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15 Jul 2020

What to look for in an investment property?

By Damon Frith For the long term investor the best time to buy is when your ready

COVID-19 cast a pall over the housing market with a number of commentators and institutions predicting 30 per cent or greater falls in the property market. Such an outcome would be concerning for the economic outlook.

A healthy property market is a cornerstone of the economy. The Australian housing market was worth $7.2 trillion at the start of the year, which is many times larger than the entire market capitalisation of the Australian share market.

Its importance is mirrored in the federal government’s $700 million HomeBuilder Scheme announced in June to provide incentives for new home building or renovating existing homes.

The primary aim of the package is to create construction and associated services jobs, but the impact of the activity generated will have additional broader economic benefits.

In mid-July it was reported there had been 40,000 applications for the grant, with residential construction activity shifting back to pre-COVID-19 levels.

It's painting a picture for property that is far from grim. CoreLogic’s monthly data showed consumer sentiment to property recovered to pre-COVID-19 levels in June, and it was reflected in a 29.5 per cent increase in sales volumes nationally over the month.

But much will depend on the path of the economic recovery. If the expected U-shaped recovery occurs, we could be back to pre-COVID-19 economic activity in 12-18 months. We already know official unemployment numbers will worsen in coming months, so government stimulus to generate economic activity and job creation will be key to the eventual shape of the recovery.

A quick recap of property prices

From 2008 to 2017 Australian property prices soared, particularly in Sydney and Melbourne. In Sydney the price of the average home topped $1 million in July 2017, before falling to $865,000 in June 2019, according to CoreLogic’s price data.

In January this year CoreLogic was again expecting average prices to soon top the $1 million mark, as property prices were fueled by a combination of low interest rates and lower serviceability tests for loans.

Those expectations were brought to an abrupt halt by COVID-19, as isolation measures introduced across the nation resulted in auction clearances rates falling to the lowest levels on record.

It resulted in many economists and property market commentators indicating that expectations of rising unemployment and loan serviceability issues would lead to an extended property slump, as the economy took years to recover.

To date, it’s not playing out as a looming property crash. Australian Bureau of Statistics data show across Australia property prices rose 1.6 per cent in the first quarter of this year, and were up 7.4 per cent over the same period last year.

More anecdotal evidence coming from auction data shows prices are holding up and even increasing in some areas, and falling in others.

What’s it mean for an investor

For investors, property is a long term asset, and with all such assets there is a golden rule: ‘Don't try and time the market, and buy when you are ready.’

The global financial crisis of 2008 was a salient lesson of how long term investing can help people look through the noise of current events, no matter how loud it is.

"When you look at capital growth returns over the 10 years following the GFC and factor in rental income, housing returned quite strongly compared with other asset classes," says Cameron Kusher, CoreLogic’s Head of Research.

So what should investors be looking for in today’s market?

Hunt for yield

Typically investors seek a high rental yield from their property. Gross yield is calculated by taking your annual rental income and dividing it by purchase price of your property, then multiply that figure by 100 and you will have a rental yield.

To get a net rental yield deduct expenses associated with the property from your rental income. Redo the calculation and you will have your net yield on the property. To state the obvious, the lower your purchase price and the higher your rental income, the better your yield will be.

In January average rental yields in Sydney and Melbourne were at record lows of 3.1 per cent and 2.9 per cent respectively. Once you take inflation and taxation into account, there’s not much income left, so even long term investors need to factor in low cash flow, potentially for an extended period.

Capital growth is good, but it’s not the key driver

But remember, you are not buying an investment property just because you think it’s in an area of rising prices.

“As an investor, you really should be looking for rental yield. But most people bank on capital growth," explains Kusher. "When housing stock goes up, you need to be confident you can rent your property and keep your tenants."

Within Sydney and Melbourne, there will be pockets of higher yield. Look for areas with high rental demand – near universities or major employment hubs like hospitals, for example. Or look outside these markets. In June, national rental yields came in at 3.73 per cent.

Kusher says it’s also good to remember reported yields assume the property is occupied 52 weeks of the year. "Rental markets are still relatively soft – rents are declining in Melbourne, Brisbane, Canberra and Hobart for example, and across all capital cities rents were down 0.6% last year."

Stick to the basics

If you’re unfamiliar with an area, it pays to do your homework first – look at past yields, and check plans for infrastructure, business investment and developments in the area.

As well as looking for areas with greater tenant demand than supply, positive signs for future growth include:

  • Population growth (check Census data)
  • History of good capital growth over 10 to 20 years (CoreLogic’s data can guide you)
  • New infrastructure such as recreational facilities, retail centres or better CBD transport (ask the local council)
  • Improving local employment (plans for new hospitals, corporate centres and improved transport to employment hubs)
  • Signs of gentrification (look for renovations and council programs)

Beware of oversupply

Kusher urges caution if you’re considering investing in off-the-plan units in inner city locations. "Be very choosy with the type of property, especially in Melbourne and some parts of Sydney, as a lot of new stock has come onto the market in recent years.”

He recommends reading local papers and council records to check plans for new developments, and looking for locations and developments that will appeal to families as well as other types of tenants.

"The risk of investing in a big development is that if another investor needs to sell quickly to free up cash, their asking price will impact all the other units, he says"

Focus on the future

With the cost of borrowing so low, Kusher believes this is an ideal time for investors with equity to look at buying a property they might want to live in during retirement.

If you want to look at regions outside of capital cities that’s ok, and may provide better value. But keep in mind options for tenants to commute, and enjoy the facilities and lifestyle benefits of the region.

Damon is the content editor for Citi’s wealth business.

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