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02 Jun 2018

Build it and they will come


The followers of New Thought philosophy hold that we can actually bring wanted experiences and opportunities our way by feeling and believing that they have already arrived. In other words, if we engage in a powerful combination of positive thought and belief we will achieve resonance with those experiences and opportunities we desire and “attract” them to us. It’s pure mind over matter and wouldn’t be of further interest to investors, except that it occurs quite often in the world of property investment. 

You may have seen advertisements by sellers’ agents and developers spruiking new block of units or housing estates or other property developments claiming that they will actually generate demand that didn’t exist beforehand. This is classic build it and they will come stuff, but what really matters to investors is who will come?

HOUSING SATISFIES FOUR DIFFERENT TYPES OF DEMAND

Demand for housing can arise from owner-occupiers, renters, investors or speculators, each with different needs and aspirations. Owner-occupiers buy homes to live in, motivated mainly by the desire for status and security. They have no interest in rents or yields and demand is controlled by the ability of first home buyers to enter the market by raising deposits and obtaining finance.

First home buyers then become upgraders, moving several times during their lives to bigger homes in better locations dictated by their changing financial and family situations. Finally, most owner-occupiers become downgraders, moving to a coastal or lakeside destination with a nest-egg in hand from the sale of the family home for their retirement.

RENTERS HAVE IMMEDIATE CONCERNS AND OBJECTIVES

The main financial priority of renters is to pay the rent. They can and do move often, seeking locations that offer convenience, lifestyle, employment, social and educational opportunities and properties with affordable rents.

While renters provide rental demand, it is investors who generate rental supply. Every property purchased by an investor, unless it is already tenanted, becomes a rental vacancy until a new tenant is found.

This is why investors need to be aware of current and potential rent demand because they don’t live in the properties they own but rely on tenants to generate cash flow. Yet many investors don’t even consider this essential need when buying off the plan and new properties, because the glossy promotions often come loaded with assurances of high future population growth and are sugar coated with rental guarantees.

Remember two things about rental guarantees – firstly, the anticipated cost of the guarantee is simply added by the seller’s agent to the purchase price, so not only is the property already worth less than you are paying for it, but you are paying stamp duty on the rental guarantee component as well. Secondly, if the rental demand is genuine, why is there any need to provide such an inducement to investors?

This leads us to the fourth type of demand, which comes from speculators, the investors who buy purely on the hope that prices will rise.

SPECULATIVE INVESTMENTS OFFER THE GREATEST RISK

These investors respond to messages such as: “these are selling faster than hot cakes” or “get in quick or you’ll miss out”. They eagerly jump in and buy without checking whether the supposed high demand is coming from other speculative investors responding to the same messages, or whether there is sufficient underlying rental demand in the area for the types of dwellings being sold.

If there is shortage of rental properties in a locality, rents rise and so does investor interest, which can then lead to price rises if there is also a shortage of properties to buy. But in many areas of Australia, housing developments are sometimes undertaken without any real consideration of current or predicted rental demand. In fact, many high-rise unit developments are built and sold purely on the likely demand from unsuspecting investors.

At first, these speculative investors think all is well, but when the rental guarantees run out, vacancy rates rise and investors start to compete for tenants by cutting asking rents. Investors start to pull out and as the number of properties on the market rises, prices start to fall. It’s a vicious cycle that has occurred in many of our major urban centres in recent years, and it will keep taking place as long as some investors believe that if you ‘build it they will come.’ What matters of course is whether ‘they’ are owner-occupiers, renters or other speculative investors.