How to Avoid the High-Rise Value Trap
smartinvestor
How to avoid the high-rise value trap
Published 07 May 2014 02:17
If you’re in the market for an investment property, chances are youhave looked into buying an apartment – possibly one off the plan.If so, tread carefully.
Record numbers of new apartments are either planned or in the process of being built, a fact which is going to dramatically change the dwelling mix of our major cities and potentially conspire to keep a lid on prices over the next four to five years.
About 345,000new apartments will be built nationally between now and 2018, estimates Australian Property Monitors senior economist Andrew Wilson.
More than 35per cent of these new apartments will likely be built in Sydney, at arate of some 25,000a year, while the rate of new apartments in the already saturated Melbourne and to a lesser extent Brisbane markets are set to taper and decline.
During calendar year 2013 there were 21,570new apartments built in Melbourne and 24,510new apartments built in Sydney, according to APM’s figures.
While some of these new apartments will satisfy demand from owner-occupiers who want to enjoy a modern inner-city lifestyle, ahigh proportion of the new apartments willbe snapped up by buyers with the primary aim of making a capital return ontheir investment.
Demand for apartments from local investors has been strong, following an extended period of low interest rates. Their ranks have been boosted by like-minded investors from offshore, lured in by stronger purchasing power courtesy of the decline in the Australian dollar.
While apartments have always been a good option for investors – lower upfront costs, reliable rental yields and less maintenance than houses – the scope of developments in the pipeline could change the game for many considering this popular asset class.
“On a daily basis we are pulling back the contract prices on purchases people have made for off-the-plan and new apartment developments,” says chief executive of Melbourne-based property advisory and valuation firm WBP Property, Greville Pabst.
He says “pulling back” is the process of valuing down apartments from the amount agreed to when the contracts were signed to the deemed price of the asset when it settles.
There are daily examples of apartment valuations in Melbourne’s inner city and CBD, where WBP’s consultancy is based, coming in between 5per cent and 15per centbelow the purchase amount.
Faced with the prospect of paying more for a dwelling than it is worth, buyers are left with the option of going through with the deal or forfeiting their deposits.
Unusually, it is the smaller one-bedroom apartments in the $350,000 to $380,000 valuation range that are “holding up the best”, according to Pabst, because of the demand that exists among entry-level buyers.
Meanwhile, he says, two-bedroom apartments in the $500,000-plus range and three-bedroom apartments up to $800,000 are seeing the biggest pullbacks.
C:\Users\Executive Officer\Google Drive\In the News\Articles\smartinvestor - How to avoid the high-rise value trap 140507 Matthew Smith.docx 5/12/2018 1
Pabst offers a word of warning for investors lured into purchases on the basis of a display suite. “When you are buying something off the plan, you’re buying in one market and settling in another.”
He says contracts settling now on big new apartment developments were signed in about 2010 at what he describes as the peakof the market in Victoria’s CBD and inner-city suburbs.
WBP Property is engaged by banks toprovide independent valuations for loan agreements and Pabst says the firm currently does more than 10,000 residential valuations a month.
Most new apartment developments tend to exhibit much smaller proportions of land value, the simple function of the number of dwellings divided by the land they occupy.
Often these contracts will reflect the smallest possible land values in order to minimise payment of stamp duty and maximise the tax advantage that can be gained through depreciation when buying anapartment as an investment.
Pabst reminds readers that this puts thoseinvesting in buildings with hundreds ofdwellings at significant risk, because it’s the land component that appreciates. “Whenyou are sharing that landwith 200other people,” he says, “your share is very small.”
Pabst says a ratio of 50per cent to 60per cent land over building value is a level that offers reasonable long-term prospects.
That’s why experts such as Pabst prefer apartments in smaller, existing blocks with atrack record of capital appreciation and rental income over new developments off theplan. He advises investors seeking apartments to stick to older-style, low-density blocks with heritage overlays. Attractive art deco-style buildings with spacious floor plans are a favourite with many investors forthis reason.
C:\Users\Executive Officer\Google Drive\In the News\Articles\smartinvestor - How to avoid the high-rise value trap 140507 Matthew Smith.docx 5/12/2018 1
With new apartment development in most capital cities reaching record highs – led first by Melbourne, now followed by Sydney, Canberra, Darwin and Brisbane – Pabst and other property experts are sending fresh warnings to investors seeking to buy apartments as an investment.
“It means they really do need to do a double-take and look at this type of information closely,” says principal of property consulting firm Deep End Services, Kevin Stanley, of the skyrocketing new apartment approvals in capital cities.
Stanley is not advocating investors avoid the new apartment market – or that the planned supply of them will ruin the investment market altogether – rather, he says, potential buyers should try to understand the dynamics at play to avoidvalue erosion.
During 2013, apartment sales comprised just 27per cent of all dwelling sales, down from about 31per cent in 2009, according to research houseRP Data.
That ratio is about to be flipped on itshead.
Across the country, apartment approvals are outpacing home approvals, says RPData senior analyst Cameron Kusher.
Eighteen months ago, fewer than half of all property approvals were for new apartments in Melbourne, Brisbane and Sydney. All ofthese cities are now seeing well over 50per cent apartment approvals compared with houses.
The construction of apartment blocks within close proximity of each other, built ataboutthe same time and before infrastructure has been developed can lead to a periodof soft pricing where valuations willtake time for these units to find their way back to fundamental characteristics.
Meanwhile, developments in inner-city rings can benefit from density if they are clustered around transport and services thatmake the area more desirable, Stanley points out.
“Density can be a two-edged sword – it might mean you get too much supply in the short term but you might also create an interesting area people want to live in.
“Investors need to think three years ahead and what the location is going to be like then, not what it’s like now. That’s really important,” he says.
In both the new and existing apartment markets – based on the current low level of rental yields – more investors appear to be buying apartments for capital growth rather than for their yields.
In Sydney, Melbourne and particularly Perth, gross rental yields are exceptionally low based on historic levels, Kusher says. He expects to see rental yields on apartments tonot only remain down but deteriorate in the next 12 to 18months.
Even at these lower levels, yields on apartments are superior to yields on houses, according to Angie Zigomanis, an analyst with BIS Shrapnel.
With investors increasingly looking to maximise capital growth, Zigomanis suggests investors choose places they themselves want to live in.
“If it has an open plan, natural light, a good aesthetic and practical design, then you open your potential market beyond investors and into the owner-occupier market,” he says.
Another important consideration for people investing in apartments is to make sure their outgoings, including strata and body corporate fees, are manageable and sustainable, says Leanne Pilkington, general manager of Laing+Simmons.
Often investors will underestimate theoutgoings in buildings with facilities such as lifts and gymnasiums, which caneatinto returns. There’s no set amount apartment owners should expect to pay; fees and costs can be added from year to year as situations arise.
Experts suggest investors take up to 1.5per cent out of the overall rental yield to account for costs. The dollar amount can vary depending on the size and type of the property – for a simple block it can be $1000a year; a townhouse in an upmarket development might be $6000 a year, while an apartment in an inner-city or CBD high-rise could cost as much as $20,000 a year in owner corporation fees.
So it’s important that investors buy into anew or existing building with their eyes wide open. Rob Beck, Strata Communities Australia general manager for Victoria, suggests asking the property manager of an existing property if you can seethe minutes of annual general meetings of the owners’ corporation to find out if there’s harmony or hatred between the owners.
He also suggests reading through the Owners Corporation Certificate to find outifthere are any major works planned orifthere are limitations on facilities ownerscan use.
“Once you’ve bought you’ve signed on forany outstanding fees that have been struck and new owners need to be aware ofthat,” he says.
While apartments are selling quickly at the moment, according to Pilkington, who is based in Sydney, she warns that the market can change very quickly.
“I haven’t seen any problem for people selling at the moment but because properties have been selling so quickly it means there’s more development happening and the market can change so quickly,” she says.
WBP’s Pabst is often dumbfounded by investors who put down a deposit and take out a loan equivalent to $600,000 or more but don’t seek independent advice. “When you buy shares you can examine their historic performance, yields and dividends; many people seem unaware with property you can do the same thing,” he says.
C:\Users\Executive Officer\Google Drive\In the News\Articles\smartinvestor - How to avoid the high-rise value trap 140507 Matthew Smith.docx 5/12/2018 1