Mercia | Taxation, Business & Finance Advisers

Hypothetical borrowers shine light on lenders’ changes

New research shows the Australian Prudential Regulation Authority’s (APRA) crackdown on investor loans is taking effect with average loan sizes recording a sharp drop.

APRA has increased scrutiny of financial lenders’ practices in recent times in a bid to bolster the nation’s banking system.

To compare how lenders evaluate their clients, APRA created four hypothetical borrowers.

Using the four borrowers, APRA surveyed 20 banks, building societies and credit unions in December 2014 to determine how they evaluate these clients.

To test how lender’s policies had changed in response to APRA’s crackdown on property loans, the watchdog ran a second survey in September 2015 using the same four hypothetical borrowers.

The results found that the maximum loan sizes to property investors dropped 12% on average. Meanwhile, the maximum loan sizes for owner-occupiers dropped 6% on average.

Lenders tighten investor-loan criteria

To determine how different lenders evaluate these four hypothetical borrowers, the survey utilised four data points. These are:

•Borrower’s income

•Living expenses

•Interest rate for the new loan

•Interest rates for their existing loan

Most lenders use these four factors to determine a borrower’s Net Income Surplus (NIS), which is used to determine the serviceability capacity of a borrower.

The research found that lenders were now applying higher interest rate stress tests to existing loans with rates of between circa 5-8% in December 2014 compared to 6-9% in September 2015 – with most typically above 7%.

Many lenders had also raised the borrower’s minimum living expense assumptions, while some lenders applied larger discounts to borrower’s incomes, particularly those on less stable sources of income, such as overtime, bonuses and commissions.

Given the changing financial lending market, investors should engage brokers who specialise in investor loans to ensure they’re optimising their borrowing capacity.

Building approvals a telling sign for investors

Despite the soft property market, building approvals for medium density houses in Perth have grown, highlighting the continued shift in buyer’s attitudes towards these dwelling types.

The number of medium density housing building approvals in Western Australia increased 0.4% to 8,001 in the year ending November 2015.

Although the growth was only minor, the number of approvals was still higher following a 35% increase in medium density approvals a year earlier and amid a slower property market in the state.

The growth in the medium density housing segment also came at a time when approvals for stand-alone dwellings dropped by 12.9%.

The new figures were released last month in Bankwest’s Housing Density Report. Bankwest said the resilience of the medium density housing space would be underpinned by Perth’s population growth over the next decade.

“Perth’s population is forecast to grow by 33% to 2.8 million in 2025, bringing an extra 700,000 people into the city,” Bankwest said.

Medium density housing has become more popular in Perth in recent years as residents increasing want to live closer to their places of work, specifically the CBD, as well as the Swan River, coastline and established amenities, such as café and retail strips and train stations.

The shift towards medium density housing highlights the importance of acquiring investment properties in Perth’s inner metropolitan ring.

As the city’s population continues to grow, so too will the demand for properties within this zone.

Properties that have large land components in suburbs with restricted supply capacity are likely to perform the best in the long term.

While the move to medium density housing has increased in Perth in recent years, the city is still lagging behind its capital-city counterparts.

Medium density building approvals comprise just 30% of total building approvals in Perth compared to 57.9% in Melbourne, 64.5% in Brisbane and 69.4% in Sydney, according to the report.

Concerted and coordinated approach maximises returns

When it comes to designing your property development, a coordinated effort between builders, architects and town planners is needed to optimise your site.

During the design process of a property development, many investors will either engage a builder or architect to help determine the size and number of dwellings to build.

This stage of a development is highly important because the decisions made now will have a big influence on the final yield of the project.

As such, a better approach is to incorporate both building specialists and architects into the design process, as well as town planners, who have a firm understanding of the residential design codes that govern what can and cannot be built.

For example, a client recently engaged Momentum Wealth’s developments team with a 1,000 square metre development site located in a north-east suburb in Perth.

With a zoning code of R40, the site was, on face value, suitable for the development of 8 multi-dwellings.

However, particular to this site was a 5.5 metre slope to the rear.

Typically, sloping blocks can be more costly to develop because they present unique challenges in terms of drainage, excavation and building height.

Subsequently, more site and earthworks typically need to be completed.

In this case though, our in-house town planners and development specialists worked with designers to utilise the natural contours of the site to the client’s advantage.

The final design, which recently received building approval, comprised a 2-storey building on the street front and a 3-storey building at the rear with car parking in between.

The sloping block meant the height variation between the front and back building was negligible, despite the extra storey at the rear.

Adding the extra storey also allowed us to include 10 dwellings, compared to the original design of 8, and an additional 150sqm of floor space.

Using the innovative design, the projected yield for the client has increased by more than 30%.

This project is an excellent example of why it’s important to incorporate building specialists and architects as well as town planners into the design process.

This approach will help to ensure you utilise your development site to its fullest potential and, in turn, optimise your returns.

Legal risks and liabilities: the real cost of self-managing

Are you considering self-managing your property portfolio? The decision to do so may prove significantly more costly than you think.

It’s not uncommon for novice investors to consider managing their own portfolios, particularly if they only own 1 or 2 properties.

However, by taking on the responsibility to self-manage, you’re also likely to be taking on more risk, not only financially, but legally as well.

So what are the risks if you decide to forego professional property management?

Firstly, and perhaps most importantly, self-managing landlords are susceptible to legal action if they don’t fully understand the legal requirements for leasing a property.

This can include the requirements for installing smoke alarms or ensuring minimum security obligations, among many other issues.

Furthermore, self-managing landlords may also be vulnerable if they don’t understand their own rights and the rights of the tenant.

It’s not uncommon to hear stories of tenants who stop paying their rent or who’ve trashed their rental property.

In such circumstances a professional property manager will mitigate the risk of this occurring by compressively screening applicants and understanding the legal recourses should such incidents occur.

Self-managing landlords who haven’t followed proper procedures may find that their landlord insurance company either discounts or refuses to pay a claim.

Should the need arise to go to court, a good property manager is able to act on the owners behalf, will know how to adequately prepare for a hearing and have supporting evidence and information to back up their case.

It’s important to remember, also, that the cost of hiring a property manager is tax deductable, so any perceived savings from self-managing are likely to be negligible.

Subsequently, the real savings made from self-managing don’t outweigh the benefits of engaging a professional property manager.

Eden Hill: Old suburb provides affordability

Eden Hill: This suburb was first developed nearly a century ago and provides an affordable option for property buyers.

Eden Hill is located 11 kilometres north-east of the Perth CBD and comprises about 3,500 residents.

It’s bounded by Morley Drive East to the north, Walter Road East to the south, Wick Street to the west and Lord Street to the east.

The housing stock in the area dates back to the 1920s when the first significant residential development occurred.

However, with the suburb being rezoned in recent years, more infill development has since occurred.

The stock comprises approximately 88% stand-alone houses, 7% duplexes, villas and townhouses and 5% flats, units and apartments.

As well as its proximity to the CBD, the suburb’s main drawcard is its relative affordability.

With a median house price of $477,500, according to REIWA, the suburb sits below Perth’s median price.

This is reflected in the suburb’s demographics with about 14% of resident identifying as professionals, compared to the state average of about 20%.

About 18.5% of residents also identify as technicians and trades workers (WA 16.7%) and 17.9% as clerical and administrative (WA 14.7%).

The Eden Hill Primary School is located within the suburb and Hampton Senior High School is directly to the west.

Morley Galleria Shopping Centre is also 4km to the west and the Bassendean Shopping Centre is 2km to the south.

Its closest train stations are Bassendean and Success Hill, also located about 2km to the south.

Property syndicates’ popularity grows amid planning changes

Property syndicates have increased in popularity in recent years, but why have they suddenly become a more prominent investment strategy?

It’s not uncommon to see media reports touting the success stories of “average investors” who’ve joined a property development syndicate.

Less than a decade ago, though, property syndicates in Perth were all but unheard of and usually the domain of sophisticated investors with the right connections.

So what’s changed in that time for syndicates to be more commonplace?

Perhaps the biggest catalyst has been the Western Australian government’s planning blueprint, Directions 2031, which was released in 2011.

The report outlines the government’s planning strategy for metropolitan Perth including the identification of key activity centres and transport links.

One of the document’s key goals is to achieve a 47% infill target – that is 47% of new dwellings need to be built in established suburbs, rather than developing new land estates on the urban fringe.

As such, many local councils are updating their town planning schemes to comply with the state government’s objectives and meet set population targets.

This includes increasing housing density, for example from R20 to R40, particularly around key activity centres and public transport nodes.

These zoning increases have led to a more conducive environment for the construction of medium density residential developments, such as boutique apartment complexes between $3 million and $20 million.

These types of developments are generally too large for single investors to bankroll and too small for the consideration of big state and national developers.

Therefore, property syndicates, whereby a number of investors pool their money, are a great avenue to fill this gap in the market and have proven to be highly lucrative for investors.

This development activity is also supported by rising demand for medium density housing, which is increasingly attractive to buyers for its affordability advantages, lower required maintenance and proximity to key amenities, such as transport links, employment hubs and retail and café strips.

Bigger isn’t necessarily better in commercial property

Many investors envisage city skyscrapers and large shopping complexes when commercial property comes to mind, particularly those unfamiliar with the market. However, bigger isn’t necessarily better in commercial.

Given that much of the mainstream media focuses on these segments of the market, it’s understandable that many investors only think of the big end of town.

Of course, individual investors wouldn’t be able to afford an office tower, for example, as these large assets typically cost a minimum of $20 million and are owned by big institutional and superannuation funds.

But that doesn’t mean individual investors can’t afford a high-quality commercial property.

Indeed, investors should think small when it comes to commercial property, and look to the suburbs.

Commercial space within smaller suburban shopping centres can make a good starting point.

Although retail has suffered with the rise of online shopping in recent years, service providers, such as hairdressers, will continue to need bricks and mortar stores to operate.

Investors should consider suburban shopping centres that are anchored by a large supermarket and also comprise other specialty stores, such as a baker, butcher and chemist, for example.

Similarly, specialty medical spaces, for chiropractors, physiotherapists and general practitioners, will continue to see demand over the long-term and can make great investments.

Investors must be aware of vacancy rates and market rents, though, as these can vary widely between suburbs and property types.

Unfortunately, most of the published statistics on the commercial property market relate to the CBD statistics, so it can pay to engage a buyer’s agent who will hold a firm understanding of the local suburban markets.