Property Newsletter November 2012

Beware the Hype: 6 Marketing Traps Investors Get Sucked Into

When it comes to deciding how to spend your property investment dollar, there are many options from which to choose, from established houses to off the plan apartments and everything in between.

As if the decision wasn’t difficult enough, there are also many people and organisations out there trying to sway your decision in their favour with an avalanche of marketing messages competing for your attention and ultimately your wallet.

The major problem is that many of the products these people are selling are fundamentally flawed and will ultimately underperform, as many investors have unfortunately discovered. So how do you avoid being sucked into acquiring a dud investment? Here are 6 of the main marketing traps you should look out for:

1. The big budget campaign Property marketers are typically smart people. They know how to grab the attention of buyers and are prepared to spend big money to make whatever they are selling seem very appealing.

Anyone who has ever bought an apartment off the plan will be familiar with the glossy brochures, artist impressions, detailed research reports, full page advertisements and 3D models that often accompany a sales campaign. And these tools can be very impressive. Quite often they will tell you what a great investment the property will be.

The key thing for astute investors to realise is that the more money spent on a slick marketing campaign, the more developers need to charge to recover all the expenses. Just because there is a big budget marketing campaign doesn’t mean it’s a good investment.

2. Incentives and kickbacks An incentive is a great way to encourage people to commit to a property purchase, whether it is a rebate, brand new car or furniture package. The thing to remember with any incentive is that the value of the incentive has already been factored into the price of the property. If you’re getting a $30,000 rebate on a house and land package, you’re likely paying at least $30,000 too much for the property, even if you think you’ve negotiated a good deal.

Property investors need to remember that quality investment properties, i.e. those for which there is a genuine demand, don’t need incentives to sell.

Kickbacks work in the same way but are not as obvious. A developer or building company will often pay a salesperson, which could be an advisor or marketing company, a commission of up to $40,000 per sale. As with incentives, kickbacks artificially increase the price you pay for the property and should set off alarm bells for investors. Nothing is free. If anyone says they are helping you build your wealth and there is no charge, you can be almost certain they are getting paid by the seller and working for them not you.

3. Guarantees and big claims Any guarantees that promise a particular investment outcome or that are designed to reduce the perceived risk of an investment should be clear warning signs for investors.

The classic example is the rental guarantee. Although a guaranteed rental income (for a short period of time) may seem enticing, it probably masks the fact that there isn’t a strong rental demand for the property. Worst still, the total amount of rent that is “guaranteed” is often built into the price of the property anyway.

Similarly, promises of extremely high rental returns could be designed to distract investors from the fact that the property has little potential for capital growth. These claims generally have little substance to them and almost always fail to mention the high risk that may come with the high returns. Investors should always ask why the developer needs to offer this guarantee.

4. The location trap A lot of products targeted to naive investors and first home buyers are located in parts of the country with little potential for upside. These are often areas with abundant supply of land, poor economic drivers and a lack of infrastructure, which hold back capital growth.

Many first homebuyers buy a house and land package on the outskirts of the city with a plan to get their foot on the property ladder and later upgrade to a better location. The problem is that because these locations have abundant free land and a constant flow of newer properties coming to market, the capital growth rate underperforms the market.

Property is about demand and supply. If there is lots of potential supply then the growth rate may suffer and it means there are better property investment options available.

5. Too much in the building Logic dictates that when investing you should seek out a property with a high proportion of land value as this is what will drive capital growth. With new property, however, most of the value lies in the building component and not the land, which will hamper capital growth as the building depreciates.

The 30 year old property on a good size block in the middle of suburbia might not look too glamorous when compared to a brand new property, but chances are it will make a far better investment over the long term.

6. Buying for tax reasons Some products, such as properties sold under the National Rental Affordability Scheme (NRAS), are often promoted for their tax advantages. This marketing approach is ultimately designed to distract investors from less favourable aspects of the investment, such as its location or potential for capital growth.

Investors should never base an investment decision solely on the impact it will have on their tax return. Tax deductions should be considered a welcome bonus of investing but tax is one of a number of factors investors to consider, not the main factor.

Conclusion Property investors should always bear in mind that the more marketing activity surrounding a particular product, the more red flags should go up. It’s always wise to ask the question ‘how hard is the seller or developer trying to convince me to buy?’ I’m not saying that all heavily marketed investments are automatically bad. However, noticing these marketing techniques should at least drive you to do your own independent investigations. Slick marketing is no substitute for quality research. Just because the sellers and selling agents tell you it’s a great investment doesn’t mean it is.

Perth Gains Best in the Country Perth house prices have increased more in the last year and quarter than in any other Australian city, according to data from Residex. The market could also be heating up further with September figures showing growth in Perth is ahead of Sydney, Brisbane, Melbourne and Adelaide. House prices have increased 6.63% over the year, with a 13.41% jump in the number of sales to 24,707. Rents for houses have also increased dramatically, up 21.52% for the year to $480 per week, which is double anywhere else in the country. REIWA president David Airey believes higher rents, a low rental vacancy rate and strong population growth will continue to put pressure on property prices. He also sees positive signs in the first home buyer market, which tends to underpin the rest of the market. “First-home buyer grants for the September quarter were at their highest level since 2009, before the first-home owner grant boost ended, and now account for around 30% of sales,” says Airey.

Acquisitions: Location or Type of Property – Which Should you Choose First? Two of the most important decisions you can make when buying an investment property are (1) where to buy, and (2) what type of property to choose. But which decision should come first?

Some investors choose a specific location and then find a property in that location that meets their budget and criteria. Others will have a specific property type in mind and will be far more flexible with regard to the location. Let’s have a look at whether any of these approaches is better than the other.

There are many types of property an investor can choose including houses, villas, townhouses, and apartments. Plus, you could easily divide each of those categories further,  such as new houses and old houses, which can offer very different things to an investor.

It’s understandable why an investor might decide on a property type before choosing a location because of the inherent benefits and burdens associated with each type. Certain types of property, such as apartments for instance, can provide excellent rental returns but they may also come with additional costs (e.g. strata fees). Houses, on the other hand, might cost more to buy and hold but could provide better capital appreciation.

Similarly, new property can provide impressive depreciation allowances, but buying this type of property can mean choosing locations on the outskirts of the city that are likely to offer less in terms of capital growth potential.

Buying an established villa might be a great option for an investor as it offers a good balance between land value and rental return. But a villa might not be a good choice in certain suburbs where the demand heavily favours another type of property.

It would seem therefore that a location should be chosen first. However, choosing a location first could also be problematic. For example, an investor might not be able to afford the right type of property in a chosen location and end up buying a sub-standard asset that is either inappropriate for the market or that has fundamental issues associated with it (e.g. being on a main road).

In the end, the choice of location is arguably more important in determining the long term success of an investment, though it’s difficult to separate it entirely from the decision of property type. Both decisions need to happen in unison and ultimately be based on the investors goals, budget and appetite for risk.

Property Management: A Risky Friendship There may be times as a landlord when you personally meet and directly converse with your tenants. You may even get to know them quite well and start forming a friendship, or perhaps you were even friends before they became your tenant. But is it a good idea to be friends with your tenant? Some would say it’s a good thing as there will be mutual trust and better communication and understanding. Plus, it may even encourage the tenant to stay in the property long term.

However, there are very good reasons why it isn’t advisable to get too friendly with your tenants. For instance, tenants may get too comfortable and start asking for favours, such as delaying their rental payments or bringing a pet into the property. And you as the landlord may find yourself being easier on them with some matters such as how they are maintaining the property.

When the boundaries between landlord and friend become blurred, it could easily open a can of worms, especially if something goes wrong. What will you do when the neighbours complain about loud parties at the property? How will you handle a serious breach of the lease agreement? It might be tough to evict a friend.  It’s absolutely a good idea to be courteous and treat your tenants with respect, but being friendly is very different from being friends. So by all means, feel free to send your tenant a Christmas card but perhaps don’t invite them over for Christmas dinner.

Always keep in mind that owning an investment property is a business, and it’s rarely a good idea to mix business with pleasure. The tenant-owner relationship should almost always remain at arm’s length. That’s where a professional property manager is essential, to help keep your business on track, remove the emotional component in decision making and act as the ideal intermediary when handling issues.

Wealth Protection: I’m Ok, I Don’t Need Insurance

Many people think ‘It’s ok I’ve got Workers comp… I don’t need any more insurance!’ or ‘I pay enough taxes, the government can pay for me if something happens.’ Well do you think if these people really knew how much they would get this will still be their response?

As at September 2012 the payments from Centrelink would be the following;

Centrelink   Payment Type If you are Maximum   fortnightly payment
Sickness   Allowance Single, no   childrenPartnered $492.60$444.70 (each)
Carers Payment SingleCouple $712.00$536.70 each
Disability   Support Pension SingleCouple $712.00$536.70 each
Bereavement   Allowance* You are paid   for up to 14 weeks after the death of your partner $712.00 a   fortnight which includes a pension supplement of $60.60 a fortnight

Compare that with what you could insure yourself for in the domestic market:

Type Maximum Amount   Payable
Term LifeAccidental death cover No Limit$1 million
TPD $5 million
Trauma $2 million
Income ProtectionAccident Only IP Up to $30,000   monthly benefitUp to $30,000   monthly benefit

I am sure if asked yourself would you CHOOSE to live on $492.60 per fortnight your answer would be probably be no…

How much do you need to service lifestyle expenses, living expenses, debt expenses, medical expenses and how much would you receive right now if something happened?

If you don’t know or are concerned about the answer then come in and have a chat as to what insurance can provide a better alternative to the above.

Justin McManus is a Corporate Authorised Representative of Marsh Pty Ltd Australian Financial Services Licensee No. 238983. This information has been prepared without taking account of your objectives, financial situation or needs. Before acting on this information you should consider its appropriateness, having regard to your objectives, financial situation and needs

Development: The Pay Off for Converting to Strata-Title Have you driven past one of those old run down blocks of flats recently and thought “what an eyesore?” Getting council approval and converting old flats over to strata title could make you a tidy profit, meaning that “eyesore” could in fact be a goldmine.

Strata titling of old units is a unique strategy used by some savvy developers to make great gains. And although the likelihood of finding these opportunities is becoming slimmer as the years go by, they are still available with some shrewd investigative work (and a bit of luck!).

Strata titling was first introduced in the 1960s. Before then, it was virtually impossible to own a portion of a property. Most blocks of units or flats were effectively owned in full by one entity, with the individual units leased out. Strata titling enables you to subdivide the units, meaning each can then be owned by individual persons or entities immediately adding value (and flexibility) to the property. Despite strata titling being introduced in the 1960s, it’s quite typical to find opportunities even in property built around the 1970s or thereabouts.

Of course, as with every development, there is an element of risk to this strategy. You need to be confident that you’ll be able to get the necessary approval from council to make it all worthwhile. The first obstacle is making sure the property was originally built as a block of flats, or converted with approval. You’ll also need to make sure the current zoning will allow for strata titling. If the area has been down zoned it may mean that you can’t strata title the property and you will have to keep it on one title.

Adhering to current building practices and codes is the other major and costly hurdle. You may need to comply with a range of council requirements which could include things like firewalls, visitor parking, private open space for residents, and meters for services like electricity and water housed in a common area with each property being on an individual meter. Even just getting the necessary access to address any of these potential requirements can be one of the biggest risks of all.

Finding one of these gems and successfully navigating the approvals process can potentially reap financial rewards. But finding these types of properties is certainly not easy. Often they are silent sales so it pays to get a buyers agent with good connections and let them know what you’re looking for.

Finance: Comparing Loans Beyond the Interest Rate With all the news about interest rates recently, it’s not surprising that many borrowers seem obsessed with them. There are the people that typically choose a loan on the interest rate alone. This can be a costly mistake. You’re not necessarily better off by going for the lender with the cheapest rate. Even if two loan products seem very similar on the surface, they may in fact be very different.

It’s important to not just look at the interest rate as the deciding factor between various loan options – differences in the small print can mean thousands of dollars difference between two loan products.

First, the interest rate quoted may be similar or may be the same. If you will be selling the property rather quickly, you should investigate paying higher interest rates with lower application costs and exit costs. There are other costs that may be added on but may not be immediately noticeable. You need to read the fine print and determine exactly how much you are paying and see if you can convert application costs to interest rates and vice versa. Once you understand these components, you need to compare the interest rate using the Comparison Rate. The Comparison Rate gives a clearer idea of the true interest costs after taking into account all the fees and charges involved in establishing the loan. The term of the loan is also very important. You also need to be aware of any early repayment penalties that are associated with the loan.

At the end of the day you will have to make a decision on what you consider is the best loan for you. If you are able to obtain some of the features that are important to you then the fact that the interest rates is a little bit higher shouldn’t scare you off. For instance, if you got a higher loan to value ratio, it may be worth an additional half a percent interest rate. A good finance broker will be able to steer you through all the alternative options and help you find the most suitable loan for you.

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