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Investors have been driving property prices higher on the back of record-low interest rates.
Property prices have risen by about 50 per cent in Sydney and Melbourne since the start of 2009, says researcher RP Data.
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In the apartment market, which is favoured by investors, prices have risen by about 11.5 per cent in Sydney over the past year to September 30. In Melbourne, which is still suffering the effects of oversupply of inner city apartments, prices have risen by about 5 per cent.
Baby boomers investing with an eye to retirement and home owners upgrading to a bigger or better house have sidelined first-time buyers. Investor housing loan approvals account for almost 40 per cent of the total value of housing loan approvals, the highest share in 10 years.
However, property analysts expect price rises in Sydney and Melbourne to rise in-line with, or a little in excess of inflation over the next several years as interest rates start to rise.
Rate rise tipped
A major reason for the strong rise in prices is interest rates at historic lows.
But analysts are expecting the cash rate and, therefore, mortgage rates, to start rising within the next 12 months.
Robert Mellor, the managing director of BIS Shrapnel, is expecting a rise in the cash rate of about 1 percentage point by the end of 2016.
Due to competition in the mortgage market, mortgage interest rates will probably not rise by the full one percentage point, he says. “We think that the headline (or advertised) variable mortgage rate may rise from 5.95 per cent now to about 6.8 per cent”, Mellor says.
That is not much of a rise by historical standards. However, because of the large size of the typical mortgage even a modest rise in interest rates will affect affordability, Mellor says.
Forecasts contained in QBE’s Housing Outlook for 2014, conducted by BIS Shrapnel, shows Sydney dwelling prices are expected to rise only by a cumulative 9 per cent over the next three years, or only marginally above inflation.
“Momentum” in the Sydney market could see stronger price growth this financial year with even less growth in prices in the two subsequent years, Mellor says.
He is “less positive” on Melbourne with a forecast of only 5 per cent cumulative growth in prices over the next three years. And, after strong price rises during the winter months, it looks as if property markets are already starting to cool. RP Data says that prices were almost flat across the five largest capital cities over September.
The levelling in price growth over September is largely attributed to slowing of growth in Melbourne and Perth, with both of these capitals recording a slightly negative result over the month of September.
“It remains to be seen whether these softer conditions will persist throughout the rest of spring,” says Tim Lawless, RP Data research director.
John Edwards, the founder of researcher Residex, expects price rises to slow and consolidate through 2015; rising in line with inflation. He says, for would-be investors there is “no rush as there will be good opportunity in 2015, once the market moves into a consolidation phase”.
Mellor says Melbourne is a particularly segmented market. There is continuing oversupply of apartments in Melbourne’s central business district, Docklands and Southbank, Mellor says.
There is even a risk that prices of inner Melbourne apartments could fall by 5 to 10 per cent over the next three years, he says.
Louis Christopher, managing director of specialist property researcher SQM Research, agrees that investors should be wary of Melbourne inner city apartments. He favours apartments in South Yarra and St Kilda as likely to provide good capital growth over the long term.
He is positive on Sydney apartments overall. However, investors need to be careful not to overpay, he says. “Some developers in Sydney are pricing [their apartments] at top dollar and getting it,” he says.
“Some are charging in excess of $14,000 per square metre for off-the-plan, which is full on,” Christopher says. Richard Wakelin, Director and founder of Wakelin Property Advisory in Melbourne, says it is land values that drive capital growth.
Wakelin says the best bets are apartments in small blocks – 10 to 20 unit blocks that are within two to 10 kilometres of the Melbourne central business district. He favours older apartments (and “character” houses) in areas where no more apartments are being constructed.
“Fads” should be avoided, whether it is Gold Coast units, time share or opportunities in booming mining towns, Wakelin says. He is wary of off-the-plan property.
“In Melbourne, we can count the number of multi-unit high rise blocks that have actually worked for investors,” he says.
“All the enticements, rental guarantees and all of the glossy stuff can be thrown out the window if the asset is not sound,” Wakelin says. John Edwards says it is “easy to overpay for a property at this point in time and over payment will not be covered by increasing property values over the balance of this growth cycle”.
Novices on notice
First-time landlords need to consider the tax and financing issues of owning a property at the outset.
“Many of these issues need to be considered before purchase, such as ownership structure,” says Peter Bembrick, tax partner with accountants and advisers HLN Mann Judd Sydney. Other issues include how the property is to be financed.
Many investors take advantage of “negative gearing”.
This where is where the costs of making the investment, such as interest on the mortgage are greater than the rent from the property, the shortfall can be used to reduce income tax paid on the investor’s other income.
Bembrick says a loss is a loss, even if there is some tax benefit and positive gearing is preferable.
Investors who negatively gear are hoping to be able to eventually sell the property for a price that more than makes up for the losses incurred along the way. Bembrick says it is very important for would-be investors to be able to cover any shortfalls in cash flow.
“For example, the impact of inevitable periods when the property does not have a tenant, as outgoings still continue even if the residence is empty,” Bembrick says.
Consideration should be given to whether some, or all, of the mortgage should be at a fixed interest rate in order to help reduce the impact of future interest rate rises, he says.Beware of spruikers
Property spruikers and mortgage brokers are tapping into the booming self managed superannuation funds sector.
Their pitch is that investors can hold investment property inside a SMSF and enjoy superannuation’s confessional tax rates.
Some are showing disregard for investors’ individual circumstances, says John Hewison, managing director of Hewison Private Wealth, which has many SMSF clients.
Those who do not have the money in their super fund to buy an investment property outright are being advised to take out a mortgage. Hewison says borrowing to invest inside super can be an appropriate strategy for high net worth individuals.
However, younger investors with minimal account balances are encouraged to borrow large amounts of money in order to buy properties in their super funds, Hewison says.
Older people, who should be risk adverse and who will need to draw an income stream in retirement, are also being led down the path of gearing property, Hewison says.
Richard Wakelin is also concerned. Super is a nest egg that most of us are relying upon for a comfortable retirement, he says. “Unfortunately, there are companies that are using the growing interest in SMSFs to market sub-investment grade property developments to the public,” he says.
“We’re worried that many of these investors will suffer losses that could compromise the investor’s retirement lifestyle,” Wakelin says. Anyone thinking of going down this path should engage a reputable, independent accountant or financial adviser to look at their specific circumstances, Wakelin says.
They should advise you on the merits of establishing an SMSF and using it to invest in residential property, he says. The Australian Securities and Investments Commission and the prudential regulator of SMSFs, the Tax Office, have issued repeated warnings to the public about property spruikers targeting the trustees of self managed funds.Real estate giant moves into advice
News that one of the biggest real estate agencies, Ray White, intends to establish a financial advice arm has sparked concerns it would be used to help facilitate the sale of real estate and mortgages to people with self managed superannuation funds.
The White family owns a string of real estate agencies across Australia, and also owns a mortgage broking business and an insurance business. These are commission-based businesses.
The new advice business, Wealth Market, which is expected to open before Christmas, will be part of the mortgage broking business, Loan Market.
Sam White, the chairman of Loan Market, has said that, initially at least, Wealth Market will focus on providing “insurance opportunities” as well financial products from an “approved product list” to clients.
“Our advisers will not be recommending properties to our clients,” he said.Action planDon’t invest for the tax breaksBeware of spruikers recommending property inside DIY super fundsUnits in smaller blocks can offer a higher land value component.Lower-priced properties will often have higher rental yields, but may have lower capital growth.Factor-in higher interest rates from the current record lows.Consider fixing whole or part of the mortgage, though there may be costs if the loan is terminated early.Make sure there is sufficient cash flow to cover temporary loss of rent
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