Defence housing: danger zone

For sale to investor

Four bedroom, 2 bathroom house at Bomaderry, Nowra, New South Wales. Close to bus, shops and schools. Yours for $365,000 with guaranteed rent of $280 a week.
Or'¦
In Melbourne’s South Morang, a four-bedroom gem for $440,000 – 12 year lease and guaranteed rent of $350 a week.
Both properties virtually maintenance free

Sound familiar? Sound too good to pass up? Sit down, take a deep breath and get ready for the bad news.

The selling and managing “agent” for the above properties, advertised online, is the Federal Government’s Defence Housing Authority (DHA). Judging by the number of questions I am receiving from Eureka Report subscribers as to whether these deals constitute a good investment, they are doing a good job on getting their message out.

Traditionally, defence housing has been pegged at an affordable rent level or subsidised by the Government. It looks to me as though the Federal Government has reinvented the DHA as a commercially driven real estate agency and is keen to see private investors funding its defence housing requirements and at the same time generating ongoing revenue by charging exorbitant fees as the “managing agent”.

The DHA either builds or sources the properties – generally less than 10 years old – close to defence force facilities, and integrates them into the general community. Those properties are then sold to investors at a non-negotiable price, which the DHA states is “based on independent market valuation, taking into account costs, overheads, end of lease 'make good provisions’, and the security and value provided by the DHA.” The owner can’t unilaterally increase the rent and the monthly fee to manage the property is often twice as high as the usual market rate.

Prospective buyers should be looking at market prices for comparable properties and in the event that DHA prices are higher, carefully checking the detail of what costs, overheads or end-of-lease provisions they are paying for. I don’t quite know how you would calculate a monetary value for “the security and value provided by the DHA”. The DHA markets its properties as having “no maintenance hassles”, but does not detail what it offers in this regard.

Then, there is a rental guarantee – in most cases 10 to 12 years – with the rental income clearly stated. To access this package, the investor will pay a management fee of 16.5%, inclusive of GST, of the gross rental income per month for a house. For an apartment, unit or townhouse, the fees will be 12–14%. In the private rental market, the usual management fee is 7–8% plus GST.

Draconian terms

On a house returning $1120 a month, the investor is left with $935.20 per month for the DHA property, as opposed to $1027.60 (based on a management fee of 7.5% plus GST) for a private rental. One wonders why the DHA seems to feel it can dictate such draconian terms when in many parts of the nation, agents' fees are subject to negotiation. In Victoria, for instance, rental management agreements state that agents’ fees are subject to negotiation and this often occurs, in the investor’s favour, where an investor may have several properties or has been a long-standing client of the agent.

DHA investors can sell the property at any time, but the DHA will insist on certain conditions in regard to how it is marketed and you will take your chances on the open market when it comes to price at the time of sale.

While the DHA urges investors to take a long-term view of their property purchases, the million dollar questions hinge not only on the accuracy of asking prices and the cost of ongoing management and resale conditions, but on the crucial issue of correct asset selection. It is asset selection, incorporating scarcity value, land value, location and demand versus supply that is going to return steady long-term rental income, capital gains and equity build-up. As I have said many times before, properly selected, sought-after investment property does not need rental guarantees because underlying demand underpins consistency of rental demand.

The locations currently being advertised to investors include Ashtonfield/Newcastle and Nowra in New South Wales or Albany Creek and Carseldine in Queensland. Melbourne has properties in Bittern, which is commuting distance from Hastings and Cerberus. These are not areas generally noted for their consistent capital gains. Sales prices range from the low $300,000’s for a house to about $750,000 for a property on Sydney’s lower north shore, or in the mid-$600,000’s for a Canberra property. Many properties are in new housing areas with lowish land values, which means the bulk of the price is in the structure as opposed to in land value borne out of high demand or scarcity value. This also makes it difficult to assess a growth track record over time.

And so to the bottom line? Why would an investor buy an investment property that a) is overpriced and non-negotiable; b) comes lock, stock and barrel with exorbitant management fees at twice what you would expect to pay for even a premium service level in the private market; c) that effectively excludes resale prospects to most of the available buyer pool of owner/occupiers and many investors; d) excludes any tenant that is not a DHA employee; e) as an owner you can’t opt to occupy yourself or rent to a tenant of your choice; f) is dependent on the DHA to continue its operations at a viable level in that location for the very long term g) usually lacks architectural scarcity and; h) is located where land values are generally low because widespread, underlying demand is often absent.

The DHA does include a disclaimer in its material that suggests prospective investors seek independent, professional advice before investing.

Now that is good advice.

Property Q&A

This week's questions cover

• Investing in the NSW highlands.
• Whether to furnish an investment property?
• Locating investments in Melbourne.
• Selling out in north-west Sydney.

Investing in the NSW highlands

I just sold my two-bedroom investment apartment in the Sydney CBD for $1.3 million. I want to invest some of this money into a few smaller properties again. But I am very attracted to buying 110 acres of beautiful land for $470,000 about two hours’ drive from Sydney. It has 360 degrees of stunning views. I am worried that it wouldn’t be a good idea as an investment for capital growth. Would it be better to buy inner-urban property with similar capital input for the better growth.

From a lifestyle perspective this sounds idyllic, but if it is capital growth you are after, then there is no contest. The inner-urban property, as long as it is properly selected and located in areas of high demand and limited supply, will outperform the wider marketplace, outpace inflation and show far greater capital growth, especially if it is underpinned by high land values and the style of building has some scarcity value.

I suspect that the rural land has captured your heart for its sheer beauty and its low price tag for the amount of land involved. Are you comparing what $470,000 would buy in the Sydney metropolitan area? If your primary purpose is to make money, then focus on how much capital growth you can buy for your money in a high land value location. Put the emotion aside and consider from an investment point of view: what is the future for this piece of land? At two hours out of Sydney, it is not within easy commuting distance.

While you are waiting for it to either become a lifestyle option for yourself or appreciate in value as an investment, there is no income and therefore no tax relief, but you will be required to maintain it. Even supposing that at some future stage it may be split into smaller lifestyle blocks, assuming there would be local government planning permission to do so, is this really the type of risky, high-cost project you want to take on, especially if investing for long-term growth is your key priority?

Furnished or unfurnished?

I recently bought as an investment a one-bedroom unit in Sydney, within 12 kilometres of the CBD. The agent told me that I could get an extra rental of $100 a week if the unit is furnished. Is it wise to furnish the unit before renting it out?

It is not uncommon to see units in the CBD advertised as furnished and being rented for more than an unfurnished apartment. Ask your agent exactly what they are basing this advice on and whether they have a consistent, long-term pool of tenants looking for furnished accommodation in the location of your unit and what type of tenants they are. If this pool of tenants is predominantly short-term, such as executive expatriates, the cost of maintaining the furnishings may not be worth the extra rent. Furnished apartments often limit the pool of tenants you can attract. Calculate what it will cost to fully furnish the unit up to a level that would inspire a tenant to pay that much extra a week and take that into account. These furnishings will have to be maintained and probably replaced about every five years – perhaps more often, depending on the wear and tear. As a rule, I tend to advise investors against furnishing apartments.

Where to in Melbourne?

I am looking to buy an investment property (a small house) in the inner suburbs of Melbourne. I will have $600,000 to $750,000 to spend and I am deciding between inner bayside, inner east and inner north. I realise the various suburban markets fluctuate over time, but could you make a general suggestion as to which direction from the city is likely to achieve good capital growth over the next five to seven years?

Each of the areas you mention offer optimal growth assets within selected pockets. However, unless you understand the key selection criteria that apply to choosing a high capital growth property, you would still be flying blind. Areas two to 12 kilometres from the CBD are underpinned by high land values and ongoing high demand and limited supply. Even if you do concentrate on one location within the inner zone, you need to focus on a property with architectural scarcity that is in the right location (right street, complementary surrounding uses) and with good proximity to infrastructure such as public transport, schools, health and leisure facilities. With $600,000 to $800,000 to spend, I would probably narrow the search down to the bayside and inner east, given that the financial capacity – especially at the upper end of your range – is better deployed in the absolutely prime part of the inner zone.

Selling in Sydney

I am in a quandary about whether to sell an investment property I bought in early 2002 on the north-west suburban fringe of Sydney. It wasn’t such a great investment, but the question is whether to sell now or wait until the demographic flow in this area takes greater root. My fear is if interest rates go higher, these sorts of area often seem to be worst hit, as you suggest. If I sell, I will suffer a small loss or break even and it would release funds to make new investments. If I wait, rents may go higher, but I have significant interest payments to make, despite negative gearing.

I suggest you cut your losses, sell now and redeploy your funds into a higher land value, higher capital growth location. The western suburban fringe of Sydney is, according to the 2006 Census figures, main Australian Bureau of Statistics indicators and a range of other social studies, the hardest hit location in Australia when it comes to fallout from interest rate rises and low housing affordability. Prices on the western fringe have dropped in many areas and shown very little or no movement in others. This is unlikely to change in at least the medium term. Remember that the further out you go from the CBD the less your land value becomes – and, it is high land value driven by demand that perpetually exceeds supply that underpins values in the long term. On the outer fringe, a greater proportion of your value is contained in the building rather than the land and buildings depreciate. Waiting for demographic shifts can be an extremely long and frustrating process and in the meantime, you are losing valuable time in terms of capital growth.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in depth information that is specific to their situation.

Monique Wakelin is co-founder of Wakelin Property Advisory, www.wakelin.com.au, a Melbourne-based independent property acquisition and advisory company, and co-author of Streets Ahead: How to Make Money from Residential Property.

Do you have a property question for Monique Wakelin? Send an email to monique@eurekareport.com.au