What data drives property decisions?

Investors considering property should learn to look beyond short-term trends.

PORTFOLIO POINT: Confronted by a bewildering array of data, property investors need to look beyond the short term. Here’s how.

The release of benign inflation figures last week has restarted the media debate about whether we can expect another interest rate cut from the Reserve Bank. Unfortunately, we’ll have to endure this pantomime until next Tuesday but it won’t end there: any cut will be followed by an excruciating period in which the big four banks gauge public opinion, among other factors, to decide whether they’ll follow suit.

Clearly, the days the Reserve Bank board meets (the first Tuesday of every month except January) have become important for property investors. But there are other economic parameters influencing investors’ decisions.

The great challenge for investors is to determine what information is genuinely pertinent to forward-looking decision making and what can be screened out as noise. It is also critical that they determine how to interpret the data in the context of the property market.

For instance, a raft of international affordability reports are published each year comparing affordability in Australian cities against cities around the world. Many of these reports conclude that Australian cities are relatively expensive. As investors, we need to be very careful about accepting these conclusions at face value.

As I have previously written (see Dent-proof liveability), property will be expensive in desirable places that are relatively economically robust. If it is not, you’re usually in a place that is in trouble, especially these days. So even though it may be counter-intuitive, relatively low affordability in Australia tells us we are in good shape compared to the rest of the world. If Australia wasn’t supposedly “unaffordable” I’d be seriously worried.

Affordability aside, there are some indicators that are always important to watch: inflation, employment and GDP growth always matter. We know that high inflation leads to higher interest rates, which dampen demand for property because it’s more costly to fund. Strong GDP and employment growth underpin property prices unless they stray way out of the norms and trigger inflationary pressures. Currently, the status of these indicators – by and large – supports the property market: inflation is falling, GDP growth has been soft but is beginning to build and unemployment remains low.

The currency of other indicators rises and falls. Population growth is an interesting one. Many people assume population changes are relatively small and so have little impact on property market dynamics. Consider this: Western Australia’s population grew by 2.4% in the 12 months to September 2011, according to the ABS. That sort of large change is not unusual in a fast-growing country like Australia and this means it’s useful for investors to factor in the impact of population changes at a state level into their investment decisions. Useful questions to ask include whether the population increase is likely to be permanent or temporary, what the new residents are doing – are they working or retired?

As Australia’s population has grown, building approvals and building activity have become less meaningful signals of what to expect in the property market in the short term, in spite of their prominence in the media: new dwellings account for less that 0.5% of the stock in each year.

The vast majority of property transactions in Australia relate to the established housing stock, which has become progressively larger over time, so these building figures can only ever have a marginal impact on the broader market despite their message that there is a chronic shortage of housing. These indicators tend to be highlighted by the development industry, seeking government permission and support to build more houses on greenfield or infill sites.

Focusing on specific property markets brings a mind-boggling amount of data, including median prices, capital growth, sales volumes, auction clearance rates, days on market, rental prices, rental yields and vacancy rates, much of which comes from real estate institutes and commercial research organisations such as RP Data and Australian Property Monitors. One needs to be wary of placing too much emphasis on any one measure at the expense of others.

For instance, even at a metropolitan level there are substantially different values reported for the median dwelling price across the different suppliers, and monthly and quarterly growth rates can differ significantly. The small sample sizes for particular suburbs means the reliability of data can be quite problematic. Further, the fact that these data sets are retrospective and don’t necessarily reflect current conditions means that investors must balance their view of the market with their own research, such as attending auctions and property inspections.

More fundamentally, given property is a long-term investment, don’t be overly influenced by shorter-term trends, such as the so-called hotspot suburb that might have had strong capital growth in the past one, two or three years. It is very possible that this is a short-term blip (which is what we have seen in some mining towns) and the capital growth will soon revert to mean shortly: prices will fall.

Rather, when considering an investment proposition, look at long-term capital growth over at least 10 years and focus on the track record of the property in question via previous sales history. Take nothing at face value and always challenge commentators’ interpretations.

Ultimately, investors need to be cautious and holistic when weighing up various economic and property indicators. Try to bring all that data together, keep it mostly local and give it current context to establish a broad-based direction for the market. Pair that with some pavement pounding in the area you’re interested in buying into and you’ll have a better than average shot at getting it right.

Property Q&A

This week:

  • Best investments for $500,000.
  • Considering Montmorency.
  • Student accommodation.
  • SMSF and property.

Five for 500

What would be the five best property investments around the $500,000 mark with a view to maximising capital growth and a reasonable rental yield?

As a property investor you will need to choose between capital growth and percentage rental yield because no property will give you both over the life of an investment. The focus should be on maximising capital growth. With that in mind, perhaps the best way to approach this is to provide a list of investment propositions in descending order of quality, in my judgement:

  • With a $500,000 budget you can’t beat a good one or two-bedroom flat in a prime inner area of Sydney or Melbourne, given the size and diversity of each of their economic base and perpetually strong demand from buyers and renters.
  • In second place is a similar property in Brisbane, our third city by population and economic diversity.
  • Next would be a one or two-bedroom apartment in Perth, our fourth-largest city and one that will benefit disproportionately from the rise of Asia over the 21st century due to its abundance of natural resources and location, assuming this trend is sustainable.
  • My next recommendation would be a two-bedroom house close in to the CBD in Adelaide. I’ve opted for a house rather than an apartment as the larger land component will power greater capital growth.
  • Finally, a quality two or three-bedroom house in a large regional city such as Newcastle, Geelong, Albury or Wollongong comes next. You’ll need to be very selective in your choice of asset and note that, over the long term, capital growth will tend to be lower than in our capital cities.

Montmorency’s prospects

I am looking to spend $550,000 for my first home in Victoria. I would like a brick home with three bedrooms, two bathrooms and neat garden area. I like the Montmorency, Eltham area. What do you think of growth potential there please?

Your question perfectly illustrates the conundrum between lifestyle and investment needs and the compromises that sometimes have to be made. From a lifestyle perspective, you’re seeking a house with plenty of accommodation. However, $550,000 is a relatively modest budget in Melbourne and the dual requirement for considerable accommodation and growth at a moderate price means compromise!

At about 18 kilometres north-east of the Melbourne CBD, Montmorency has great liveability and facilities nestled in a green belt. It can’t be faulted as a lifestyle location. However, given its distance from the CBD, the lower intensity of buyer demand means lower capital growth.

Ultimately, you’ll need to decide which is most important: lifestyle or investment needs. Avoid the trap many fall into of applying a 50/50 weighting as this impedes decision-making. The relative weighting should be at least 60/40 in favour of one of these objectives. Moving closer to the CBD will give you more capital growth but less accommodation.

If lifestyle turns out to be the most important aim, try to reduce debt quickly with a view to using the equity you build up to invest in a prime area at a later date.

Student accommodation

Last week you warned against buying an established property and renting it out as student accommodation. What’s your view about investing in purpose-built student accommodation instead?

I’m afraid that purpose-built student accommodation is usually an even worse investment option than established housing that is rented out. Invariably, these purpose-built properties are very small – often less than 35 square metres – and many come without car parking. You have a narrowly defined and consequently very limited market that you can rent or sell to. The body corporate fees are often high to maintain the cleaning and security services associated with these properties.

Despite their drawbacks as an investment, there are always developers building more of these properties so there is no scarcity value. In short, these properties are serious underperformers. Even the banks are nervous about purpose-built student accommodation and it can be very hard to obtain finance for them.

SMSF and property

I have a self-managed super fund (SMSF) and I am looking into purchasing a property within it. Can you advise me if it is still possible to purchase a property as tenants in common? I read this in your Street Smart book from 2007. If this is possible, I would look at purchasing a property of approximately $500,000, using $100,000 from super and I would then borrow the balance in my own name outside of super. Can you also please advise what is involved in setting up a bare trust for the property purchase, I have heard that this can be costly but have not been advised what the approximate cost may be.

Rules and legislation change often in the world of super, so I’m grateful to Bruce Brammall, director of Castellan Financial Consulting and Eureka Report’s resident super expert, for providing the following update.

“Yes, you can purchase a property via tenants-in-common (TIC) where it’s done between your SMSF and yourself. But an SMSF cannot invest in the asset if there is a mortgage over the asset. So, if you do want to proceed down that path and you need to borrow money to raise the funds, you can, but you can’t use the TIC property as collateral for the mortgage.

“If you have other properties (home, investment properties) against which the money could be loaned, you have that option. This arrangement wouldn’t change the tax deductibility for you personally. The purpose of the loan would still be for investment and income-producing purposes, so you would still get a tax deduction.

“A bare trust is only needed when the SMSF itself is borrowing the money. In the instance you’ve described above, the super fund would be funding its portion with cash, while the individual would be borrowing. In those circumstances, a bare trust would not be required, as the super fund is not borrowing any money. If the SMSF wanted to buy the $500,000 property with $100,000 of its own money and then a loan for $400,000 to the super fund, then a bare trust would be required. Costs for bare trusts vary. Allow between $2000 and $4000 for a bare trust and a corporate trustee (which many lenders will insist on).

“Importantly, this is a very, very technical area. No one should be attempting any sort of borrowing within super TIC arrangements without the advice of suitably qualified financial advisers, accountants and/or lawyers.”

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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