What’s on the horizon?

A city skyline is easy to imagine. It’s simple to see the tall buildings in your mind’s eye, stretching straight up to the sky. A skyline is dynamic, evolving over time, almost as though it has a life of its own. Yet, from our perspective on the ground, it all takes place so slowly. Over time, we grow accustomed to the cranes perched atop the newest building, the ever present clatter of the tools and workmen moving purposefully around the building site. We may not even notice any progress at all until one day when the lack of activity draws our attention to another ready to rent high rise building.

How did we get here? What reasons are there for such a monumental change in our cities?  More importantly, are they sustainable?

Manufacturer led proposition

Let’s take a closer look and try and make some sense of it all.

Currently, it’s estimated that there will be around 94,000 surplus dwellings, mainly high rise apartments, across Australia. The majority are going to be located in Melbourne and Sydney simply due to the size of the markets.

This surplus amount does a number of things. It makes the selection of a property based on availability very easy indeed. Imagine that you have decided to buy a property in your SMSF and your only selection criteria was availability. You would be very happy indeed to see these sort of numbers. You may even be convinced that BECAUSE there are so many apartments coming on line you should take advantage of it. It all seems very easy and I certainly understand the appeal of easy.

But is easy the right methodology to use when investing your hard earned money in property?

Surplus numbers also affect the market as a whole. They create a lack of demand and 94,000 is a huge number. To put that into perspective, imagine the suburb you live in now, completely vacant. How long will it take for that figure to come down to a sustainable number and create demand again?

Maybe we should look a little more in depth about why it’s happening in the first place.

What we are seeing is a manufacturer led proposition. The current situation is occurring partially because Developers are taking the easy way out and building up rather than out. It’s easier to build 300 apartments on one site than 300 houses on 300 sites. It’s also easier to fund a high-rise project because of the Banks emphasis on pre sales. Targeting overseas buyers as well as marketing OTP apartments as a viable option for SMSF provides potential Lenders with an indication of public interest in the project.  As long as there is the perception that OTP apartments are satisfactory for a SMSF we will continue to have this problem. At least until any market self-correction occurs  perhaps?

Don’t get me wrong. Developers are not doing anything illegal. They believe that building these apartments will bring them a profit and at the end of the day that’s the name of the game. The Banks for their part quite rightly ask for proof the project will be completed. The simplest method to achieve that is to set a percentage of apartments that must be Pre sold from the project.

Pre-Sale requirements

For these projects to get off the ground, a pre-sale ratio of 60% must be achieved. In a building with 300 apartments, that’s 180 pre sales. Imagine the vigour and potential lack of ethics the sales channel associated with this development may employ to get it funded and to adhere to the developers profit goal. Whose best interest is at play here?

Usually, the sales channel predominately sources 30% from its immediate domestic network and overseas interest, with the balance outsourced to local real estate agents looking to make a quick sale and commission.

The integrity of the apartment building is lost with this approach as it is all about sales and it undermines the buildings original appeal and proposed point of difference, particularly with having the right balance of owner occupiers. The community feel of an apartment building, so important to attract tenants, is compromised by the lopsided sales strategy. It’s important to note that rental income in an area is decided by the disposable income of the tenants, the higher the capacity there is to pay, the higher the rental yield possible. If the target tenant of an apartment building is lost through the clumsy presale efforts mentioned earlier, would the projected rental yields be achieved once these apartments are finished?

The benefits of buying early can include reduced stamp duty, potential capital growth while the project is completed and of course profit in the long term. Naturally, this relies on growth, sustained growth, which is usually projected forward from historical data. Presales are simply a tool the Bank uses to ensure the project has enough market interest.

Are the Banks complicit in their funding models?

After all, the Banks don’t want to be left holding the bag if something goes wrong.  Even though presales are an important part of the Banks risk management position, they would also have data indicating the likely effect of dwelling numbers coming into the market.  Given that, you could be forgiven for thinking that the Banks believe there is no issue because they keep handing over the money. 

However, the Bank is not concerned with the Developer making a profit, their only concern is that the Bank itself doesn’t lose money.

So surely they would know that the project could well be undermined by the looming surplus.

Wouldn’t it make sense for them to limit exposure to certain types of borrowers as a good corporate citizen?  Is it wise to accept presales if the majority are for SMSF investors and off shore buyers? Does that make the Banks complicit in any correction to prices as a result of the known oversupply? 

How can we protect someone from making a mistake? If the Banks are not protecting us what can we do?

I believe the missing piece here is advice

Is an Apartment SMSF suitable in the current market?

A Financial Planner has a fundamental obligation to help the client get into a better financial position than they currently have. This is spelt out in the Best Interest Duty requirement.

All the data we have access to say there will be a surplus of apartments. Why then, would anyone buy an apartment inside a SMSF? Clearly, when a surplus of stock leads to a lack of demand, limited number of tenants, higher vacancy rates, and a possible loss if a sale is required,  which equals poor investment, questions need to be asked.

A manufacturer led model promotes only one product, not diversity or choice. While there is a known surplus of apartments it’s also obvious that there is a shortage of House and Land products.

Can you guess where the profits are in a manufacturer led model? Not in the hands of the investor….

How would advice change the property purchase dynamic? Well, imagine if it was compulsory for formal financial advice to be provided on the benefits of buying a property, any property, in a SMSF? Currently it is a requirement for a SMSF to obtain independent financial and legal advice concerning the proposed loan but not whether the property is fit for purpose.

Would raising the issue of surplus apartment stock change the focus of novice investors?  What form would this advice take and who would be able to provide it?  These are all interesting questions facing us at the moment.

Perhaps the answers will be forced upon us if there was to be major losses within the superannuation industry.

Demand is for House and Land, Townhouses and Off The Plan

The clear feedback we are receiving in our workshops from property investors and consumers alike is that they want house and land. That’s houses, town houses and units, either fully built or OTP. There is also a universal acceptance that apartments are in oversupply. In other words, it’s obvious.

Interestingly though, even with growth rates predicted to be around the 3 – 4% range for the next decade, property is still the investment of choice. There is a confidence in property that goes beyond mere facts and figures. High returns from capital growth are not the driver here.

People believe they can rely on bricks and mortar – there is a long held belief in the strength of property in the Australian psyche. The type of property sits at the core of that belief so it’s important to choose wisely.

The desire for house and land is just as strong as it has been. The difference is in the vision of the Developer. The shrinking house block is a result of developers squeezing more and more out of the available land rather than consumers demanding smaller back yards. The quest for profit is always going to be strong. Just take a look around; even the streets are getting smaller.

Change usually occurs when current circumstances demand new solutions to existing problems. After the GFC, ASIC introduced consumer protection legislation that reshaped the Mortgage industry.  Financial Planning was subjected to a similar overhaul when relatively small numbers of people lost their Superannuation. What questions would be asked if large numbers of SMSF holders faced the prospect of losing money through poor property choices? More importantly, what action would be taken?

Is there an event coming?

What sort of event could occur to make property subject to similar checks and balances?

Could falls in the price of OTP high rise apartments cause such a public uproar that Governments would be forced to protect consumers with more regulation? Superannuation is a sensitive subject anyway and losses to SMSF’s could provide the impetus to Legislate the Property industry.

When it is all said and done, perhaps the safest move is to buy where the real demand is.

If you want to know what areas can work well for investors you should work with someone who has the data you need.

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Investors Direct Financial Group (IDFG) was established in 2001.
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