Waterfront warning

Smack in the middle of Australia's biggest prestige apartment precinct, a new low-income housing project at Melbourne Docklands is set to unleash a change in dynamics that could quickly skewer a recovering rental market.

Victoria's Bracks Government has bankrolled a new Lend Lease apartment project that will subsidise lower income earners; the project will allow tenants in the new Docklands building to pay 75% of market rates.

What's going on? When the supply of rental accommodation dried up between 1985 and 1987 as a result of the Hawke Government quarantining negative gearing, rents skyrocketed by 37% across Australia and by a massive 57% in Sydney, according to the Real Estate Institute of Australia. There was public outcry over the lack of affordable, low-cost housing; there was no way to bridge the gap and the legislation was repealed.

Now rental accommodation is rapidly becoming expensive again and governments are once again tinkering with the market.

The background to the Bracks experiment is the rental accommodation crisis that is gathering pace across Australia '” a crisis that could be exacerbated by the Australian Taxation Office.

The ATO is threatening much tighter scrutiny of landlords’ claims about income and losses. Such crackdowns are often a precursor to yet another sabre-rattling round of “should we tighten the generous negative gearing provisions?”

It is appropriate for the tax watchdog to jump on dishonesty, but any hint of the Federal Government significantly diluting negative gearing provisions should be viewed with alarm '” not only by unscrupulous taxpayers, but by the wider community because of the huge impact it would have on the availability of affordable accommodation which is already stretched, as the Bracks experiment confirms.

There is a pervading but false assumption that property ownership and negative gearing are the preserve of the wealthy. This is not true. The very reason we have a viable residential investment property market is because long-range ABS data shows that about 30% of the population rents. The majority of both investors and tenants have modest incomes. According to the Real Estate Institute of Australia, nearly 1.5 million individual taxpayers receive income from rental properties. Of those, the vast majority '” 87% '” earn less than $80,000 a year. The basic entry level for a residential investment property is $250,000–350,000: still a significant outlay. Therefore, together with the rental income, it is the negative gearing provisions that allow individuals on this level of income to borrow what is a relatively large sum and provide the vast majority of rental accommodation.

In the current rental cycle, we are seeing very low vacancy levels in many parts of the nation and rents are finally firming for the first time in almost five years. Because of the perceived lower capital growth and low yields since late 2002, many investors have been sitting on their hands waiting for the proverbial bell to ring to herald the return of better yields. As the rental cycle now begins to turn, investors are trickling back into the market.

But is this fragile recovery about to be thwarted? Any set of factors that produce a significant imbalance between the demand for rental accommodation and the availability and cost of renting is destined to affect investors and tenants, irrespective of the underlying reason.

It has been clear for some years that governments do not have the budgetary capacity to fund the provision of large amounts of public housing. At Docklands, Lend Lease Corporation is to build a $75 million apartment complex at Victoria Harbour. A third of the building is to be set aside for low-income earners. The company described the move as “a down-payment” on a commitment to provide greater housing diversity when it first won the right to develop Victoria Harbour.

State Housing Minister Candy Broad foreshadowed an examination of planning systems for “options to increase the proportion of affordable housing in new residential projects”. A low income housing association, Melbourne Affordable Housing (MAH), has been created to own and manage the low-income apartments in the Lend Lease project. In this instance, 67 apartments will be rented at 75% of the market rate. The MAH is being funded through a combination of state government backing, commercial bank finance and GST rebates. The MAH will also be permitted to sell some of the apartments after three years to pay off debt.

But it's worth noting that this experiment is occurring at a time when there are still relatively high vacancy rates in a number of existing CBD high-rise apartment blocks. Could we expect to see some of these buildings being reassigned for public housing? If we also came face to face with a major dilution of negative gearing provisions, even though investors’ tax advantages would be compensated for by high rental income, this would escalate the need to provide more subsidised rental accommodation.

The implications for investors are very simple. As firming yields stimulate investor demand in the wider market and prime residential precincts, developers may seize the opportunity to reassign existing vacant high-rise units or build more. We could easily see this new wave of apartments marketed to investors based on tax incentives and guaranteed rental income. The unwary investor who predicates their strategy on these peripheral issues rather than the fundamentals of capital growth through astute asset selection '” scarcity value of both location and style of building '” will come undone. Again.

This week I have selected the following questions from subscribers.

Melbourne move

We are looking to invest in a rental property in Melbourne and want both consistent rental income and strong growth. Being from interstate, we are not very familiar with the Melbourne market in respect to areas and how property prices differ. We would prefer to get something within seven to 12 kilometres of the CBD. Would a house have stronger and more consistent capital growth compared to the purchase of two units instead, or even two terrace houses? Which of the options are likely to give me more consistent rental? Where can I find information regarding this?

Your investment choices will depend on your total purchasing capacity. If it is between $250,000 and $650,000, then one top-notch property '” an optimally located house '” is the better option. If you will be investing more than $650,000, then you could consider two apartments. Either option will give you good market rental and strong growth, as long as you get the asset selection absolutely right. There is no substitute for detailed on-the-ground knowledge of any property market. Simply looking for a list of preferred areas for investment could be a very costly mistake. Choosing the right suburb or precinct is one thing; choosing the wrong architectural style, or a house or apartment in a poor position or in the wrong street is a common and serious mistake. Even the best areas have poorly performing pockets.

Not only do you need detailed knowledge of location, architectural style, scarcity value and supply and demand, but you must also have a current and working knowledge of values. Investing is part science and part art, so I strongly urge you to make the optimal use of the money you have to invest by seeking advice from a qualified, independent property adviser who can provide unbiased advice specific to your needs.

Empty investment

Is vacant land a good investment? I don’t feel I could afford to buy a house or unit, but there seems to be a shortage of building blocks.

In most cases, vacant land is not a good investment. There is little or no vacant land in prime inner urban areas and if there is it is usually too expensive. Land in outer-suburban or rural areas may be more plentiful but there is generally insufficient demand relative to supply to generate the required level of capital growth. Vacant land does not generate rental income or attract income-related tax concessions. You would have to meet costs such as municipal rates, loan repayments and any maintenance required entirely out of your own funds.

Spread your bets

We are considering buying two or three investment properties '” probably units '” in Sydney. We feel it would be a safe bet to buy them in the same block or the same neighbourhood. Would this increase our chances of selecting the right assets?

Don’t fall into the trap of having too much of a good thing. It is vital to choose properties in prime locations with timeless architectural style. However, resist the urge to stick to just one location or property type. Sydney has a variety of property styles and not all of them grow in value at the same time or at the same rate in any property cycle. Spread your risk by diversifying your property holdings with a range of styles, prices and locations. This ensures your investments benefit from seasonal and cyclical variations in capital growth and rental supply and demand. It also minimises the risk of any unforeseen issues, such as new infrastructure or a rash of new apartments suddenly springing up in one area and adversely affecting values.

Out the back door

I have had an investment property for four years and although it has provided good rental return it has barely increased in value. If I take stamp duty and other costs into account from the time I bought it, I have really gone backwards. I know you talk a lot about property being a long-term investment, but I am really at the point of selling this one and doing a lot more homework before buying the next one.

You don’t tell me where or what your property is. However, if you have held the property for that period of time and it has not shown any capital growth above the prevailing inflation rate, then work through the reasons why this might be. If the location is normally a good performer, then your property may be atypical of properties in the area, in the wrong street, or lacking scarcity value for some other reason. You say it has provided good rental return: was it a relatively cheap property in a second-rate location that was purchased for its rental potential and tax benefits rather than capital growth? Once you have looked at the reasons for low capital growth, decide whether this poor performance is likely to continue for the foreseeable future. If the answer is yes and you decide to sell, then don’t delay. The gap between the value of a non-performing asset and values in prime investment areas will grow ever larger. Simply persevering could diminish your ability to get back on track and buy a really good asset.

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