Dismal Docklands

At 200 hectares, Melbourne’s Docklands precinct is Australia’s largest urban renewal project. Attracted by slick marketing campaigns that highlight Docklands excellent location and the promise of rental guarantees, stamp duty savings and depreciation benefits, thousands of investors have already invested in Docklands residential apartments, believing they have made a quality investment.

The problem is that the investment has failed. While the rest of Melbourne has enjoyed a boom, Docklands property values have fallen.

The graph below shows that, notwithstanding short-term peaks and troughs, median value for Docklands fell from $492,450 in the second half of 1999 to $422,500 in the same period of 2004. That is a 14 per cent tumble (source: Valuer General/REIV). By contrast, the median values in established inner-suburban areas of Melbourne have continued to climb. For example, apartment value in Armadale rose from a median of $175,000 in 1999 to $300,000 in 2004 (70 per cent). In the same period in Sydney, the Glebe median value increased from $298,000 to $540,000 (80 per cent).

Source: Valuer General/ REIV

Since 1999, more than 1900 properties have been bought in Docklands. Disappointed by lacklustre capital growth, many owners are now trying to sell. At time of writing, 164 properties in Docklands, representing almost one in 10 of properties purchased in the precinct, were advertised for resale. It is an alarmingly high level of stock for sale compared with the established inner suburbs, where the figure is around 2-3 per cent.

On top of this, Docklands vendors will have to compete with several thousand new properties that are expected to come onto the market over the next decade.

What is going on? Why such a gulf between glossy promises and grim reality?

It all begins with land

Unlike many other projects that seek to redevelop rundown areas on prime land originally settled for residential purposes, Docklands has been built on industrial wasteland. Because there was no pre-existing demand for residential use, this land was worth far less per square metre than prime residential areas such as Hawthorn in Melbourne and Mosman in Sydney.

Not only could developers purchase land cheaply, but state and local governments, keen to encourage development, made it easier for them by making generous planning provisions.

This enabled developers to build more units on each site. The more units per site, the more profit the developers made when they sold them to investors and owner-occupiers. This was a boon for developers. But what about the buyers?

Retail value versus market value

When you buy a brand new property (completed or off the plan) in a developing area such as Docklands, you are paying retail price, that is, the
price set by the developer. In determining the retail price, the developer factors in a range of costs:

• Land
• Installation of infrastructure (roads, street lighting, electricity, gas and water mains
• Professional services (architecture, interior design, legal, council permits)
• Materials
• Labour
• Interest on borrowings
• Marketing
• Selling agents’ commissions.

On top of all that, the developer adds its profit margin. When you buy a brand new property in Docklands, the vast majority of your money is going towards meeting the developer’s costs and profit margin. Because your property has no purchasing history, it doesn’t actually have a market value.

The market value of a property '” what it is really worth '” is determined by three factors:

1. The level of supply of similar style properties in the immediate area. The fewer the number of buildings with a particular architectural style in an area, and the harder it is to reproduce them, the stronger the demand and capital growth potential.

   Docklands is being built in stages over about 15 years. During this period, the developers are expected to build 6000-8000 apartments (source: Charter Scott Keck, Nov 02). With so many properties of a similar architectural style in such a concentrated area, your property has a limited chance of standing out from the pack. This factor will hinder capital growth.

2. The level of demand from the buying public. Developers in new sites such as Docklands market aggressively to create interest and demand, then sell as many properties as possible off the plan to recoup outlays and secure their profit. All of this is before a stone is laid. Then they market another tower, sell and build again . . . and so on.

   In this situation, the demand '” created by the developer '” is artificial. Real demand - created by buyers '” does not begin to kick in until the first and subsequent resales. In other words, real demand does not take full effect until well after all the land has been developed.

   Docklands is due for completion around 2012, so it will be at least seven years before real demand shows the true market value of apartments in the area. If you buy in Docklands today, that could be seven years of lost opportunity.

3. The land-to-asset ratio (LAR). This is a calculation of land as a percentage of a property’s overall value. Land is a finite resource, so it usually grows in value. The stronger the demand for a finite resource, the higher the LAR. And the higher the LAR, the higher the likely market value.

   In residential developments, each apartment takes on a notional proportion of the building’s overall land value. For example, if the land is worth $3 million, and the building has 100 apartments of the same size, the notional land component is $30,000 per apartment. If you purchase a brand new apartment in that block for the retail price of $300,000, the land value accounts for only 10 per cent of the purchase price, creating a low LAR and limiting the market value.

Short-term gain, long-term pain

What about the promises in the Docklands marketing material? How do they figure in this scenario?

When estate agents try to sell a property in the Docklands, they will cite a range of financial and lifestyle benefits in trying to persuade you that it is a good investment.

Lifestyle benefits

• It has an unrivalled view of hills/bay etc
• It has luxury on-site facilities (eg. swimming pool, tennis court, sauna, spa, gym . . .)

Financial benefits

• Rental guarantee
• Depreciation benefits
• Stamp duty relief for off-the-plan purchases

But these benefits are variable and time sensitive. The lifestyle benefits on offer when you purchased the property may not be looking so attractive later on:

• Very few apartments have absolute prime frontage and few cannot be built out. Your property might have had unrivalled views when you bought it, but if a tower has gone up right next door in the meantime the once-glorious view may now be a view of someone else’s loungeroom. Your apartment will lose appeal to prospective tenants, investors and homebuyers alike.

• Facilities such as pools, spas and tennis courts need constant maintenance, so your body corporate fees are likely to rise when maintenance is. Moreover, the financial benefits, almost without exception, are shortlived.
• Rental guarantees last for a short period (usually 1-3 years). When the guarantee ends, the market rate may well be considerably lower. This could have a big impact on your ability to service the loan, particularly if interest rates have risen.
• The tax office allows investors to claim depreciation on the building and fixed contents, but most items depreciate within 7-10 years. As time goes by, your tax benefit reduces dramatically and then disappears.
• If you buy off the plan, stamp duty relief is available on the purchase price. This is a one-off exemption and provides no further tax relief.

Think ahead to a time when you’re ready to sell the property. The rental guarantee will probably have expired, and the depreciation benefits will be coming to an end. Would-be purchasers will not be able to take advantage of stamp duty savings because they are not buying off the plan.

These flaws in the financial benefits proposition are not specific to Docklands '” they are common in many new developments '” but, combined with the negatives of ample supply and artificial demand, they weigh heavily on investment returns within the precinct.

The built-in price cap

In a developing area such as Docklands, the market value of resale properties will always be less than the retail value of brand new properties. When faced with the choice, buyers will invariably opt for the brand new apartment, whre the rental guarantee is still intact and they can take advantage of stamp duty relief and a full depreciation period.

Although Docklands is still developing, for at least another seven years your property’s market value will always be capped at a level well below the retail value of a brand new Docklands apartment of a similar style and size.

Exceptions to the rule

For residential property investors, Docklands is generally a poor investment choice. However, for other purchasers, there are circumstances in which Docklands may provide good opportunities.

Cashflow properties

Since the first Docklands properties were sold in the late 1990s, the resident population has grown from zero to more than 3000. There are expected to be 5000 residents by the end of this year and 20,000 by the time Docklands is complete (source: VicUrban, April 2004).

This means there will be more people spending money on essential services, leisure and entertainment. Facilities such as offices, food outlets and medical services can provide high and stable rental returns.

Owner occupiers

There’s no question that, for some people, Docklands can offer a terrific lifestyle: no garden to maintain, a berth for your boat, CBD just minutes Away...

If you are genuinely attracted to the idea of this lifestyle, and are considering buying a residential apartment purely to live in, then Docklands may be a suitable option provided you have no expectations of capital growth.

Action Plan

Residential investors

As an alternative to Docklands, turn your focus to prime established residential locations. If, for example, you were originally considering a brand new 2-bedroom/1-bathroom Docklands unit with balcony, research the likely purchase price of the same size property in an established area. Look for properties in smaller developments and quiet streets within short walking distance of shops and transport. Look for a logical floorplan, off-street parking and abundant natural light.

Cashflow investors

Docklands developers know that a rapidly growing population equals strong rental returns from businesses that provide services to residents and visitors '” so commercial and retail property in the area will not come cheap. However, if you already have significant equity in several properties, you may be able to sell them and use the proceeds to buy a commercial or retail property.

Owner occupiers

Deciding whether or not to buy and live in Docklands really comes down to the way you want to live your life, and what you are prepared to trade off. Does the location offer features that are particularly important to you (eg, proximity to the water or a berth to moor your boat)? Can you tolerate the high noise levels that characterise inner city living? Can you afford high body corporate fees? Are you comfortable with the possibility that you may not achieve a profit when you sell?