04 Dec Residential vs Commercial | Same property – two outcomes | Property correction
Jan Somers details her reasons for advising investors to look first at investing in residential property and not commercial property and she has a one word reason.
What happens when property markets correct? Not crash but correct because as Michael Yardney points out, that is what is likely to happen.
Margaret Lomas explains why positive cash flow property investment is not a strategy and how the same property, if owned by two different investors, could deliver a totally different outcome.
Finance broker Andrew Mirams tells us what valuers look for in a property and then we get a valuer to tell us about adding value to a property. Gavin Hulcombe tells us what works and what doesn’t.
Property investor and TV host Chris Gray has some tips on safe property investing.
Kevin: Earlier in the show, we were talking to Gavin Hulcombe from Herron Todd White, who was talking about what improvements to a property actually add value. There is another aspect about values, and I want to ask this question of a financier, and that is what, in his opinion, do valuers look for in a property, and what are the key things that he’ll look at.
Andrew Mirams from Intuitive Finance joins us.
Andrew, thanks again for your time.
Andrew: My pleasure Kevin. Thanks for having me.
Kevin: In your experience, what is it that valuers look for? What’s going to impact the valuation of a residential property?
Andrew: There are a couple things that a valuer would look at. Probably the first key is the way it’s presented, it’s aspect, is it neat and tidy, is it in a good state of repair, or is it run down, does it need work? All that sort of things a valuer will look at.
If instructed from a bank, they’re looking at how do they get out? If the client can’t meet their payments and they have to sell it, what’s their get out? How do they realize the property to get their funds back?
The first thing to get a great valuation is present your property really well. Tart it up. Make it neat and tidy, as if you’re almost preparing it for sale. So that’s probably the first tip: when someone’s having a valuer come around present the property as if you’re going to go sell it.
Kevin: That’s a very good point. I just pick you up on that, too, I think valuers will look at it very, very commercially so you take the emotion out of it and they’ll look at it as a buyer will look at it.
Andrew: Absolutely – and/or an agent would want to sell it to attract the best possible price. If you’re trying to get a premium for your property, please present it in a great manner. Also, it doesn’t hurt to have some evidence with you of how you might have arrived at that sales figure.
Andrew: I guess in terms of getting to a figure, just what do they look at? There are a couple of methods they’ll use. The first one’s called a comparable or comparison method. The second one is called a summation method.
With the first one, really what they’re looking at is your property might be a three-bedroom, two-bathroom, two-car-space in a suburb in Melbourne, Brisbane, Sydney, wherever it is. They look at like properties that are selling as yours, with a similar aspect, similar finishes, and what sort of market or what sort of salability they’re going for in your market. That’s pretty much how they get to a comparable.
On occasion when we get a difference of opinion, I guess it always comes down to a valuer’s opinion of what a comparable is and what a client and/or financier’s opinion of what a comparable might be.
The second method I said was a summation method. Really, that takes into effect the value of your land, the value of the improvements – it’s the house, pool, garage, landscaping, anything that might be in nature architecturally or anything else like that in relation to the property.
For example, in Melbourne, you can often get a great premium for your Edwardian, Victorian places with the beautiful lattice and things like that, if they’re presented really well because they’re unique and they have a rarity or scarcity factor.
They’re the two methods that people look at, Kevin, when all the value they look at when they’re looking to make a decision.
Kevin: Do they use a combination of both of those methods or is it one and/or the other?
Andrew: It’s probably fair to say a combination, but that’s really property specific, then. It’s probably fair to say they’ll use the summation to look at what they think it would cost you to buy that land and put those improvements on it.
I think that needs to be supported by “Does that stack up in the market in terms of what other places that are similar to these level of improvements and features that are getting in the market, as well?” It will generally be a combination.
Kevin: Yes. That second one that you mentioned is something you can have very little influence over is. The size, the shape, the location, the views – all of those are built into the property, you can’t change them. But you certainly can have some impact on that comparison method.
Andrew: Absolutely. The level of your improvements and how you maintain them, as I said earlier, is probably the real key that you can have an impact over.
Just because you’ve had your first and second child there, and that’s emotional for you, that doesn’t matter to the valuer. People aren’t going pay a premium for your memories; they’re going to pay a premium for the level of features and what the market is dictating at the time.
When a valuer does go in, if you said, “Well, how then does a valuer arrive at this decision?”
often before they even go to a property, in terms of a residential property, they’ll do some research on the land, what size, and they’ll have an idea of what like properties are doing.
Then they’ll generally visit a property, if they’re doing a full valuation, go around take some photos. That’s where I have plenty of examples of valuers, if they think it’s a bit short of what a client’s opinion is, they’ll take a photo of a crack in the wall or the dishes lined up on the sink, mate. So that’s why I’m saying, have it cleaned up.
Kevin: Yes. Good stuff.
Andrew: They’ll measure the allotment of the land, they’ll look at other physical improvements, and the level of the finish, and then they’ll generally prepare and provide their report on their assessment. That’s how they arrive at a residential valuation.
Kevin: Very good insight there from Andrew Mirams at Intuitive Finance; and a great website, too. You can always link to that through Real Estate Talk, the website there. Andrew, of course, has his own channel and that will take you through to Intuitive Finance where you’ll find a lot more blogs and articles, as well.
Andrew, thank you so much for your time.
Andrew: My pleasure, Kevin. Thank you.
Kevin: Median-priced urban investment properties make the safest investment. That’s according to Chris Gray, one of our experts, who joins me.
Good day, Chris.
Chris: Hi, there. How are you doing?
Kevin: Good, mate. Chris what are your tips for investing in these areas; these median priced areas?
Chris: I think the main thing is to use the research companies like Residex, RP Data, or SQM Research – all of those guys. Those guys are people who study the markets for decades and decades, so they have a really good idea.
You can then suddenly use those guys to find out what are the blue chip areas, what are the median prices in those areas, and then check your affordability to see what you can actually afford.
I know Residex for one – and I never get a dollar for this – they do a top 100 report for rents or capital growth, which costs about $250. I reckon it’s a nobrainer to buy one of those reports and just double-check what you’re thinking of investing to see where it comes up in their top 100.
Kevin: Well, based on your experience, where do you find the properties that actually perform better than others?
Chris: I think the main thing to realize here is I’m looking 10 to 30 years, so I’m not looking for the latest, greatest thing that might flip for a year or so. I typically stay away from the CBDs because there’s no limit of supply. You can keep building these massive tall towers, and they keep getting taller and taller. There’s a limited demand because not many people want to live in the heart of the city.
Typically, it’s my general rule of thumb to be roughly 5 to 15 Ks from the capital city anywhere in the world, because that’s where most young people with money want to live. It’s close to the beaches, the cafés, the parks, the schools, all of that kind of stuff. Generally you get [1:36 inaudible], so if there’s no supply and there’s plenty of demand, basic economics says that’s going to lead to price rises no matter what’s happening in the economy.
Kevin: Tenants being happy are pretty important to you. We spoke to you a few weeks ago about a recessionproofing your investment. One of the points you made is to make sure that your tenants are happy. If you do, then you can apply those rent increases, as well, Chris.
Chris: Exactly. My target market for my properties is to get 20 to 35yearold suits, because they, basically, work in the city, they probably earn sixfigure salaries, they probably have wealthy parents, they have massive disposable incomes, and they worry about where they want to live.
They don’t want to commute. They don’t want to spend hours doing stuff. They want to be next to the parks, the clubs, the restaurants, and the leisure, so I think they’ll pay whatever price it takes.
What I even knew when I invested 20odd years ago when I was 22, was I thought if you have a good job you’re going to pay your rent because you don’t want your boss finding out that you haven’t paid your rent and you’re deep in debt. That attitude seems to have worked for the last 20 years.
Kevin: You’ve developed quite a good portfolio over the years. I know even from this chat that you look to the long term. How important to you is it that you look at an investment property that if you needed to sell it, it would sell well – that is, it’s popular in that particular area?
Chris: I reckon I could sell my whole portfolio within a week, and I reckon I’d get 95% to 100% of the value, maybe even 105%. Again, one of my keys is that I buy at the median price level for that area.
Chris: I want 80%of the population to be able to afford to buy it or rent it, because then I know it’s in massive demand.
Kevin: Yes. We quite often see medians improve, and people think that this is an improvement in price, but it’s actually just a reflection of the fact that people are buying in that popular price sector. While it may increase in price, it doesn’t necessarily mean that values are going up.
Chris: Yes. I bought in 1990 just before the Olympics when I first immigrated to Australia in Fuju, a few beaches down from Bondai. I paid $360,000. Everyone said, “Chris, you’re mad. You’ve paid over the odds. It’s going to collapse after the Olympics.” But I knew young professionals could spend that kind of money.
Now that same unit is a million dollars 15 years later, so it’s doubled and then some maybe another 50% or so. A million dollars sounds like a lot of money, especially to people outside of Sydney, but for the local area, people can afford it.
At 4% or 5% interest rate, it’s $50,000 a year mortgage. If you get two young 30yearolds on $100,000 salaries, they can afford $50,000 a year in payments.
Kevin: Chris’s website is http://www.YourEmpire.com.au.
Chris Gray, thanks for your time.
Chris: My pleasure.
Kevin: I often wonder with property whether or not there are any improvements you can add to a property that would always add value, and which, in fact, are the ones that don’t add value. I’ve spoken to a lot of investors who believe putting in a pool is going to add a lot of value, maybe adding another bedroom might do just that.
Let’s try and find out from a valuer what he believes does actually give you extra bang for your buck when you’re doing renovations.
Gavin Hulcombe is the chairman of Herron Todd White Trading and also Queensland managing director for Herron Todd White.
Gavin, thanks for your time.
Kevin: Gavin, in your experience, are there any areas of a property that will always add value?
Gavin: I think I’m always a bit cautious about saying always, but I think there are areas where you have the best potential for adding value. I think if you start focusing on the kitchens, the bathrooms, outdoor living areas, that’s what really draws a lot of the lifestyle decisions that people make.
That’s what they see as being most important, so I think if you do it right and if you do it well and you don’t get too carried away in terms of over-capitalization, I think they’re the areas that I’d be concentrating on.
Kevin: Are there some areas that are purely there for lifestyle that probably won’t add any value? I’m citing here pools as an example.
Gavin: Of course, that’s always the first one that comes to mind. That’s a lifestyle decision not a financial decision in most cases. They look great, they’re great in the summers and those sort of things, but it is really a lifestyle decision; it’s not a financial decision.
As a general rule of thumb, you would like to get about half your money back on a pool, depending on where it is. Tennis courts can be a bit the same, albeit you don’t fit tennis courts on most suburban blocks. Yes, there are a few things like that, which are really about improving the livability rather than adding value.
Kevin: What about things like double garages or even adding a bedroom to a property?
Gavin: Look, it’s one of these things that is a bit difficult to generalize. Certainly, the second garage is really important, particularly if it’s a family area and the expectation is that you want to be able to garage two cars. Then yes, in those areas, the second garage is really important.
There are other areas where lifestyles are changing. People are saying, “Well, actually I don’t need a car.” If you’re living near city locations and everything’s within walking distance or there’s good public transport, then the second car is less important. Again, you probably just have to do your research and understand the local drivers of the market, rather than getting caught up in generalizations.
Bedrooms, they’re often expensive. Any additions like that often will cost you more on a rate per square meter than what you could buy the original property for. But I think one of the things to really take into account is the cost of selling the house and buying another house verses adding additional rooms or extensions.
On a $500,000 house, the transfer costs alone are something like 7.5% of that, so it’s a substantial cost that you lose just by selling a property and buying another one. Sometimes if you step back and say actually, if you reinvest that money into an extension or modifications, you actually end up better off rather than selling and buying again.
Kevin: I think you make a very good point there, too, and that is looking at some of the additions you can make to a property. It probably depends on its location. As an example, an outdoor living area is probably going to be more attractive in, say, a Queensland market as opposed to a Victorian market or an area where it’s a lot colder. Would that be true?
Gavin: Absolutely. And even aspect – if it’s a northeast aspect where you’re adding your living area, then that becomes very livable. If it’s direct west facing or it has no outlook, then the added value is perhaps limited.
Yes, it is the specifics, but as you say, quite rightly, if this is an area where it really does facilitate outdoor living, ala Queensland, then that’s where people want to be, and certainly, they will pay more for it there then somewhere where you’re exposed to the elements and it’s just not a very pleasant environment to sit.
Kevin: Gavin, thank you so much for your time. It’s been great talking to you.
Gavin: You’re welcome. Thank you.
Kevin: Is Australia’s property market really a precarious house of cards waiting to topple? Well, there’s a lot of debate at present raging. Some say that the future for property is bright, while others suggest that the markets are set to crash.
Obviously, if you’re considering investing in property or about to buy a home, it would be really good to know who’s right – and history does actually teach us some great lessons. What can we learn from the past that we can take forward into the future?
Michael Yardney from Metropole Property Strategists has been looking at this for us, and he joins me.
Michael: Hello, Kevin.
Kevin: Michael, what lessons can we learn from the past? The market probably isn’t always going to move forward.
Kevin: There are times in the past where it has actually checked. What have we learned from that?
Michael: Well, no, it’s not going to keep moving forward, Kevin. But I guess the first lesson is our markets are fragment. There’s not one property market. There’s where people get it wrong to start with.
Not only is each state its own state of its property cycle, but, Kevin, even within each state there are different market segments behaving differently. Some of them are geographic, some of there are different price points or different types of property.
The first lesson is there isn’t one property market, and we have to define more clearly where we’re talking about
Kevin: You know, there might be another lesson here, too, Michael. Firstly, is there a bubble? And just because there may be a bubble doesn’t always necessarily mean that it’s going to burst.
Michael: Well, some people say it’s a bubble because house prices are high and unaffordable to some. But you’re right, Kevin, that doesn’t mean it’s a bubble, and it doesn’t mean it’s going to burst.
I think we could take some lessons from what’s happened in the past, because it’s likely that the future will repeat itself in one form or another.
Kevin: Has there ever been a time, Michael, where the market has checked?
Michael: Well, the market’s corrected. If we want to be honest about crashing – in other words, where it’s dropped significantly, albeit for a short time – it was after the Second World War and during the Great Depression.
Our financial markets were very different then. The world’s circumstances were. In the 1940s, house prices dropped 17% over a twoyear period. But, Kevin, they jumped back and grew strongly afterwards. And you can understand during the war why that could happen.
Of course, in the Great Depression when unemployment was high, property prices corrected significantly, as well. But, Kevin, no one is suggesting there’s a depression on the horizon for Australia. Sure, our economy is slowing a bit, but it’s still the envy of most developed nations.
Kevin: Michael, what’s happened at other times when the market has actually corrected?
Michael: Corrected is what normally happens, and to understand what’s ahead, let’s have a look. Sydney was in a terrific property boom between, probably, late 1990s and the end of 2003, early 2004. It was one of the best performing property markets for that period of time; helped by the excitement of the Olympic Games.
But after this boom, the Sydney property market corrected. Kevin, it didn’t collapse. It just corrected. Property values dropped from their peak by about 9% or so, but, Kevin, it didn’t happen instantly, either – it took 23 months to play out – and of course, not all parts of Sydney’s property market dropped in value equally.
Again, if you look at what happened in Brisbane and Perth where values peaked in around 2008, they had a really good run in the middle of the last decade, but again, property price didn’t collapse. They just sauntered along for a while allowing fundamentals to come back into alignment.
Much the same happened in the 1990s. I know you and I lived through those difficult times, the recession we had to have after a huge property boom in the 1980s, and at that stage interest rates rose to 17%.
Kevin: I know. Yes.
Michael: But, again, properties didn’t collapse; they just flatlined for a few years as affordability, supply and demand, and all those other economic fundamentals caught up.
Maybe just going back in our memories, most of us will remember, not that long ago, property prices peaked in late 2010, and that was the last time the Reserve Bank pushed up interest rates to slow our property markets down. In general, in the capital cities property prices gently eased; they didn’t plummet.
Now, of course, if you’re looking at certain very specialized markets, like the mining towns, like the holiday destinations, Kevin, like some regional areas where there isn’t a lot of depth to the market by owner-occupies, yes, in those locations, property markets can drop in value significantly – and we’re seeing that. But in the big locations, Kevin, unlikely to have a crash.
Kevin: Okay, Michael, thank you for your time. We will catch up and we’ll talk more about this in future shows, as well.
That’s for your time, Michael.
Michael: A pleasure, Kevin.
Kevin: Inside Jan Somers’ book “More Wealth,” chapter eight actually deals with a very interesting subject, and it’s a question we get asked from time to time: why should investors choose residential property rather than commercial property?
The author of that book joins me. Jan Somers, hello. How are you?
Jan: Hello, Kevin. How are you?
Kevin: Fantastic. Thank you, Jan.
Now, the reasons behind that?
Jan: Well, there’s probably just one word and that’s called risk.
Jan: Risk, just like the insurance ad, things become risky and they’re not worth doing. Now, it doesn’t mean to say you can’t make money out of investing in commercial property, but in my experience and my observations, it’s a lit bit hitandmiss – not a little bit, very much hit and miss.
Kevin: Do you need a different mindset for it, Jan?
Jan: Yes, you need a personality that can cope with the ups and downs of a commercial market.
Kevin: Yes. Because unless you get that tenant and property mix right, you can have some pretty long vacancy periods, can’t you?
Jan: Very long vacancies. In fact, I can pinpoint back in 1992 when I was traveling a lot and back and forwards to Brisbane and Sydney and Melbourne. I don’t think I’ve ever seen so many vacancy signs in my whole life. In fact, I was virtually paying people to come and rent their commercial premises in Melbourne.
Kevin: When you have to cut deals in commercial, as well, because you go into such long leases, these deals can really drag their heels for you for quite a number of years. It also impacts the value of the property, as well, Jan.
Jan: Well, exactly, because the value of a commercial property is based on its actual lease, so if you have a property that’s vacant for a long period of time, that certainly isn’t worth very much as far as the value of that property.
Kevin: Is it wise, do you think, Jan, to have a balanced mix, or do you think it’s either one or the other?
Jan: I tend to go for one or the other. I would probably put some even holiday units and apartments verging on that commercial rental frame, because it’s very much up and down, too, and depends very much on the economy. It doesn’t matter whether the economy is up or down; people need somewhere to live, but they don’t necessarily have a place to go to work.
Jan: I tend to stick to residential. I would have to admit, whenever I ventured any further, I can’t say exactly I’ve got my fingers burned, but then the pie hasn’t grown, either.
Kevin: Yes. Is there a better time to be looking at commercial rather than any other time, or does it depend on the marketplace?
Jan: Yes and yes. There is a better time, and it does depend on the marketplace; but I don’t know when that time is, and I doubt that anyone knows when that time is. I guess the time to buy is when the prices are down, and that’s when no one is renting.
If you could have bought those properties that I saw vacant in Melbourne back in 1992 and held on to them for a few years, you would have made significant gains. But, of course, no one wants to buy when the place is vacant, and of course, that’s the time to buy because the value of the property has been deflated so significantly.
Kevin: I wonder how many people actually are in business and decide that it would be a good idea to buy their premises, and it probably is for that reason.
Jan: I think it is. I think it is. It’s probably about the only time that it is a good time to buy property – when you have a business and you’re the owner of that premise, because you get control over it. You don’t get told what to do, what you can do, what the rent is.
People who do own their own land and buildings, when they have a business, it’s probably one of the few times I’d recommend that you do own commercial property.
Kevin: Indeed. It’s a great read. It’s called “More Wealth.” It covers a whole multitude of topics, and you can access that book by going to Jan’s website, somersoft.com.
Jan, always a pleasure talking to you. Thanks for your time.
Jan: My pleasure, Kevin.
Kevin: I remember talking to Margaret Lomas from Destiny Financial Solutions about this time last year. I said, “Margaret, how is cash flow? How do you see cash flow as a strategy?” and you rightly pointed this out to me.
Hi Margaret, how are you going?
Margaret: I’m going really well.
Kevin: Cash flow is not a strategy; it’s more an outcome.
Margaret: Exactly. I know when we did talk about this last year, you asked me whether or not it was possible for people to use positive cash flow as strategy for buying property, and I said to you then that the thing about positive cash flow is that it isn’t a strategy; it is simply a tax outcome. And because all property is different, then it’s a tax outcome that will also be different for each individual investor.
Let me give you an example. Let’s say you and are were going buy a property and we found a property next door to each other. We’re going to buy them to the same price, they would rent for the same amount, and fairly similar properties.
But Kevin, you’re very wealthy, and we all know how much money you earn, so you’re in that top tax bracket. And I’m a poor, struggling writer, so I don’t pay very much tax at all. I’m right in that bottom bracket.
Also, you happen to get one that has an upgraded kitchen, it’s had a brand new bathroom, so you’ve got a bunch of onpaper deductions that I can’t get out of my property because I don’t have those kinds of deductions available.
The bottom line for both of us will be very, very different. Even though we’re getting the same purchase price and the same rent return, you may well get a positive cash flow because you’re going to get back more of your tax dollars because you pay more tax in the first place, plus, you have all that onpaper, which you don’t pay anything out for but you get some of your tax dollars back for.
On the other hand, I haven’t paid much tax, so there’s not much to get back. I’ve got nothing on paper, so my property is likely to be negative cash flow because I didn’t have those tax dollars to plug up the gap between income and outgoings.
Kevin: It’s a very good example, Margaret.
Let me ask you this question. People who look for positive cash-flow properties, would you say they’re more risk adverse – they just don’t want to take that risk?
Margaret: Maybe. Let’s just sort of talk about how people go through that process, because people call me all the time and say, “Look, I want to buy a positive cash flow, and I only want to buy a positive cash flow.”
What that mean is they’re seeking a property that’s going to be able to give them enough money that they’re not really dipping into their own pocket. That’s really what their strategy is and that’s what they’re aiming to achieve.
Now, we need to understand, as I just said, all properties are different. There is a basis that you can start on, though. Some properties, no matter how much tax you get back, will probably still be negative if it’s got really low yield.
And if we’re in a really low interest rate environment, then that makes it hard to get positive cash flow too, because the more money you pay in interest, then the less money you’re going to have left over to meet all of your other costs.
If we’re in a low enough interest rate environment, and if we also can find areas where the rent returns aren’t too bad – say 5 to 6% in the minimum – then we could also find properties that have a decent amount of onpaper depreciation – so they’re properties that are a little bit newer – then you have a better chance of getting a positive cash flow.
Now, the other thing that people have to understand is that first of all, it’s unusual and unlikely for you to find a positive cash flow property that’s positive cash flow from day one. When you first buy a property, remember that at that point in time your expenses are going to be as high as they’re ever going to be, and your rent is going to be as low as it’s ever going to be.
Over time, rent goes up and expenses go down because you start to repay debt. So a property that’s negative cash flow can become positive cash flow within a couple of years of buying it. That’s the first thing.
An investor should probably seek out a property that’s likely to become positive cash flow as soon as possible, because it’s already got good rental yield. But the trap that investors fall into is in looking for this positive cash flow, they often buy areas that don’t have anything else going for it.
Margaret: The important thing to understand about cash flow is cash flow might keep you in the market because it means that you are not financially burdened by a property, but unless there are other things about that area, such as the growth drivers that I always talk about, then if the property never grows, then you’re not going to achieve anything because it’s the growth in the asset that get you out of the market when you retire. You have the build up a net worth in order to be able to afford to leave the paid workforce.
Kevin: Now, you talked about growth drivers there. You and I have chatted on previous occasions, and if you only go back and search through some of the interviews that I’ve done with Margaret, we actually do touch on those key drivers.
Margaret: There’s so much information out there at the moment, yet still, we have too many of the property experts hawking the same message. They talk about things that really are relevant in terms of whether or not a property is going to perform well for you.
People still buy property emotively, as well, so they still want to buy property according to one they can get for a good price, or one that they think they can get a rental return for without having to look at what really drives growth and the importance of those growth drivers.
Kevin: Margaret, once again, thank you for your time. It’s always great talking to you.
Margaret: Thank you.