The investor report

Finding the right investment property can be hard work and there are many factors that need to be considered. These factors include, but are in no way limited to, local market conditions and forecasts, vacancy rates and rental yields, interest rate expectations, transactional costs, and the performance of and regulations around different properties.

According to the Australian Housing Outlook 2013-2016 report produced by BIS Shrapnel and QBE LMI, the Sydney median house price is forecast to grow 18.8 per cent between 2013 and 2016,while the Canberra median house price will only increase by 2.5 per cent. The dramatic difference in these two markets demonstrates the importance of research and investing in the right area.

The state of the market

This same report indicates the residential property market experienced an average growth of 4.2 per cent in capital city median house prices nationally for the quarter ended 30 June 2013; a significantly improved performance compared to a fall of 0.95 per cent for the quarter ended 30 June 2012.

This impressive recovery has been driven by several factors.

Consumer confidence is rising, with the Westpac-Melbourne Institute Consumer Sentiment Index up by 9.2 per cent in the past year.

This increased confidence, combined with historically low interest rates has seen housing demand spike in many markets.

While this is all good news for investors, RP Data analyst Cameron Kusher warns the current rate of growth will not continue once interest rates inevitably rise.

“Although home value growth may be strong at a time when mortgage rates are incredibly low, once rates eventually increase, value growth can quickly slow,” he says.

While no one can be certain in predicting interest rate movements, many economists have stated their belief that rates will begin to rise in the second half of 2014 or early 2015.

AMP chief economist Shane Oliver says recent economic results are likely to mean the end of the Reserve Bank’s (RBA’s) easing monetary policy cycle.

“The September quarter surge in inflation has further reduced the chance of another interest rate cut in Australia,” he says.

As well as interest rate movements, Mr Kusher warns investors to consider rental yields when looking to invest in property.

“Given that yields are based on rental rates and home values, if values rise quicker than rents, you will see an erosion of rental returns,” he says.

Mr Kusher gives a soft assessment of rental markets nationally, saying he expects yields to diminish from their current levels.

“If we firstly look at the annual change in major capital city rental rates, we will see that the general trend is that rental growth is either slowing or quite sluggish,” he explains.

“With values anticipated to continue to increase in Sydney and Melbourne, and the potential for value growth to accelerate in Brisbane and Adelaide over the coming year, we should expect further erosion of rental yields.”

In addition to yields, investors should look at vacancy rates. Recent SQM Research data shows vacancy rates have increased nationally by 0.3 per cent in the 12 months to August 2013.

The research reveals Canberra and Perth have performed poorest in this measure over the year, with 0.9 per cent and one per cent increases in vacancy rates respectively.

What to buy

Units and houses will perform differently according to their market, and it is important to study current trends.

For example, in the Sydney suburb of Annandale, 10-year average growth for units is one per cent greater than that of houses, while in the Western Australian suburb of Cable Beach, houses have outperformed units by 2.9 per cent.

Investors should also weigh up the costs and benefits of buying commercial property as opposed to residential.

Statistics on self-managed super fund (SMSF) investment from the Australian Taxation Office (ATO) show that around $17 billion is now invested in direct residential properties, compared with $54 billion invested in non-residential property.

Under current legislation, trustees of SMSFs are not allowed to buy or occupy residential property owned by a fund member or a relative of a fund member. However, SMSF rules do allow for business owners to purchase and occupy the commercial property from which they operate.

A small business owner is able to transfer their business property and assets into their SMSF and receive a capital gains tax exemption up to a lifetime limit of $0.5 million. After the property has been transferred, the fund can lease the property to the business owner at a commercial rate and the rent paid by the business owner can then be claimed as a business expense.

Restrictions in place

While property investment often involves buying cheaper property and increasing its value through renovation, legislation actually restricts what work can be done to property bought through an SMSF on a limited recourse borrowing arrangement (LRBA).

Once property has been acquired and the loan remains in place, it is not possible to make alterations or improvements to the property if this work would have the effect of changing the function or character of the property.

The ATO ruling SMSFR 2012/1 gives clarification on what is considered repairing and what is considered improving. These are complex definitions and investors should always seek professional guidance.