Property developments: a hornet's nest
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Wayne Lee*
23 November 2008
Professional property investor explains why he never bought off-plan over the past 10 years - but what he's looking for in developments now.
Many operators and others in the property media continue to aggressively punt off-plan developments. Should you invest - or could you lose money? Wayne Lee, founder of Sirius, shares his thoughts on developments.
In the 1990s fund managers who steered clear of IT companies they didn't understand were frowned upon. Similar parallels can be drawn with the property market.
We have not bought a new development unit as an investment property since 1998. Now some may think we missed out. Not really, considering freehold has continued to outperform sectional title, and your gearing figures are really positively affected when your rent is nearly double!
So the early catchers made some easy money from the developments on the back of declining interest rates. Remember that when interest rates go from 24 to 10,5% in seven years, everyone's a property investment guru. Then some go on the speaking circuit, release the "secret" of gearing and people are chomping at the bit. So, the natural opportunity is to link with developers and sell these property reformists as much as possible.
They want it and are ready: what else is there to do? The upfront cash is minimal and sometimes we'll even give you a cash injection! Any good businessman would tie up all the related revenue streams and maybe create some more, except of course the goose that lays the proverbial golden eggs in property - the rentals, but management of that is a low margin operation. If you think you know who I am talking about - you're wrong, there are many with the same model.
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Trusts and property
As an emerging "Rich One" you need a trust. All rich people have trusts. The only problem is that not all those who have trusts are rich, as we have learnt. You see being rich is a way of thinking; it starts with that - not the entity you create. Is there a place for estate and tax planning? Definitely, but in my experience, most who have trusts today don't know whether they will eat at 70. Their estates better be well-managed because they're going to die of hunger.
To be honest, had I been buying off-plan I too would've used an entity. But that's not the point: Am I trying to create wealth through property or entity creation? You find profitable listed companies as well as lemons. So too you can have all the entities in the world, but if your properties don't have value you probably did not need the estate planning. I find it amazing how many people have become entity experts and don't actually know the difference between a rental yield and a car instalment
Inflated prices
So, the capital growth to completion is seen for what it is - a fairytale. Actually, it is theoretically true - you will get an inflationary growth on that asset. Developers start inflating the price, which makes sense with this insatiable demand. I mean, if you can s ell 1 000 and only produce 300, wouldn't you push up your price? Although location is more important for commercial and industrial property, residential letting is more price-sensitive so the golden rule of residential investment property is "price, price, price".
People ask me whether I buy for capital growth or rental yield? I buy so that in 20 years I have rent forever, and probably positive cash-flow way before that. I then own that land forever. I want to be rich while I am alive not when I am dead, so I am not that focused on the taxes my kids will pay. If they don't like it, I probably failed as a parent, and it seems like the less I give them the more likely their chance of succeeding on their own anyway. The ironic thing is that when I buy rental yields our capital growth does better than others - because there is a fundamental need to live there in the first place.
Euphoric arbitrage opportunities are short-lived, and fundamentals will reign. Fundamentals are so boring, but so predictable. And in today's market predictability becomes desired. What are the fundamentals of residential investments? If it is price, then the fundamental question is how do you win in this game? Considering most buy and sell emotionally to live in, it's quite easy, don't be emotional: buy from desperate sellers.
Will I ever buy new developments? When a developer's desperate I will - just haven't seen many of those for 10 years. Why would I buy there? If I can buy 100m away with a higher rental yield and way below replacement costs. Residential property comes with its own risks, eviction laws, specific management issues like maintenance etc. If I want to participate I want to be able to make good returns based on my risk. I need to be able to tap into the desperate seller game - where the real money is.
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