For anyone who owns or works with investment property in Perth, the last few years have been interesting, to say the least. The market was cruising along until the Global Financial Crisis (GFC), which caused a major “reset” in the market, lowering prices and property values and costing those who had neither the patience nor resources to hold on to their investment properties a lot of money.
Over the last 2-3 years, we have not only watched property prices return to their pre-GFC numbers, but we have seen the median home price in Perth grow to an all-time record of $545,000 at the end of 2013 with some predicting it to rise to $600,000 by the end of 2014. This has been mostly due to interest rate cuts that have left the RBA cash rate at an all-time low of 2.5%.
While this has the appearance of a great market, there are a few caveats to be aware of. We believe the growth cycle is entering its next and final stage as growth heads to the outer suburbs. There is still plenty of opportunity out there, but there are still opportunities for those who don’t know what they are doing to lose a lot of money, too.
In other words, we believe that investors should be careful not to get caught up in hype or move too quickly in fear of missing out on a “hot market.” I would like to tell you about three potential mistakes that can derail your dreams of being a successful property developer.
Buying on Potential Instead of Developing Now
If you can hold onto your investment properties for a period of years, you are almost sure to profit. But when you invest in a property with development potential, the house is usually much older and because you are buying a larger land component, you will have a lower rental return. This will usually leave you negatively geared and having to tip in money every month.
That is why we recommend that if buying a property with development potential, you progress plans to develop your property as soon as you buy it. So you must make sure that it is within your financial means to develop the property now. It is also mandatory to make sure that local council and zoning regulations allow you to develop and/or subdivide the property now.
I personally made a mistake along these lines and it cost me a lot of money. At the end of the previous cycle in 2007, I bought a property in Ipswich QLD. When I bought it, I didn’t have enough money to develop it right away, but the deal looked great on paper, with plenty of potential for developing it later.
Unfortunately, things would change for the worse within one year. The council imposed significantly greater contribution costs, just in time for the GFC to hammer the market, then the floods dropped market sentiment to an all time low. The property ended up costing me too much money per week to hold and I was forced to unload it. The cost of this lesson: $70,000.
Some would say that I just had bad timing, but the longer you hold a property without seeing the development through, the longer you are exposed to changes in the market, council or zoning regulations. Of course none of this is a problem if the property is positively geared, but really hurts if you are losing money every week.
Failure to Protect Returns
No one has a crystal ball to predict market downturns. However the best way to ensure your financial health in any market is to focus on locking in decent returns when you purchase to insulate you from future changes in the market.
For example, if you are subdividing and redeveloping a house behind house duplex, make sure that you achieve a minimum gross return of at least 15% of your total expenses and preferably aim for 20%. For a smaller apartment development, shoot for a minimum gross return of at least 25%.
Failure to Account for Interest Rate Rises
Interest rates are at a record low, but they will eventually rise. When they do, it’s going to impact your holding costs and its difficult to lock in rates when you need the flexibility to sell and refinance. It is important that you do your numbers to see if you can still afford interest rates at 7% and 9% p.a. and make sure it is within your means to see the development through. Otherwise, you could end up selling a property before you want to.
Don’t Go It Alone
We think the current market is too tricky for a part-time investor to “go it alone.” At Investors Edge, we have more than 70 years of combined experience in property investing and management. Call us today and take advantage of our experience and market knowledge: 1300 472 427.