Property Wealth News December 2019
The biggest cost drainer in property investment…and how to avoid it
When you’re purchasing an investment property, ongoing costs are likely one of the first things you will factor into your buying decision. How much are you going to outlay for maintenance, council rates, repayments and other outgoing expenses against your rental income? And are you comfortable with that figure, or is it going to put a strain on your finances?
With the different expenses that accompany property ownership, your rental income will likely play a critical role in providing you with stability of cash-flow until you realise longer-term capital growth.
And the single biggest threat to this? Vacancy periods.
Let’s say you are renting a property for $400 per week, and that property remains vacant for a period of four weeks. At the end of the four-week period, you would already be $1,600 out of pocket, and that’s without accounting for the marketing and advertising costs of re-letting the property to a new tenant. It’s easy to see how these costs would stack up quickly.
Whilst vacancy periods can be an inevitable reality of property ownership, keeping them to a minimum should be one of your key priorities when it comes to keeping your rental expenses in check. So what steps can you put in place to minimise the frequency and potential cost of vacancies?
Set the correct market rent
Setting the wrong rental rate is one of the single most common causes of extended vacancy periods we see amongst owners. Whilst setting a competitive rental rate is important to maximising your rental income, being overly ambitious with your asking price can be equally if not more detrimental to your overall cash flow.
What our property managers say:
“Increasing rental rates in the right market conditions can (and should) be an effective strategy in maximising rental returns, but owners need to tread with caution when it comes to raising rents out of alignment with market conditions. In cases where owners have been receiving above market rent or are facing a particularly challenging market, they may need to reduce rental rates to avoid costly vacancy periods before readjusting them when market conditions improve.”
Dynamic marketing
If your tenants are vacating your rental property, one of the most important things you and your property manager can do to avoid lengthy vacancy periods is be proactive in re-marketing the property for rent. A good marketing strategy will go beyond simply advertising the property, and should focus on a tailored plan based specifically on your target demographic.
What our property managers say:
“If you’re re-advertising your property for rent, the marketing plan for your property should also be reinforced by strong internal follow-up procedures, including call backs to all parties who have attended any home opens. This is a great chance for you or your property manager to gain feedback on the property and plan any potential improvements that could appeal to future tenants. We generally recommend listing the property at the higher end of the rent range, but it’s important to be prepared to make adjustments to this during the marketing process based on the feedback obtained from prospective tenants.”
Be proactive with improvements
Whilst it may seem counter-intuitive to invest funds into your property as a means of getting greater returns out of it, property improvements can sometimes be an important aspect of the pre-leasing process, and can be a crucial factor in minimising vacancy rates and boosting your property’s long-term potential, especially in softer market conditions.
What our property managers say:
“Performing upgrades to a rental property can be a great way for owners to improve its immediate rentability and encourage tenant retention, but not all property upgrades result in higher returns. Before undertaking any improvements, owners should consider speaking to their property manager about what’s in demand amongst tenants to ensure they’re making worthwhile changes that will appeal to their target demographic.”
Bring the property manager in early
If you’re in the process or yet to buy an investment property, a great way to gauge a property’s rental potential is to involve your property manager from the start of the buying process. By asking your property manager for their insights on aspects such as vacancy rates in the local market, tenant turnover and features that appeal to tenants, you can make a more informed investment decision that supports your cashflow needs.
What our property managers say:
“Owners who are working with a buyer’s agent to purchase an investment property should speak to their agent about including an early access clause in the purchase contract. This will allow the property managers to advertise the property for rent before settlement, which could help to further reduce potential vacancy periods.”
Keep hold of good tenants
One of the most effective ways to avoid vacancy periods and re-marketing costs altogether is to retain good tenants for as long as possible. Many landlords will take a ‘set-and-forget’ approach once they’ve rented out their investment property, and whilst easier in the short-term, this will often come to the detriment of tenant retention.
What our property managers say:
“When it comes to maintaining good tenants, we recommend that owners take a proactive approach and are regularly reviewing their property for potential improvements to enhance tenant experience. Proactively keeping on top of tenants’ needs and addressing their concerns throughout the lease period will help to reduce landlords’ vulnerability to vacancies.”
Account for seasonal changes
Much like the buying market in Australia, leasing markets will also be impacted by seasonal trends and activity. Generally, tenants will be less active in the winter months, which can lend itself to longer vacancy periods if the right steps haven’t been taken to mitigate this risk. In these cases, it’s important to be realistic about the rental rate you ask for and focus additional attention on the presentation of the property to increase its appeal during home opens.
What our property managers say:
“Owners who are leasing out their property at a quiet time of year need to be thinking ahead to strategies that could reduce this occurrence in future. Whilst 12-month lease contracts are considered the norm in Australia, extending or reducing this lease term to prevent vacancies falling during unfavourable periods could help owners improve the leasing process in future and achieve more favourable rental rates.”
Without the right strategies in place, vacancies can turn into one of the most costly expenses for property investors, so it’s important that you take the right steps to mitigate these risks. If you would like more advice on reducing vacancy periods, or to speak to our property managers about strategies to proactively maximise your property’s performance, organise an obligation-free consultation via the Momentum Wealth website.
Case Study: Interstate investors exceed profit margins with develop-to-hold strategy
When two experienced interstate investors approached us in 2017 looking to purchase and complete their first residential development in Perth, it took a team effort to deliver their build-to-hold strategy. Below, we look at how our divisions brought the project together to exceed initial profit expectations.
Project Highlights:
- Development delivered under budget, with profit margin exceeded.
- High bank valuations realised an additional $200k in equity
- Construction completed within six months
- All properties rented on 12-month lease term and above initial appraisals, with development coming to completion in a recovering rental market
- Land use maximised to enhance long-term capital value and improve re-sale potential
- No joint liability and over $40k in stamp duty savings through complex finance strategy
- Depreciation benefits on brand new developed product
Brief:
In December 2017, two Melbourne investors approached Momentum Wealth with a brief to jointly purchase a site for immediate development. Working with an acquisition budget below $900,000, the clients saw an opportunity to take advantage of subdued market conditions and low construction costs in WA to purchase a well-located site in close proximity to Perth’s CBD, with a strategy to develop and hold on completion to generate an attractive rental income (in addition to manufactured equity).
Property Search & Acquisition:
With the brief in mind, our buyer’s agent conducted a thorough market analysis, narrowing their search to a number of key areas that met the clients’ criteria. This search focused on strong lifestyle and location attributes to align with the investors’ holding strategy, including proximity to prominent transport routes, schools and nearby amenity to support the development’s long-term growth potential (rental and capital).
After an intensive six-month search period, which included closely monitoring housing stock and off-market listings for suitable opportunities, our buyer’s agent identified a site located 5-6kms south of Perth’s CBD with R40 zoning allowing for group dwellings. The existing dwelling on the site was run down with minimal improvements, making it ideal for a develop-now strategy with low demolition costs. The nature of the site as a decreased estate also provided potential for a quick purchase and settlement process, allowing for a fast construction turnaround as per the clients’ requirements.
The site and existing dwelling were shown to our development team to carry out a comprehensive pre-feasibility analysis on projected returns and end-costs. This resulted in a bid being placed by our buyer’s agent at auction, with the site being secured at the lower end of our appraisal at $850,000 (below land value, with the site revalued post-demolition at $875,000).
Design & Build:
Once due diligence was completed, Momentum Wealth’s research, development and buyer’s agency teams worked together with an architect to evaluate different design options, with a development application submitted to the local government for approval shortly after settlement to minimise the investors’ holding costs. During this process, we were able to make use of the rear laneway to strategically design four villas on survey-strata titles (two street-facing and two laneway-facing). This negated the need for a common driveway, which allowed us to maximise build size (250m2 land area), in turn protecting the development’s end value and removing the need for shared strata levies. Whilst making this ideal for a long-term hold, this design also suited the investors’ joint investment strategy by allowing for two identical developed products that could be evenly split on completion.
Following a competitive tendering process and a thorough review of the specification, we were able to work together with the preferred builder to establish high-quality design choices that strategically influenced the time on site required by the different trades involved. By preparing a fixed lump sum construction contract over the entire site, we also enabled the builder to programme the build strategically to further reduce construction timeframes and associated costs whilst maintaining the high quality of design. This allowed for a shorter build timeframe, with the development coming to completion in June 2019 following a six-month construction period.
Final Outcome:
Upon completion, the bank valuation for the new units came in $50k above initial projections, resulting in the investors realising an additional $200k in equity across the development. Due to the short construction timeframe, low construction costs achieved and high-quality design of the final development, the project exceeded initial projections, achieving a final profit margin of over $350k.
With the existing construction loan covering all four units, our finance broker was then faced with the complex task of separating the loans and splitting the titles of the units, which we were able to achieve through a disposition. This mitigated the stamp duty costs associated with transferring the titles, saving the investors an estimated $45k in expenses and removing any joint liability on the final products.
Following the implementation of an in-depth marketing strategy by our property management team, which included targeted online advertising, after-hours viewings and rigorous follow-up procedures, we received eight applications across the four properties from prospective tenants. Within eight weeks, all four units were rented out on a 12-month lease and above our initial rental appraisals, with the properties achieving a final rental rate of between $450 and $475 per week (initially estimated at $405-$435 for street front, and $445-$475 for rear laneway properties). This saw us achieve an additional $100 per week in rental income for the clients, totalling an additional $5200 per annum.
Why you should be considering commercial property
Commercial property will often get overlooked by investors in favour of the more familiar residential sector.
Although it’s natural for buyers to want to stay in the market they’re most familiar with, there are also a number of benefits that could come with diversifying into the commercial sector, especially as your financial and investment needs grow over time.
In fact, while most start their investment portfolio in the residential market, savvy investors will often look to incorporate commercial property into their portfolio as they progress in their investment journey.
So why should you consider adding commercial property to your portfolio?
Diversification into different markets
The first reason is simple – commercial property can offer exposure to an alternative market which is subject to different fluctuations from the residential sector. While both are somewhat influenced by macro-economic factors such as population and economic growth, on a micro-level commercial markets and the varying segments within them (i.e. industrial, retail and office) will fluctuate according to their own market influencers and will often experience growth at different intervals. This can hold a number of benefits from both a risk and opportunity perspective by reducing an investor’s exposure to a single market (and hence its downturns) whilst also enabling them to take advantage of growth cycles in different segments.
Higher cash flow returns
Exposure to different markets isn’t the only benefit commercial property can offer in terms of diversification. Generally speaking, commercial properties will offer much higher returns than the residential sector, with net yields typically ranging from 6-8% as opposed to the 3-4% often associated with residential properties. This does, of course, generally come with a lower capital growth focus, which is why residential and commercial assets often work well when combined together into a diversified property portfolio. For investors who have already built a sizeable portfolio of residential properties, commercial property can be a great way to balance their portfolio with different wealth creation strategies, or alternatively provide an alternative source of income for cash-flow focused investors such as those nearing retirement.
Fewer outgoing expenses
There are a number of other benefits that come with investing in commercial property, one of the main ones being that investors are able to recover outgoings from the tenant. This means that expenses such as council rates, land tax, insurance, and repairs and maintenance are generally covered by commercial tenants, with landlords facing fewer ongoing costs as a result.
Longer lease terms
In addition to lower outgoing costs, the lease terms on commercial assets will generally be much longer than the 12 month leases we often associate with residential properties, with standard commercial leases ranging anywhere from five to fifteen years. This can be highly beneficial for investors seeking a stable income stream, with many commercial leases also containing fixed annual rental increases to support rental growth over time. While reducing the likelihood of frequent vacancy and re-leasing periods, this does however increase the risk of longer vacancies when a tenant leaves, so it’s important to have a strong and proactive management strategy in place to combat this.
But commercial property is too expensive…
While commercial property can be a great addition to an investor’s portfolio, the biggest hurdle for many buyers is the high cost of good quality commercial assets. These can range anywhere from $2 million to $20 million and above for high-quality properties, which needless to say isn’t within the financial reach of most investors (let alone the risk associated with putting all this capital into a single asset).
However, this isn’t the only means of gaining exposure to the commercial market. A growing number of investors are looking for different ways to access the commercial sector, with many finding a viable alternative in pooled funds and commercial property trusts. These options can offer the same benefits in terms of exposure to alternative markets and cash flow returns, but without the same risk and capital outlay associated with investing directly in a single commercial asset.
Want to learn more about commercial property funds? Download the latest guidebook from our sister company, Mair Property Funds, or visit their website for more information on their upcoming investment opportunities.
Mair Property Funds expands portfolio with two new acquisitions
The team at MPF are excited to announce we have expanded our asset portfolio with the settlement of two new acquisitions in Adelaide and Perth.
The assets include a modern office/warehouse facility located in the prominent industrial area of Pooraka in Adelaide’s north-west, and a brand new Commercial Service Centre in Banksia Grove WA, acquired by our team for $7,550,000 and $20 million respectively.
These mark our fourth and fifth acquisitions this year after placing a strong focus on expanding our portfolio in response to growing levels of investor demand, both in the retail and wholesale space.
The Adelaide-based warehouse also represents our first purchase in South Australia following close monitoring of the market by our acquisitions team, and our fourth raising for MPF Diversified Fund No. 2, which now holds six assets across Western Australia, South Australia and Queensland spanning the retail, medical and industrial sectors.
The asset offered a number of benefits including reduced acquisition costs through the stamp duty exemption in South Australia, and is well-located along one of Adelaide’s most important freight transport routes.
The property also has a strong tenant in leading steel distributor, Vulcan Engineering Steels, who currently have over seven years remaining on their lease term.
Our second acquisition – a mixed-commercial service centre located in Perth’s expanding North East corridor – also marked a milestone for the MPF team, with the launch of our new wholesale investment trust, MPF Banksia Grove Property Fund.
The asset, which spans a site of 13,164 sqm, benefits from a prominent corner location at the intersection of Joondalup Drive and Joseph Banks Boulevard, and is well positioned to leverage future growth opportunities in Perth’s expanding North East region.
While benefiting from a shortage of further commercial service and retail space in the surrounding suburb, the centre offers excellent rental prospects through its diverse mix of national tenants including 7-Eleven, Repco, Pet barn, Mercy Care and Chicken Treat, which collectively offer a WALE of almost 12 years by income.
Given the strength of the tenancies across the two assets and the high levels of income security they offer, we are confident the acquisitions will make strong additions to our portfolio and help to further support distribution expectations for our investors.
Having received high levels of interest for these funds, our research and acquisitions team are now actively searching for further opportunities to expand our portfolio. If you would like to be notified of future investment opportunities at Mair property Funds, please contact our Key Relationships Manager, Brad Dunn at bdunn@mair.com.au
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