positively geared when significant borrowings are involved? I was hoping to buy an investment unit or apartment as close as possible to the Brisbane CBD for around $320 000, borrowing the whole amount.

Positive gearing – when a property with significant borrowings still delivers a positive cash flow after all expenses due to a high rental yield– sounds great, but it is indicative of a property with a low propensity for capital growth and low resale demand.  There is something inherently wrong with any property which can be purchased with zero or little equity that shows positive gearing from day one.

In contrast, a well-chosen capital growth oriented property will become cash flow positive as the debt is reduced and/or the rental income grows, but not usually until the amassed equity reaches around 40-50% of the property’s value. This is the desirable and only legitimate way to become positively geared!

One of the problems with high rental yield properties is that much of the attraction of the property to tenants is the fit-out of the accommodation – its features, finishes and facilities – which justifies a strong rent. Investors have to compensate for the property’s poor location by supplying superior accommodation. These features may look great when new, but they date and suffer wear and tear and need replacement – a high cost to the investor borne from their after-tax dollars.

Your budget of $320,000 is not quite sufficient to purchase a one-bedroom apartment in a small block that ticks all of the boxes of an investment grade property. Are you able to extend you budget to around $380,000, the threshold for entry level property in Brisbane at the moment?  If not, but you are willing to make some small compromises and accept a slightly lower level of capital growth, take a look at property in Gordon Park, Kedron, Lutwyche, Newmarket or Windsor.

What is the investment potential of Freshwater?

How do you regard the investment potential of a two-bedroom walk up 1970s unit with lock-up garage in Freshwater, Sydney? Freshwater is one beach north of Manly and is close to golf courses and large playing fields and parks. This unit is also close to buses to Manly and Warringah Mall and is serviced by a peak hour express bus service to the city.

From what you’ve told me, the property sounds like it has potential, or at least shouldn’t be ruled out.  It is in a desirable part of Sydney, situated in a small block and has off-street parking. But there are of course other questions to ask.  Is it on a quiet street? What is the outlook like? Does it have a logical and conventional floor plan? What is it worth, what capital growth has it achieved over the last 10 years and what will it rent for? What sort of property is next door, behind it and over the road?

So at face value, the property sounds good, but I strongly advise you to get a Sydney-based independent property investment advisor to assess the property before you proceed.


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