Market Comment – Monday 31st May 2010

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No surprise over the weekend. The Melbourne market continues to defy doom and gloom. Even with a record number of auctions, clearance rates remain above 70%. But the real numbers to look at are the total number of sales. Up over 1300 reported sales amongst unprecedented volumes of property on the market.

This categorically shows that the underlying factor of massive demand with a dramatic undersupply of total available properties will mean property prices in Melbourne will continue to steadily climb over the next five years. At the next state election in another four years I can foresee housing being a, if not “the” key election issue that will decide who will govern the state.

Whilst we may see the RBA leave rates on hold tomorrow due to consumer sentiment and other states property markets not fairing as well as Melbourne’s, it will not be long before the underlying pressure puts rates up again.

Investors who are looking for the safety of property need to watch out for property spruikers; Those “advocates” who will tell you “you can have your cake and eat it too”. I was reading an article last week where an advocate said there was no correlation between high rental returns and potential capital growth. What she forgot to mention is risk! If there were properties that have a positive cash flow, excellent capital growth and were “as safe as houses” then every one of these would instantly be bought by every major superannuation fund in the world. No non institutional investor would ever get a look in. The only way to get high rental yield and high capital growth is increase risk: i.e. Buy where capital growth is not usually found and hope for the best (regional areas, mining towns, outskirts of major capital cities etc)

Can some high rental return properties achieve good capital growth? Of course! Do some long shots win the Melbourne cup? Yes! But you are strongly betting against the odds. You may end up tying up your deposit funds in areas that “may” start to return capital growth in ten years, but more than likely will not. Does this mean you have lost money? No, it just means you have not made any.

Take the example of two different suburbs and their respective 30 year history of growth. Elwood has long had stable rental returns and good capital growth. If you purchased a property for $500k and received rent at $350 per week, even with no rental increase for 10 years, whilst you would have an average shortfall of $200 per week, if you sold the property, paid Capital Gains Tax, agents fees and the shortfall in rent each year etc you would pocket a little over $920,000.

Conversely, Melton has an average annual growth of around 7%. And whilst you could never get it, let’s look at a rental return of $700 per week, double that of Elwood (this is simply to show a positive cash flow, no matter how unlikely it is to get it). If you used the same purchase price of $500k, or bought 2 properties at $250k, you would be looking at about $10 per week positively geared (in other works you would not have to find any money each week). After 10 years if you sold the property and paid Capital Gains Tax, agent’s fees, the extra money you have received each week in rent, you would have around $407,000.

If you go for the high yield option, you will miss out on two things. Firstly, whilst you have not lost money, it is the opportunity cost that hurts; you will be $500,000 worse off. Secondly it is very difficult to grow your property portfolio, as your equity is growing very slowly. If you had the Elwood property, most banks would lend against this property within a couple of years. As the rental return grows, this would allow for a further property whilst costing you no more out of pocket. The exponential effects are astounding.

The argument that most “advocates” will use to go after high yield is the fact they can get you finance easier. They can buy these properties very easily: WHY!!! Because the smarter investors are not buying them!! If you can get high growth and afford to negative gear then you will be substantially better off in the long run.

If you are think about purchasing a property either for investment or to live in please feel free to contact our office. There is no obligation and the first meeting is free.

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About the author

Ian has been operating his own businesses for more than 25 years. During this time the self taught lessons of building the business, dealing with staff, suppliers, clients and economic woes have been invaluable. Ian is a fully licensed Real estate Agent, a member of the REIV and registered with the Business Licensing Authority.

Buying property is not just sticking up your hand and outbidding your rival. It is an emotional, fiscal and psychological decision that needs to be planned and well executed. Ian is usually involved in over three hundred property negotiations per year; ranging from the $250,000 first unit purchase for a young couple to multiple million dollar residential developments. Ian's business background and endless numbers of negotiations make him one of the industry's leading negotiators.

Ian is married with two adult children, living in Patterson Lakes. He is a keen fisherman when weather and business allows the time.