Is it safe to buy off the plan? What you need to know to mitigate risk – Part 1
For many property investors, buying off the plan is one of the most easily accessible and affordable options for getting a foot on the property investment ladder.
Unfortunately, oversupply issues and criticism over the quality of some developments are rife in the current marketplace. It’s not surprising that investing in property off the plan has developed a reputation for being high risk.
So, is it safe to buy off the plan? It certainly requires another layer of due diligence. But with education, thorough risk mitigation, attention to detail and professional advice, it can be a rewarding investment strategy. Here’s why:
What are the benefits of buying off the plan?
· Low cost entry point – You’re able to secure the property with just a deposit and finance pre-approval. The balance isn’t required until settlement giving you plenty of time to prepare.
· Lock in the price – Secure the property with just a deposit and benefit from the capital gains during the construction period in a rising market. (Of course, the opposite is also true – the market could fall leaving you at a loss – so this is where market research comes in).
· Stamp duty exemption or reduction in some states – Depending on the state, type of property and value, you may be eligible for a stamp duty exemption or discount.
· Maximise depreciation tax and minimise maintenance – Because the property is brand new, you’ll be able to take full advantage of depreciation tax, and will have minimal maintenance costs – all helping to boost returns.
While this all sounds pretty good, it counts for nothing if you don’t do thorough due diligence.
How can you mitigate risk?
So how can investors take advantage of the benefits of buying off the plan and avoid getting themselves into trouble?
The due diligence process for buying off the plan is different and more involved than that of an established property.
These are the questions you need to be asking:
1. Is the developer reputable?
Market risk aside (because that is a factor in any investment), off the plan is considered a risky strategy by many investors primarily because there’s nothing built yet. You are investing in a promise – that is, that the developer will deliver what they say they will deliver.
What you need to know about the developer and sale contract:
· The quantity, design and quality of their previous projects
· The quality of the floor plans, fittings, finishings, appliances, and parking options (will they appeal to prospective tenants?)
· If the specifications of all the above are clear in the sale contract and the process for rectifying defects is clear.
· Whether there are options for customising floor plans and fittings. Depending on the rental market in the area, this may help you add value and attract higher quality tenants.
· Whether the architect, and the construction company undertaking the build, have sound reputations.
· The workmanship and products will be of high quality with suitable warranties.
· The developer can demonstrate solid financial strength and a track record in delivering on schedule.
Don’t be afraid to ask them directly for this information. Just make sure you also do your own research – online, by visiting previous developments, and talking to the residents – to substantiate their claims.
Usually, you will inspect the property prior to settlement to advise if there are any issues with the quality and discrepancies between what was promised and what was delivered.
2. What insurance does the developer have in place?
The developer is legally obliged to have home warranty insurance in place although there maybe some exemptions to this depending on the state and building type. For example, buildings over three storeys maybe exempt, and single level stratas may be exempt if construction hasn’t started.
If a home warranty certificate isn’t attached to the contract, ask the developer why and consult your lawyer.
3. What rights do I have if the developer doesn’t meet its contractual obligations?
Sometimes the finished product will not match your original expectations. It’s important to understand your rights and the rights of the developer, and ensure these are clearly stipulated in the contract.
Issues that may arise:
· The specifications of the completed apartment are different from the contract/display unit. Bear in mind that the plans you sign off on may not have been council-approved yet and the developer will retain the right in the contract to make modifications to complete the project. The specifics of the developer’s rights should be detailed in the contract and any modifications made should not impact the value of the property.
In the event that changes do impact on the quality and value of the property, make sure the contract allows you to withdraw from the purchase and obtain a refund on your deposit. You can ask for these conditions to be added to the contract if they aren’t in there.
· The project’s completion date is delayed. The contract should state when the project is due for completion. It will also give the developer some flexibility – typically another year – if things aren’t running on schedule. If the developer fails to meet this extended timeframe, then it should state in the contract that you are entitled to a full refund of your deposit.
· The project collapses. In the unfortunate event that a project collapses, you need to make sure you will get your deposit back. Deposits should be held in a trust account which guarantees its security if things go pear-shaped for the developer. It’s also worth checking who gets the interest earned on your deposit while it’s in the trust account – you may be entitled to a 50% share. It’s something worth negotiating for during the sale process.
Part 2 of this blog, out next week, will look at off the plan financing and assessing the market.
Are our capital cities facing an apartment oversupply?
There’s concern in the marketplace at the moment over the prospect of an apartment glut in some of our capital cities. While Melbourne has been at the centre of discussions for some time, now Sydney and Perth are finding themselves the subject of media articles on apartment oversupply.
Australia as a whole is well known for having a housing shortage, which is why property is typically seen as a sound investment.
So how can we now be facing an oversupply? Well, in short, it generally comes down to whether the right type of housing is being built in the right areas. Large apartment blocks bring plenty of accommodation to market. But small flats in the CBD only appeal to a certain demographic. Is there enough demand from single professionals and students to fill them?
New and off the plan apartments are appealing investments. They offer a host of benefits: affordability, the option to secure a property with just a deposit, minimal maintenance and the ability to maximise depreciation claims, to name a few.
Some areas, such as inner Sydney, have also delivered impressive capital growth in recent years, returning 12% on average over the last 12 months according to RP Data.
It’s easy to see why investors are drawn to these opportunities. So, should you be considering these types of investments in the current market or are you wise to stay away?
What’s happening?Inner city apartment development has gone into overdrive in Melbourne in recent years as developers have sought to capitalise on the population boom that was fuelled by overseas and interstate migration. Unfortunately, the now slowing population, coupled with many inner city complexes poor reputation for quality and below-standard floor space, has resulted in a glut.
Consequently, price growth in the Melbourne market has been poor, declining more than 2% over the past 12 months and vacancy rates are at 4.6% (SQM Research).
What can we expect? The outlook from BIS Schrapnel’s latest housing report isn’t rosy with continuing poor capital growth and vacancy rates predicted to rise further over the next 12 months.
What this does suggest is that the market is bottoming out. The next couple of years may provide investors with an opportune time to buy in low before the market turns. Selecting quality properties from reputable developers will be key.
What’s happening? Sydney’s inner city apartment market is caught in the middle. On one side there are those who are confident the market will remain undersupplied for at least the near to medium term. On the other, there are those concerned over the influx of Chinese developers and the growing pipeline of supply.
Currently, there is still strong demand from young professionals and students – plenty it seems to absorb supply. However, it could be a different story in a couple of years.
What can we expect? BIS suggests that the level of supply hitting the market combined with affordability issues from skyrocketing price growth could see a price decline in 2016. As I have discussed frequently in my blogs, understanding how to read property cycles is essential to maximising returns. Consider where Sydney CBD apartments are at in the property cycle and what returns are likely before it peaks and enters decline.
What’s happening? Perth has also experienced a surge in inner city development in recent years driven by the resources boom and the ensuing large workforces.
Unfortunately, the mining downturn is now having the opposite effect – rising vacancy rates (sitting at a very undesirable 9% for city units according to RP Data) and slowing price growth have been well reported.
What can we expect? Perth as a whole certainly appears to be trending downwards and BIS forecasts this trend to continue for at least the next three years. As with Melbourne, this presents an opportunity to buy in ahead of the next upswing. Agriculture is tipped to be the next driver of economic growth in WA and investment in civil infrastructure, particularly in inner city areas, will create a highly desirable lifestyle that will help drive the next boom cycle.
For investors already in these markets, a long term strategy is required, with the possible exception being Sydney where some capital gains could be realised in the next 12 to 24 months if nimble investors keep their finger on the pulse.
For those ready to invest now, I would suggest keeping your eye on the Perth and Melbourne apartment markets over the coming months and re-evaluate the situation in 12 months time. In 2014, consider other housing types and locations where demand drivers are more favourable.
The 4 mistakes that made me a better Investor
As a young, inexperienced investor, I made my fair share of mistakes in the early years of my property investment journey. Sure, I’d read plenty of books, but with no personal mentor to guide me, I had little idea of what I was really in for when I began my ‘real life’ investing.
Making the mistakes I did and learning from those experiences provided the foundations of my investment coaching capabilities today. I’m now able to share my experiences with others so they can learn from them. However, my journey would have been a lot less painful had I the resources that are available to investors today!
After more than 10 years investing in property, these are my top four ‘Don’ts’ to avoid.
If you can avoid making these mistakes, you’ll find the path to reaching your goals much shorter and smoother!
DON’T buy with emotion
Among my first purchases was an amazing ocean side home. I had visited the property as a guest and was immediately taken with it. I said to myself that if it ever came up for sale, I would buy it, no matter what. Well it did. And I bought it – at well over the asking price. Straight away I had a severe case of buyer’s remorse. I hadn’t done any due diligence. I hadn’t done any number crunching. I had bought purely on emotion.
It’s essential that you treat investments for what they are – assets that are there to make you money. Completing thorough due diligence and calculating projected returns on every potential investment is the only way to minimise risk and maximise return.
DON’T fail to investigate the best structure for your investments
This is a common mistake to make and one that can cost you thousands in tax each year. It was a valuable lesson that, unfortunately, I learned the hard way!
Before you invest, you need to consider what legal structure will own the property. The most suitable structure will usually depend on your investment strategy – are you investing for tax minimisation, retirement planning, capital growth, cash flow? Are you looking to invest for the short term or long term? Are you building assets to pass on to family? Answering these questions and discussing with your accountant and/or financial advisor will ensure you structure your investments correctly from day one.
For example, positively geared property might be best held in a trust to minimise the tax you pay on the annual cash flow profit. Negatively geared property, on the other hand, might be best held in an individual’s name, which will allow you to claim the tax benefits (Please note: this should NOT be taken as financial advice. Please speak to your accountant or financial advisor to determine the best structure for your personal circumstances).
DON’T buy at the top of the market
For many investors, it’s easy to get caught up in the hype of a rising market. Many times I jumped into property in a market where prices had been rising for more than two to three years. This isn’t the best purchasing strategy if your looking for short term growth to help fund your growing portfolio.
Learn how to read the property clocks of the areas you’re interested in investing in to identify the market troughs and peaks. This will enable you to buy in at the low points to maximise returns, and help you to avoid buying in at the top when the capital growth curve is reaching its peak. You can watch my video blog here on property cycles.
DON’T over-leverage your portfolio
The ability to release equity from a portfolio to continue investing is one of the greatest wealth-building advantages property investment offers. However, this should not be undertaken without careful consideration. Refinancing loans to release funds can result in an increase in your interest payments. You need to consider whether you can service them!
After becoming comfortable and reaching a medium sized portfolio, I quickly diversified into coastal land sites and even a small subdivision. While exciting, these projects were very capital intensive and soon drew substantial funds from my portfolio as I released equity to develop. In some cases, I even lost money. This put strain on my serviceability and therefore my ability to grow the portfolio further. I was forced to sell a number of sites and projects to stabilise my portfolio before I could begin building it again.
DON’T get complacent
All investors can be guilty of this – myself included. Once you get comfortable with investing, it’s easy to get complacent. You forget about the impact of interest rates, forget about thorough due diligence, forget to review your portfolio regularly and fail to act swiftly in changing markets.
This is where it’s important to retain some of those qualities from your beginner investor years – the hunger and acute awareness! Experienced investors can easily fall into the complacency trap which can ultimately cost you your success. So stay keen, hungry and involved!
Understanding investment options – the difference between negative, neutral and positive cash flow property
Before embarking on your property investment journey, it’s important to understand how different investment options deliver different capital growth and cash flow outcomes.
It’s not uncommon for investors to jump into an investment without considering whether the type of return it’s offering is the right one for their personal financial situation and wealth creation goals. I learnt this the hard way early in my investment journey and it took me years to get back on track!
According to ATO data, the majority of property investors investing in negatively geared property fall within the lower tax brackets. Given negative gearing is a tax minimisation strategy first and foremost, are these investors really on the right path?
What is negative cash flow property?
In a nutshell, negative cash flow property or ‘negative gearing’ is defined as when the interest and holding costs you are paying on your investment property are greater than the rental income you receive.
The appeal of negative gearing is that it allows you to deduct the losses you have made on the property from your annual personal income (under current tax legislation), thereby reducing your taxable income and the prescribed tax you’re required to pay on that income.
Frequently the subject of much debate, negative gearing was introduced to encourage investment in property with the idea that this would increase the supply of rental accommodation throughout the country. Whether it has been successful in doing so is debatable but the advantages of negative gearing from a tax minimisation perspective cannot be denied.
What many investors don’t fully understand though is that the tax savings rarely cover the cash flow losses, leaving you with less cash in your pocket each year.
The underlying investment case for negative gearing is based on the premise that each year the property will have grown in value, which provides the return. With a long term outlook, over time gradual rental increases will eventually see a negative property reach a stage of neutral and then positive gearing. However, it’s important to remember that capital growth year on year is not guaranteed and your return is only fully realised when the property is sold.
Who benefits most from negative gearing? Investors who typically gain the most from negative gearing are high income earners – those in the higher tax brackets are those best placed to maximise the tax benefits. Further, higher earners can afford to have less cash in their pocket every year and are generally content with taking a long term approach to building assets through capital growth. Their long term goals may be to turn their negative properties positive for retirement cash flow, create a portfolio of family assets, or to liquidate and pocket the profit.
Who doesn’t? Lower income earners considering negative gearing should investigate the pros and cons carefully to determine what benefits negative gearing will really provide. After all, investing is about the return, and until you sell the property, the return is not realised. You will need to weigh up whether you’re better of having that extra cash in your pocket each year – rather than waiting for a capital return that may not bear the fruits you had hoped for.
What is neutral and positive cash flow property?
In contrast to negative cash flow property, neutral or positive property doesn’t leave you out of pocket.
A neutral cash flow property means the property is making neither a profit or a loss each year because the loss is balanced out by the rental income. Hopefully the property is generating capital gains, and it will likely become a positive cash flow property if rents rise and/or interest rates fall.
A positive property is one that that generates you an annual profit because the rental income exceeds the property’s annual holding costs. Tax will be payable on the profit but can be miminised by maximising your eligible deductions such as depreciation.
Who benefits most from positive gearing?
Positively geared property can be advantageous for most investors. The extra income stream can replace or supplement your salary, allow you to retire early, improve your lifestyle etc. It can be particularly beneficial for those on lower incomes who are looking to replace their current salary, or that of their partner’s, so that they can give up work to focus on family or other interests. It’s also a good strategy for building a portfolio quickly – the profit from your positive property can be used to invest in another.
Finding property that is positively geared from day one can be challenging as it’s often limited to regional areas.
Many believe that by investing in positive property from the outset they are forgoing capital growth. While it’s true that in many positive property markets, rental yields are high and capital growth is slow, this is not a definitive pattern. Plenty of investors achieve both by making well-researched and informed investment decisions and selecting strong performing positive locations around the country.
Can a negative property turn positive, and vice versa?
As touched on above, a property that was originally negatively geared can turn positive if it’s a long term investment. Over time, rents will rise, interest rates may drop or you may pay down some or all of the principal (thereby reducing or cutting your payments).
Eventually, the rental income will become equal to or greater than the costs of holding the property – turning it neutral or positive. This is often the long term strategy of negative gearers who see it as a retirement plan – an asset that will provide them with cash flow during retirement.
Unfortunately, the opposite is also true. A property that was originally positively geared can turn negative in the event of a rental market shift and/or interest rate rise. Both cases typically need to be quite extreme to put a property into the red – it’s more likely that your profit will decrease rather than disappear. This, of course, is not ideal either.
Investors – whether positively or negatively geared – are encouraged to plan for these situations to minimise the impact if they are faced with one. With some simple preparation – i.e. ensuring you have emergency funds put away – you will be well positioned to ride out tough market conditions.
Should I invest in negative and positive property?
Portfolio diversification is very important for risk reduction. Many investors find that a balance of negative and positive properties gives them exposure to a range of markets and doesn’t leave them with a cash flow problem. Investing in well-located negative and high returning positive properties is an ideal overall strategy for achieving the best of both worlds – growth and passive income.
How long does a property market take to run full cycle?
A regular question I’m asked is ‘How long does a property market take to run full cycle and how can I pinpoint the bottom of the market?’ My answer generally depends on whether it’s a capital city or regional location as the two can be very different beasts.
Understanding how the two differ and learning how to recognise the various stages in the cycles are key to getting comfortable over when to get in and when to sell.
Falling or flat markets often scare investors away as they give the misconception of poor performance. Rather, informed investors know that this can be an indication that a market is at or may be reaching the bottom of its cycle. Markets showing years of little or no growth can present exciting opportunities to buy in at the bottom of a market cycle and ride the capital and rental growth curve as it trends back upwards.
So, what IS the difference between a capital city cycle and the cycle of a resources city or town?
Regular market movements are commonplace in resource towns and the market cycles and annual fluctuations differ greatly from those seen in capital cities.
The housing market in a resources town can turn a full cycle in as little as two to three years, as it responds to infrastructure and economic development activity in the area. During a down cycle, prices and rents may roll back as much as 25% before the market moves through its cycle and begins its upwards swing.
In contrast, capital cities generally experience a full market cycle every seven to eight years with prices and rents detracting by up to 15% on average.
What this means is, investors have an opportunity to take advantage of the more frequent and pronounced growth cycles in regional areas to generate greater returns more quickly.
How do you know when a market has reached its bottom?
News reports in the media are great at telling us when a market is in steep decline, or when it’s booming. However, pinpointing when a market has reached its lowest point can be very tough as we never know the bottom has been truly reached until the market shows a consistent rise again!
This is where market research comes in. It is critical in determining what the growth drivers are for a particular area and when those drivers are likely to come in to play. Check out my recent blog on how to conduct market due diligence here (which applies to both regional and city areas).
Buying in ahead of a boom always requires some risk-taking. Industrial projects can, and do, falter from time to time which consequently impacts the demand for housing in the area. While the greatest returns in resources towns are often made by those who invest before the large infrastructure projects receive final approvals, investors should exercise caution and consider both the best case and worse case return scenarios. Get the timing right though, and you have truly led the pack and uncovered the next boom market ahead of the rest!
Capital cities also experience up and down swings but they are more gradual and less pronounced due to their population size and industry diversification. And while, as a whole, capital cities will experience a broad cycle, suburbs within it can behave differently to the broader market trend.
This means that while the city as a whole may be trending down, you will still find certain suburbs within it weathering the storm. This makes research into capital city suburbs just as important as regional towns.
When should you sell?
Each and every investor’s personal situation is different and the answer to this will depend heavily on your personal circumstances and financial goals.
While it’s true that many investors see resource towns as short term capital growth investments – getting in before the upswing and getting out before the downswing – these are fundamentally positive cash flow markets which provide ongoing opportunities for cash flow and capital growth over the long term.
When taking a long to medium term view of investing it’s important to ensure you’re financially positioned to ride out the downturns during periods when rents and equity drop.
The advantage of positively geared markets however is that yields can typically remain high enough to cover the property’s holding costs during down cycles which can help insulate investors portfolios and repayment ability.
Rather than focus on trying to pick the exact bottom of a marketplace before committing, I suggest doing your research and identifying a location with sound dynamics and growth prospects – if the market has performed well in the past, been through a decline and levelled out in recent years, chances are it may be poised for a recovery.
Where to find Australia’s best High Yield capital city suburbs
Last week I looked at three regional towns currently delivering strong rental yields with good prospects for future capital growth. This week’s blog highlights three capital city areas with promising investment profiles for strong rental return and capital growth prospects.
Units, over houses, are generally performing better across the board in capital cites.
Brisbane – City
· Yield: up to 7% (units)
· Vacancy Rate: 4.5%
· Growth (1yr/3yrs/5yrs): 0.11%/3.33%/1.09% (units)
Sources: RP Data, SQM Research
Why Invest: The Brisbane market has now entered its next growth phase after a period of decline. Investors have the opportunity to buy-in at very affordable prices, considerably less (up to 45%) than the Sydney and Brisbane medians for quality inner city units.
Brisbane has been undergoing transformation in recent years and along with fantastic weather now counts world-class culture, entertainment and dining options among its draw cards. It’s also investing heavily into infrastructure with $132 billion of projects planned between 2010 and 2014, with a significant focus on improving transport.
Queensland is also one of Australia’s most resources-rich states with a massive LNG export industry that’s only in its early phases of development, further strengthening the state’s industry with significant flow-on effects to Brisbane.
Top tip: Investor demand is most definitely on the rise in Brisbane – apartment sales in 2013 almost doubled that of 2012. Get in now and make the most of the current affordability and opportunity to maximise growth. Look for boutique apartments with unique features.
Risks: Apartment oversupply is an issue in Brisbane, as it is with many Australian capital cities. This could result in slow rental and capital growth, and high vacancy rates in the short to medium term until supply is absorbed.
Sydney – Western Suburbs (e.g. Whalan, Mt Druitt, Lethbridge Park)
· Yield: 6-7%
· Vacancy Rate: 0.7%
· Growth (1yr/3yrs/5yrs): 15%/35%/34% (Averages)
Sources: RP Data, SQM Research
Why invest: Sydney’s market has boomed in recent years prompting investors to look outside the usual inner city areas – which have reached unaffordable heights – to suburbs where they can secure decent sized blocks for renovation or development and where the low buy-in can facilitate good yields.
While not considered highly desirable locations to live in the past, suburbs such as Whalan, Mt Druitt and Lethbridge Park, which all fall within the local government area of Blacktown, have emerged as areas worth further investigation for these very reasons. Despite the LGA’s rapid population growth – a 25% increase over the last 10 years – median property prices range from just $270,000 for a unit to $410,000 for a house across Whalan, Mt Druitt and Lethbridge Park.
They might be 40km from Sydney’s CBD, but transport connections are excellent which is one of the area’s most desirable features. There are direct rail lines to central station and close access to major motorways. Vacancy rates are extremely low at 0.7% and the area is very popular with families.
Top Tip: These outer suburbs are ripe for renovation projects and larger blocks mean the addition of granny flats to increase income are also worth considering.
Risks: Sydney’s capital growth over recent years has been huge and is now slowing. A ‘crash’ is unlikely but investors should be aware that growth will more than likely to be slower than recent years and this is cash flow investment rather than a capital growth investment.
Perth – City of Bayswater
· Yield: Around 5-6% for units
· Vacancy Rate: 1.9%
· Average Annual Growth: 10% (houses and units)
Sources: RP Data, SQM Research
Why invest: It has been reported that slower growth, sales and rising vacancy rates suggest that Perth’s booming property market is softening and maybe reaching – or have already reached – its peak. However, this doesn’t mean good yields can’t be found in certain pockets within the city.
Bayswater council – which includes the suburbs of Bayswater, Maylands, Morley and others – has plenty of highlights. It’s just 7km from the CBD, the Swan river is on its door step, there are excellent bus and rail connections and a lively cultural and entertainment precinct in neighbouring suburb, Mount Lawley.
Top tip: Morley looks to be one of the most interesting of the suburbs within Bayswater due to its recent and future development. Despite not having its own train station, unlike some of the other Bayswater suburbs, it has superb bus infrastructure – the CBD is only around 15 minutes by bus. Major roads are also easily accessible and the light industrial area in Ashfield, under development, is within a couple of kilometres.
In 2011, the $60 million Coventry Square, Perth’s biggest markets complex, opened in Morley, creating a major tourist and entertainment destination.
A masterplan for the further development of the Morley city centre has also been approved. The plans include a new central park, improving public transport, upgrading streetscapes and public spaces, and making streets more pedestrian friendly.
Risks: The Bayswater area has experienced good capital growth in recent years and could slow based on the broader market indications for Perth.
High Yield locations in Australia and where to find them
Below are my top three high yield location recommendations.
While these can change monthly, they have been and are currently performing and in my expert opinion, look like they will continue to perform well.
- Yield: up to 9% – 10% (units are currently attracting the best yields)
- Vacancy Rate: 1.9%
- Growth: Flat to negative
Source: RP Data, SQM Research
Cairns, the gateway to the Great Barrier Reef, should be back on investors’ radars following the announcement of the proposed $8.15 billion Aquis Great Barrier Reef Resort development in the northern end of the town.
Why invest: While the proposed Aquis resort development still requires some approvals before construction can begin, it’s already having an impact on the local market. The proposed 343ha development features eight hotels totalling 7500 rooms, two casinos, a golf course, shops, an aquarium, theatres and more.
According to plans, the first phase of construction will create 3,750 construction jobs and 11,000 operational jobs. The second stage will create 3,500 construction jobs and 9,000 operational roles. Its location is 13km north of Cairns, just outside Yorkeys Knob.
Top tip: While the suburbs closest to the proposed development have experienced a sudden surge in demand, the locations to look at now are those in the southern Cairns area where property is more affordable, while still benefitting from the project and producing decent yields. Suburbs such as Woree, where units are currently delivering 10% yield, have a number of schools and other local amenities, which add to the appeal. Once the Aquis project has final approval, the market is expected to take off in a big way and those seeking to maximise capital gains, as well as yield, will need to weigh up the risks and get in quick.
Risks: The obvious risk here is what will happen to the market in the event the Aquis project doesn’t receive final approval? Cairns has a robust tourism industry and purchasing in an area that is less reliant on the Aquis attraction as the main drawcard (such as those with schools) and with a large proportion of owner occupiers will help minimise any negative impact should the project not come to fruition.
- Yield: 8-10% (houses)
- Vacancy Rates: 6.1%
- Growth: -20% since 2011
Source: REIWA, SQM Research
Why invest: Despite having undergone a significant house price correction over the past two years, rental yields in Karratha have remained relatively strong, and well above the national average.
The drop in property prices is now providing investors with an ideal opportunity to access the market at the bottom of the current cycle ahead of expected upward swing as the population continues to grow and absorb current supply on the back of developing local & resource infrastructure projects over the coming 18 months..
Recent news that the development of Anketell Port is progressing through initial approvals should help further ignite the market and stimulate population growth once in full swing.
The WA government has unveiled a master plan for the multi-user, multi-commodity deepwater port which is to be located just 30km from Karratha. The plans would see Anketell have an eventual export capacity of more than 350 million tonnes a year. This would be more than double the total exports through the nearby Dampier Port and 20% larger than shipments at Port Hedland, placing it as Australia’s biggest export facility. The government estimates the project would create 4,000 construction jobs.
Major investment into civil infrastructure in Karratha is also underway to redevelop and revitalise the town and support the projected population increase.
Fundamentally, Karratha remains the service centre for Chevron’s Gorgon LNG project – Australia’s largest ever single resource natural gas project – and
Woodside’s Pluto LNG project – both which have lifespans of 40 years.
Top tip: Take advantage of the current low prices to maximise capital growth and secure a quality property that will appeal to the corporate leasing market.
Risks: Resource towns can experience higher volatility and relatively short market cycles, compared to capital cities. Investors should have a comprehensive strategy in place focused on investing for the medium to long term to ensure they’re financially prepared to withstand volatility periods.
- Yield: 9-12%
- Vacancy Rates: 3.7% and declining based on current trend
- Growth (1yr/3yrs/5yrs): -6.38%/16.79%/56.86%
Source: RP Data, SQM Research
Why invest: South Hedland is a major residential area forming part of the economic powerhouse that is Port Hedland. Port Hedland is now the largest bulk commodity port in Australia, used predominantly by iron ore giants BHP Billiton and Fortescue Metals Group. Both companies have invested billions over recent years to upgrade and expand port infrastructure to facilitate a ramp up of exports. The town’s next mega project – rail and port infrastructure for Gina Rinehart’s $10 billion Roy Hill iron ore project – is now underway.
Investment into civil infrastructure has also been significant in South Hedland. A new town centre, waterpark and sports stadium, among other projects, have all helped create a very desirable lifestyle and multiple commercial opportunities.
In just three years, Hedland’s economy has grown by more than 60% and the rapidly increasing workforce has resulted in a population surge. The town counts 20,000 residents today, rising around 30% in just five years.
Port activity remains strong with Roy Hill ramping up development of its rail and port infrastructure. Port expansions have also been flagged by both BHP and Roy Hill.
Top tip: The recent slump in house prices has provided good buying opportunities and has an opportunity to buy in low ahead of the next upswing. Whilst the town throughout the recent slowdown has continued to benefit from nation leading rental returns as high as 12% on large family homes.
Risks: Capital growth is likely to be slow in the short to medium term as the market moves through the current cycle. Investors should also take note of the current residential development pipeline which and avoid buying older properties in the town.
When is the right time to buy your next investment property?
Recently released data from the ABS showed property investment activity to be at an all time high in April with investor finance commitments for the month rising by 2.3% (seasonally-adjusted) to a new record high. Interestingly new investment figures were up by 30% over the year!
However, Post-budget, it seems a different trend is emerging with investor confidence in the market dwindling, according to initial findings by Digital Finance Analytics.
There’s now plenty of talk in the media of Australia’s property bubble and the prospect of a looming crash. Many investors are being scared off from investing in the current market and adopting the view that they should hold out to potentially bag themselves a bargain when the market hits its low.
Investors have been trying to perfectly time property market swings for decades and although highly lucrative if you get it right, its not always the most effective or efficient strategy to grow wealth through property investment!
The right time to buy your next investment property should not be dependent on the movements of the broader marketplace
In my experience the best time to buy your next property is as soon as you’re financially able to do so!
Waiting for your local market to bottom out on the assumption that you’ll secure the lowest price and the best deal, may end up costing you more than your realize in the long-term. Experienced investors understand that there are pockets of growth in many marketplaces around the country at any given time with rewards for those willing to find and secure a property in these locations.
Economists have long been predicting the old age story of doom and gloom heralding a major crash in the Australian marketplace. If the historical performance of property in the country is anything to hedge our bets on then yes, downturns and upswings will come around once every 8-10 years in capital cities and shorter periods general in regional locations. Waiting for the national market to reach its bottom before investing is a very difficult thing to pinpoint. Chances are, that by the time you hear from the property economists and researchers that it’s reached its bottom, prices are already on the up and you’ve missed your narrow window of opportunity.
One of my key recommendations to investors is: ‘don’t follow the pack’. There is no need to be at the mercy of the broader market. With the right advice, research and property selection, you will always profit, even during a national or state downturn.
Here are the five tips to determine whether you’re ready to invest again – regardless of the wider marketplace:
Step 1: Review your equity position.
Assess the current net value of your assets? Work this out by having your property or properties valued and then deducting the balances of your loans from the current values. Say, for example, you find your current investment property has increased by $150,000. You may then able to approach your lender and refinance your loan to release part of the equity.
Be mindful of a couple of things here. Your lender may conduct thier own valuation and given the conservative approach many lenders take to valuations, it may well come in below your original valuation. Your lender will also want to retain some equity, usually around 20%, so you may find that your original calculation of $150,000 equity has now reduced to say $100,000 based on the bank’s lower valuation and its need to retain some equity. If you want your equity to act as a 20% deposit, then your budget for your next investment property is $500,000.
Alternatively, you may have a deposit ready from cash savings, or you might be able to use a mix of cash and equity.
Step 2: Talk to your mortgage broker
Find out how much you can borrow. If you’re determined to use your cash/equity as deposit then that will set the amount your able to borrow.
Often when growing a portfolio quickly investors don’t want to wait until they have 20% deposit in equity, opting to grow faster by placing only 10% down against the new purchase., if you’re happy to put down less deposit and pay Lenders Mortgage Insurance, you may be able to borrow more which will allow you to purchase a better quality property. Tips on how to maximise your borrowing capacity can be found here and here.
Step 3: Determine your loan serviceability limit
It’s critical that you only borrow what you can afford – you must make sure that you’ll be able to service the loan payments.
If you’re pursuing a strategy of negative gearing, this is particularly important. You will need to work out the maximum you can afford to be out of pocket each month.
If you’re seeking a neutral or positively geared investment, you will be in a much more secure position. However, you still need to be confident that you’ll be able to service the loan should the rental market deteriorate or if interest rates rise – two factors that will negatively impact your cash flow.
Step 4: Set your budget
By this stage you should have a clear understanding on how much deposit you have and the maximum price you’re able to pay for your next investment (your borrowing capacity). You should also know how much you’re prepared to pay towards the interest on the loan each month (assuming an interest-only mortgage) which will determine the rental yield you need your next investment to generate.
Step 5: Property search and selection
Based on your strategy (negatively or positively geared), you’ll now be able to begin your property search, which will ultimately determine whether there is a good investment out there that fits your budget and loan serviceability.
I’ve written several blogs on how to indentify potential hotspots and how to undertake market assessment and property due diligence.
Also keep an eye out for next week’s blog where I’ll be looking at some of the best locations around the country for high yields.
How do you build a portfolio you can retire on?
The ultimate goal for most property investors is to create a portfolio that will eventually provide them with enough cash to live off.
Indeed, residential property is becoming increasingly appealing as an asset class among SMSFs and among those who are waking up to the grim reality that their superannuation and pension are going to fall drastically short when they come to retirement age. For others among us, we simply want to live a life of financial freedom as quickly as possible!
I’m often asked by investors: “How many investment properties do I need to retire?” That’s a question that can’t be easily answered. Rather than a question of properties, it’s a question of “how much positive cash flow should I be generating?” Or, “how much equity do I need?”
For example, you may have several properties in your portfolio but if they haven’t increased much in value and/or they aren’t putting profit in your pocket each week, then you’re no closer to retiring than you were when you started investing! In fact, you’re further away than ever as your portfolio is costing you money, rather than making you money.
Another investor, may have just two properties in their portfolio. However, they made some smart property selections and seen their portfolio and rental income significantly increase in value in a just a few years.
So, how much do you need to comfortably retire for, say, 20 years? My current basic method of calculation when working out how much we need is based on $100,000 per couple per year for 20 years. Which means we need $2 million to comfortably retire on a 20 year timeframe.
The second question I’m asked is “how do I achieve this through property investment?”. There are several strategies – each with their advantages and disadvantages. The one that will work best for you comes down, as always, to your personal risk comfort level.
Strategy 1: Positive cash flow
This strategy focuses on building a portfolio of cash flow positive properties until you are generating $100K per year in profit.
Pros: The 20 year timeframe doesn’t apply here, assuming cash flow is maintained. You have the option to continue to build your wealth using your income and equity, and you will have some excellent assets to pass onto your family. Importantly, this strategy won’t leave you out of pocket while you’re building your portfolio!
Cons: Maintaining your portfolio (as opposed to selling it off) means you will remain at risk of market fluctuations during your retirement phase. Unless you pay down at least some of your debt, you will also maintain high levels of debt. You also need to be willing to continue managing, at least to some degree, your portfolio of rental properties.
How to do it? Creating this level of positive cash flow is challenging but certainly not impossible. It is founded on solid research which will identify areas where there are positive cash flow properties and some capital growth. Locations are likely to be regional areas undergoing significant economic development, which do generally carry greater risk. Once invested, with your cash flow and sufficient market growth, you should be able to purchase again within 24 months. Repeat this formula until your annual cash profit from your rental income has reached $100,000. Make sure you have a sound risk management plan in place and you are regularly (every six months) reviewing your portfolio and the markets you’re active in so that you are well positioned to react quickly to any negative situations.
Strategy 2: Growth – and then liquidating
This is probably the lowest risk strategy. It focuses on capital growth alone – building a portfolio of growth properties until you’ve created at least $2 million equity. At which point, you sell them and live off the cash profit.
Pros: Low risk. You’re not at the mercy of the markets as you have liquidated your assets and transferred the cash profit to a savings account and/or other low risk investments.
Cons: Your cash won’t last forever. A strict timeframe will apply and you will need to budget carefully. You also won’t have any property assets to pass to family members.
How to do it? The main issue with this strategy is that you are negatively geared. You will be relying fully on capital growth for financial gain. Smart property selection is crucial so thorough research is required to ensure you’re buying property that is going to deliver sufficient capital growth. As with strategy 1, if you can locate areas that deliver in excess of 10% growth a year, then you should be in a position to add to your portfolio every 12 to 18 months. The number of properties you need to invest in before you find yourself with $2 million in net assets will vary greatly between investors and will depend entirely on market growth and whether you have been paying down any of the principal.
Strategy 3: Growth – and then paying down debt
This strategy is combination of 1 and 2. You build a portfolio of both cash flow and growth properties. Once you’ve created sufficient equity, you then use some of that equity to pay down debt, essentially turning your negatively geared properties into positively geared properties and creating/increasing your passive income.
Pros: This strategy allows you to create a passive income to live off while maintaining your growth assets.
Cons: You will still be at risk of market volatility and will need to manage, at least to some extent, your remaining rental properties. You will also still have some debt.
How to do it? Focus on acquiring two or three high yielding properties first to provide cash flow security. Then, diversify into a couple of capital city properties to offer long term growth security. With this combined capital growth and positive income, look to reduce LVR across your portfolio to around 50% over a five to 10 year period. This will increase your cash flow, provide higher security and reduce risk during the retirement income phase.
Regardless of the strategy you choose, remember to seek the appropriate advice from your property investment strategist, financial advisor and accountant to ensure you’re making the right decision for your financial situation and goals.
Are you prepared for EOFY? Your property tax checklist
As the end of financial year draws closer, it’s important to ensure your paperwork is in order ahead of your visit to your accountant.
Being prepared at tax time offers many benefits. It not only reduces your accountant’s bill but enables your return to be processed quickly, allowing future lenders to access your up to date financials and approve your next purchase faster.
The comprehensive checklist below is one I use to ensure I’m fully prepared at tax time and maximising all the deductions available. A property investment specialist accountant should also be able to provide you with a list of what they require.
· Copies of your sale contracts which show the price and date the investment properties were purchased
· Copies of your settlement statements for those properties purchased during the financial year
· Copies of the depreciation schedules for each property – if you don’t have these you will need to arrange immediately with your accountant
· All bank statements for the financial year showing the rental income received over the period and the interest paid on the mortgages
Evidence of the all the expenses incurred during the financial year in relations to the properties in your portfolio. These may include:
· Administration and accounting fees
· Property management fees
· Legal fees
· Quantity surveyors’ fees
· Insurance costs
· Advertising costs for marketing the property to tenants
· Body-corporate fees and charges if any of the properties are strata titles
· Land tax and council rates
· Lease agreement expenses
· Repairs, maintenance and servicing costs
· Cleaning, gardening and lawn mowing costs
· Electricity, gas and water bills (only those incurred by you and not the tenants)
· Pest control
· Any stationery, postage and telephone calls
· Travel and car expenses (usually in the form of a log book, with relevant receipts)
I recommend keeping a file on each property and file all receipts and documents away as they come in. Being thorough and organised will not only save you time and money, it will also optimise your returns and will put you in the best position possible to continue growing your portfolio successfully in the new financial year!