19/01/2011
Question: My husband and I own our home in a blue chip suburb in Brisbane; we bought it in 2003 for $790,000 and were told a year ago (by agents and bank) its value would be $1.1m. An identical house in the same street recently (two months ago) sold for $1.35m, so we assume ours would actually sell for around that too. As we are now living overseas, the house is rented out for $850/week. The rental return is therefore about 3–3.5% and the capital growth has been about 8%pa.
We are considering selling this house since the yield is low, there is a lot of money in one asset, we won’t return to live there, and CGT is now applicable. Although high-end property is meant to be underperforming generally, it seems the price has increased a lot and we’re thinking of offloading this asset and investing the money in two or three lesser-value properties (ie, diversify, reduce risk, and get higher yield). Will the costs (I estimate $35,000 in selling costs and $40,000 in buying costs) of doing this make it not worth it?
The other part of the scenario is that we recently bought a property with development potential for $500,000, which is renting out at $320/week. We plan to get development approval and either on-sell it, or develop it ourselves with some (four to five) townhouses to keep and rent out. Feasibility analysis shows it’s worth doing. My question is what would be the most balanced way to move forward, given our medium-term goal is to have several properties growing in value and eventually producing income for us to live off?
If we keep our ($1.35m) home, we could borrow against it to finance the development of the other property; if we sell it, we could use the cash for the development, or borrow against the two to three lesser properties we would buy (see above) and still develop. What seems to be the best scenario, or are there other ways to use our assets and/or equity that we should consider?
Answer 1: There are a number of elements to consider from your question, so let’s tackle them one at a time.
You are correct in stating that the higher-valued properties have under-performed recently, but that is just what happens during the slump stage of the property cycle. At Metropole our research suggests that higher-value properties will rebound in 2010. I don’t know all the details of your property, but you suggest it is in a ‘blue chip’ area and this suggests it will have a level of scarcity, which means your property should outperform the general market in the long term. As property is a long-term investment and you own a good property in a strong capital growth area, and it already has proven itself to return strong capital growth, I would not be selling because of its short-term poor growth.
As for the low rental yields, I see residential property as a high-growth, low-yield investment, so your returns don’t surprise me. Remember, as a property investor you get your returns in four ways:
- Capital growth – in line with the general market
- Accelerated growth – the capital growth you ‘manufacture’ through renovations or development
- Rental returns
- Tax benefits
While you need a combination of all of these to have a balanced investment, you are getting lots of capital growth and this is tax-free, so once again I would not be selling this particular property because of its yield, which is in line with what I would expect from a well-located property.
You also mentioned diversification, but I have found that successful investors don’t diversify; they find an area of investment they become good at and specialise. So once again I wouldn’t sell so that you can average out your returns with some smaller properties. You own a property that has shown good long-term growth – stick with it.
Putting all this together and then adding the buying and selling costs, on balance it seems like you should retain your property.
Congratulations on your purchase and for moving into the exciting stage of property development. If your plan is to grow a substantial property portfolio, then property development is a great way to speed up this process.
I don’t know the details of your property or the profit that can be achieved from the development, so my answers must be general in nature.
I have found property development to be a great way to create or ‘manufacture’ capital – so my preferred strategy is to buy, develop and then refinance the end product (your new townhouses) and hold them as a long-term investment, rather than to adopt a trading strategy.
Sure you could add value to your site by obtaining development approval, and I’ve seen people make good profits with on-selling development sites, but this tends to happen during the boom phase of the cycle when developers (many of them inexperienced developers) are prepared to pay a premium to get into the market. In general those who have made good money out of their development project have completed the development, refinanced the project based on its new higher values and then kept the units or townhouses as long-term investments.
I can’t give you a specific answer on how to best finance your development project, as I don’t know your circumstances, but in general banks will only lend you 60% of the cost of a four or five unit development project, which means you are going to have to come up with around 40% of the project cost from your own resources. I would also suggest you set aside a buffer amount for contingencies (there are always unanticipated expenses or cost overruns in a development project) and for rising interest rates.
Finally, I should caution you that a four or five-unit development project is an ambitious undertaking for your first development project, especially as you are overseas. You are going to learn 80% of what you need to know about property development through your first two or three projects, and I would like to see you get through those initial projects successfully, so that you can move on to this type of larger venture.
Considering the fact that finance is easier (the banks will lend you a higher loan to value ratio – up to 80%) and the risks are less on a two-townhouse project, maybe you should cut your teeth on a less ambitious project.
Gavin Taylor
Gavin Taylor is a director of Metropole Property Investment Strategists. An architect by profession, Gavin has over 20 years’ experience in property development.
Answer 2: Congratulations on your astute purchases to date.
For most people I recommend a ‘buy and never sell’ strategy or ‘buy and hold’, but you have clearly moved into the value-add stage of property development.
Because you have so much of your assets tied up in the Brisbane ($1.35m) property (at an inevitably low yield), in your position I would sell Brisbane (market it with a high-end agent). If held in personal names, half of the profit (of around $500,000) should be exempt from GST and the other half ($250,000) taxed at your personal tax levels. (If it was your home for some time, you should be able to adjust the ‘purchase price’ to its value when it became an investment and so reduce GST). Since you are currently living overseas, it would be wise to consult a tax consultant before selling – but beware if he offers property advice!
Depending on your current mortgage (I assume it is still over $500,000), this should free up (after CGT) at least $675,000 after the sale.
This could allow you to either:
- Purchase three to four suitable investment properties (hopefully with at least 60% gearing) totalling $1.5m. This could achieve your diversification, reduced economic risk and much higher yield. It would be cashflow positive immediately but, with depreciation and amortisation, you shouldn’t be paying much tax
- Undertake the four to five-townhouse development. I would normally encourage this, but it needs a lot of supervising (and trust in the builder/ professional team), especially if it is your first development. Can you achieve this from overseas, even with some trips back? I assume the development property is in Brisbane.
If you have read my seven Your Investment Property articles, you will be aware of the detailed research I undertake (I am ex-Reserve Bank Research Dept, economist for Australian Post, treasurer of Telstra and 18 years in directorship roles in merchant banking). I am totally convinced that the best Australian capital city to invest in (over the next five to 10 years at least) is Melbourne. This is just starting to emerge in the latest median house and apartment price results (Melbourne was up an annualised 21%-plus in the June quarter of 2009).
Victoria is the only state that charges stamp duty on the value of the property when contracts are signed (eventual Stamp Duty is around $2,500 instead of $20,000+). For example, with an off-the-plan purchase, a 10% deposit in cash secures the property, at the purchase price, until settlement in 18–30 months (depending on the specific project).
This allows substantial leverage in terms of the number of properties that can be acquired, and very significant capital gains prior to settlement (because now we are clearly in the upturn phase of the property cycle – which is always the fastest capital growth phase) while the developers of these projects have been able to negotiate very competitive building contract prices over the last six to 12 months due to the GFC.
Malcolm Reid
Malcolm Reid is a property developer, licenced real estate agent and accredited mortgage broker. He is a former economist for the RBA and Australian Post.
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