Why property's top end is different

Just this month, a harbourside home in the Sydney suburb of Vaucluse set a new Australian record, selling for $47 million. Many no doubt, will gasp at this price being set while stockmarkets were generating horror newspaper headlines and wonder just what this tells us about where the property market is heading.

The answer for the property investor is that this record price (set, incidentally, by a cashed-up foreign investor) doesn’t really reveal much at all. It certainly offers little perspective on the wider market for property investors. Sales at the very top end have little to do with overall market direction and its future prospects.

For the sake of differentiation, property analysts interested in how different parts of market are performing break sales data into percentiles and quartiles. The top quartile represents sales at the top 25% of the market, and the bottom quartile the lowest 25%. The median value is the middle value with the top and bottom sales removed.

When you break the market down this way, it becomes clear that different sectors of the market respond differently to prevailing conditions and sentiment, reflecting the different supply-demand equations and socio-economic needs of buyers and sellers.

This kind of analysis shows behaviour at odds with what many of us may assume. For instance, it sounds reasonable to assume that during difficult economic times, the top 5% proves to be the least affected, as these people presumably have a lot more money than the rest of us.

Yet during economic downturns, as we saw in the early 1990s, the top end showed the most volatility. “Trophy houses” in suburbs such as Dalkeith (Perth) Potts Point (Sydney) and Toorak (Melbourne) witnessed dramatic price falls as their high-profile owners, who had bought during boom times, suddenly found themselves in financial difficulty. The resultant distressed sales, for well below what they had paid, worsened otherwise moderate declines across the top quartile.

“Blue-chip” properties are often owned by chief executives and entrepreneurs who, as RP Data research director Tim Lawless points out, are "more exposed to pain in the equity market and shortfalls in executive bonuses, which then affect both the investment and lifestyle sections of that market.”

Senior executives typically take a large proportion of their pay as bonuses, often the first item cut in a downturn. They also tend to have large, leveraged holdings in the sharemarket and so are more exposed to turmoil and margin calls, which need to be settled within 24 hours.

Business owners and high flying chief executives are over-represented in the top end and, if they find their order book facing a downturn, may try raising cash through the sale of a property.

In the cities, particularly Sydney but also in Melbourne and Perth, the headquarters of transnational companies embedded in the global economy also play a part. When business conditions are good, their demand for specialised staff and executives can exert significant upward pressure on top-end real estate. Conversely, when business slows or falls, these people may find themselves moving and selling their properties.

It’s important to note, though, that stress at the top end of the market typically falls on beach homes and ski chalets first, because they are discretionary purchases and usually the top of the list of expendable assets. “Already we’re seeing this on the Central Coast NSW, the Northern Beaches of Sydney, and the Gold Coast,” Lawless says, “and if this trend continues, we could see similar areas, like Victoria’s Mornington Peninsula, affected.”

In my experience, the broader top-end market consists of salary and wage earners who hold a small amount of shares outright and whose bonuses make up 5–15% of their package. Although rises in unemployment undermine confidence, these owner-occupiers are usually more secure than the “high fliers”. The broader part of the market is, in fact, usually more stable and predictable, and indeed the majority of the top quartile outside of the top 5% retains its price for longer, even into a slump.

As the chief executive of the WBP Property Group, Greville Pabst, puts it: “Homes in sought-after suburbs are tightly held, as inner suburban owners tend to renovate and extend while outer urban owners upgrade by selling and buying a larger home. On the other hand, highly leveraged suburbs (such as Brighton in Victoria and Peppermint Grove in WA) may react more keenly to pressures from the financial sector.”

The experience in the bottom quartile can be quite different. As Pabst points out, first home borrowers, particularly those with loan to value ratios of 90% or more, are far more reliant on stable economic and interest rate climates. In areas with poor infrastructure, higher interest rates, rising petrol and grocery prices and deteriorating employment rates have a more detrimental influence.

For example, in Sydney’s mortgage belt, buyers have seen stagnant prices and rising interest rates undermine both their cash flow and chances to build equity. When comparing the March quarter figures in the years 2005 to 2008, as supplied by the Real Estate Institute of Australia, it indicates a reduction in the lowest quartile price in Sydney of about 8.1%. This correlates with agents’ reports of price reductions in the worst-affected suburbs of about 20%. Bear in mind, this data has its limitations because it only shows one quarter (12 weeks) worth of transactions against the same period three years before. Nonetheless, it does reflect the experience of many owners in these types of locations.

So in summary, the upper end of the market tends to race ahead when the economy is doing well, the broader market improves at a more moderate pace while the bottom part of the market often struggles to improve. When there’s turmoil and uncertainty, the broader market slows, the upper 5% becomes quite volatile and the lower quartile can see negative equity results appearing for new home buyers.

Is the tide about to turn? There does seem to be an increasing incentive for people to buy. If rents are rising to the point where there is a diminishing differential between the cost of renting and the cost of owning – such as we see becoming evidenced in Sydney – the answer could be yes, especially with interest rates on the way down.

For property investors, investing astutely is a game of measure and strategy. The core imperative is not to get distracted by what is happening with trophy houses and entry level homes on the urban fringe.

Investors are well advised to focus on those sectors of the market that are the least reactive to domestic or global economic fluctuations. Good, middle-priced well-located properties consistently deliver increases in value and your equity through capital appreciation and are not as exposed to the market vagaries. Property in the lower and upper quartiles may perform well when times are good, but will often be undesirably impacted by changing fortunes.

Property Q&A

This week:

• Consolidating properties in the Brisbane area.
• Is the Gold Coast's Southport undervalued?
• How does the first home buyer scheme work?
• The future for Newcastle property investors.

Consolidating in Brisbane

My partner and I were all set '¦ a holiday shack by the sea, a cute workers cottage within two kilometres of Brisbane CBD and a combined income of more than $200 000. Then my partner finally left his job after years of burnout. He hasn’t worked for three months. We have sought financial advice and with combinations of renting assets out or using equity, we can afford to keep both. But should we hold on to these kinds of assets “at all costs” or get out?

Don’t act precipitously. Go to a totally independent financial adviser who has no personal stake in the outcome of your discussions. From where I sit, the answer to your question essentially lies in your overriding objective. I will assume, at this stage that ideally you want a combination of personal security; that is, your home, and an asset base that will contribute to, not diminish your ability to control equity and derive an income rather than drain it. If this is the case, then until such time as your partner returns to work and your earning power improves, I’d suggest you consider either renting out the holiday home on a permanent basis, to cover the mortgage and provide a small amount of net income, or sell it

The worker’s cottage in inner Brisbane probably has good long-term upside as long as it’s well located so if at all possible hold that. I wouldn’t sell both and consolidate to invest in outer Brisbane as it’s unlikely you’ll get as consistent a performance further out notwithstanding the current quieter period in the market. In addition, if you sell out then buy back in when your position improves, you’ll be up for a whole raft of disposal and subsequent acquisition costs that are totally undesirable.

Southport’s potential

I know you consistently trump inner-city locations, but I believe you are underestimating the potential of locations such as the Gold Coast, specifically Southport, which is increasingly seen as a “hot spot”. This town is going to become the retirement capital of Queensland as more and more retirement high-rise apartments are built. The Southport master plan is soon to be released, which will reveal massive increases in heights and densities within the bounds of CBD. The South-East Queensland Regional Plan is the driver here and many believe the implications for Southport are enormous. Do you agree?

One of the problems with the Gold Coast in general is that the bulk of the permanent population is increasingly made up of retirees, as you correctly point out. From an investment point of view, property performs best in an environment that has demographic diversity, economic diversity, and a critical mass of population that is actively contributing to an area’s economic output. Whilst, in the fullness of time, we may actually see Brisbane and the Gold Coast connect, for the foreseeable future the Gold Coast, including Southport, is unlikely to generate the kind of medium to long-term underlying capital growth that is required of a top-notch investment due to its demographic, economic and population limitations, even though it may be a “hot spot” for retirees.

First Home buyer

I’m confused about the Federal government’s First Home Savers Accounts. How do they work? Do they pay any interest? Is it true that you have to keep your money in them for a minimum of five years? What if I want to buy a home before five years is up?

Join the club of confusion! Today, October 1, 2008, is the first day you can start using an FHSA account. It is a tax advantaged way for first home buyers to save for their first home, but there are a number of rules around how you can use the account.

But I have been most annoyed and publicly vocal about some of the constraints that have been applied to the FHSA, not the least of which was the very quietly and recently repealed provision to tax FHSA earnings at 15%. Thankfully, the Federal government have declared that withdrawing the balance of these accounts will be tax-free but returns (interest or investment) will be taxed at 15%.

First, you have to ensure you contribute at least $1000 each year to the account, and if you do, the Federal government will contribute 17% of your contributions up to a maximum of $5000 (or $850) to your account. The government’s 17% contribution will only be made after you have lodged your income tax return for the year. You have to contribute this $1000 minimum each year for a minimum of four years and the maximum balance you can have is $75,000.

The legislation allows these accounts to be “investment-linked”, so they can be either an approved FHSA savings account in a bank or an investment-linked account (like super accounts) where the returns are linked to investments in the share and money markets). Investment earnings will be taxed at 15% (same as super) but you cannot contribute pre-tax money (ie, salary sacrifice). The rules only allow financial institutions with public offer licences to offer these accounts. Currently only two banks are offering FHSAs.

Now for the catches. To open an FHSA account and receive the government contribution, you need to be an Australian resident (for tax purposes) and you can only use an approved FHSA account. You must be at least 18 years of age but not older than 65.

The proceeds from the accounts can only be used to buy your first home, or to purchase a joint first home with your partner who has been in an FHSA for four years. You cannot withdraw the money or use it to purchase anything else.

If you don’t or can’t use the funds to purchase a first home, the FHSA balance will be contributed to superannuation and your account must be closed. You cannot withdraw the funds as cash.

Considering the complexity associated with FHSAs, I suggest you visit the government’s website homesaver.treasury.gov.au and keep up to date.

Newcastle property

Both my husband and I will retire in five years and are self-funded retirees. I have three development properties that I want to build brand new houses on. We wish to build and hold for five years, then sell and put all net proceeds into our super fund. My question is this: is there any way to predict what the capital growth for the Newcastle area will be in five years time?

Unfortunately neither I nor anyone else has a crystal ball. However, what you can and should do is look at some longer-range data, say annual median values over the last five or 10 years as a means of building up a picture of how prices have performed historically. In so doing, it’s vital to include years where the market has been flat or declining as this will tell you about the degree of decline and the rate of subsequent recovery.

There’s no doubt that the global credit and financial crisis will bite us all to some degree, but from a property-specific point of view if you intend to build and sell, the best time to build is when conditions are softer. Selling is best undertaken when the properties are brand-spanking new, otherwise bear in mind you’ll need to spruce things up quite a bit at the sale time and this will cost you more. However, if you need the rental income over the next five years, that alters the landscape, so to speak! The best way forward is to consult your accountant and undertake a detailed feasibility study on the proposed development before you make any decisions. It may also be useful to re-read the piece I wrote on redevelopment: see DIY (develop it yourself).

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.

Monique Wakelin is co-founder of Wakelin Property Advisory, 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.