New vs Old - What do you think?

Some property investors may consider the idea of buying into a new estate (or a house & land package).

These investors are not told the full story though as I have never seen the glossy brochures point out the oversupply issues with many of the new housing estates and also that fact that the properties are sold at a premium to reflect the developer's profit, not to mention the inflated property promoters commission which is often $20,000 to $30,000 per property.

When you consider that land appreciates and buildings depreciate, overpaying for a new house which is for investment purposes does not make a lot of sense.

The only real benefit to the purchaser of the new property is the depreciation allowance granted by the ATO which is really a false economy when you consider that the investor has often overpaid for the property to start with.

Over supply of land

In the map below I have shown a block of land in this new estate that was sold to an investor for $228,000; the land size is 321sqm.

You can see all the land that is available and that will be developed around the investor's property. The map doesn’t even show all of the land available because there is so much of it.

When property is scarce and demand exceeds supply, property goes up in value (like any commodity) – when supply exceeds demand the opposite occurs.


Consider the following example.





Inconsistent price’s of the land

Another problem with this investment is that the sales prices are inconsistent. Some investors have gotten a better deal than others.

The table below shows all the sales prices for the properties in the St. Sales prices range from $416 per sqm of land to $765 per sqm of land. Whilst it’s common for the sales rate per sqm to decrease for larger lots, the purchaser of No.15 paid $250,000 for 600sqm of land (a rate of $416 per sqm), whilst the purchaser of No.39 paid $228,000 for 321 sqm of land (a rate of $710 per sqm).

The property promoter might say that the land has gone up in the last 6 months but that’s not the case when you look at all the sales and dates. No.15 just got a much better deal than No.39. This could be for many reasons.





Other property sales in the suburb




This new house is on the market for $389,000 (331sqm of land) -





This house is on the market for $429,000 (717sqm of land) - it’s 5 years old so still has depreciation benefits.


Why is there a $50,000 price difference between these two properties. Clearly it’s because the 2nd property is a bigger house on a larger block. So it’s more expensive, even though it’s 5 years old and the smaller one is new.

I guess this is making the investors new house and land package look expensive. I.e. They paid $228,000 for the land + $200,000 to build so $428,000 in total.

To break this down, let’s say we were considering two investment options (in the same suburb)- the new house and land package versus the 5 year old property that is priced at $429,000 and on 717sqm of land.


New House & Land Package – costs investor $430,000

• 321 sqm land purchased for $228,000
  
• Let’s say that the land appreciates at 8% p.a.
  
• Let’s say that the cost of the new build is $200,000
  
• And as per the ATO guidelines let’s say that the building depreciates at 2.5% per year.
  

After 10 years, the land is worth

$492,000 (8% p.a x $228,000 x 10 years)

After 10 years, the building is worth

$155,000 ($200,000 less 2.5% p.a. x 10 years)

Total value @ year 10

$647,000


Or the investor purchases the 5 year old house on 717 sqm. This house is in the same suburb and not far from the new H & L investment, so we agree that if land values increase in the suburb then the capital growth on both will be the same - right.


5 Year old house on 717 sqm – asking $430,000

• Let’s say that the 717 sqm land is valued at $320,000 (i.e. conservative when you consider that people are paying from $250,000 to $315,000 for 600 sqm for new land not far away.
  
• So the building is worth $110,000. The total is $320,000 (land) + $110,000 (building) = $430,000.
  
• A valuer will often use this approach - it’s called the ‘replacement value’ valuation method.
  
• Let’s say that the land also appreciates at 8% p.a.
  
• And we said the depreciated building is worth $110,000.
  
• In reality you would likely be able to claim more than $110,000 worth of value on the building because it hasn't depreciated that much yet.

After 10 years, the land is worth

$690,000 (8% p.a x $320,000 x 10 years)

After 10 years, the building is worth

$ 85,000 ($110,000 less 2.5% p.a. x 10 years)

Total value @ year 10

$775,000


Even if you apply the common sense approach to the above two property purchase options - do you think that after 10 years that the larger 15 year old house on 717sqm of land would be worth more than the smaller 10 year old house on 321 sqm of land if they are both in similar locations - I think so.

It’s commonly accepted that land appreciates in value and buildings depreciate in value. That’s why the ATO allows investors to claim ‘depreciation allowances’ for properties built after 1987.

If property investors were provided with this information in the glossy brochures given to them by the property promoters then I am certain that they would make better investment decisions.

 

Good thread.



I think you raise some very good points.

However, some investors who build land and house packages are actually targeting smaller blocks of land because they have a formula/strategy to maximise cash flow today, buying smaller lots/blocks is the cheaper option than larger blocks, but rental return will be the same. However, both will give a different outcome and investors need to be aware of this, your post is timely.

Its a no brainer in terms of larger land component vs smaller land component, the larger land component will eventually be the winner in terms of CG/value.

MTR

 

Agree completely with the supply/demand issues Chris. I wouldn't necessarily say *all* house and land = oversupply, but in housing estates certainly this can be the case.

Well located, infill development within tightly constrained existing suburbs in inner/middle locations can and have shown to be strong investments - but likewise their established counterparts have also performed well.

 

Your beef with new H&L in new estates is misplaced. Your beef should be with the Project Marketers that developers and H&L aggregators engage to sell developer product.

I have personally and @sash amongst others in this forum made significant returns from buying development stock and building new homes on them. There was a recent relevant thread about this exact topic.

I have also engaged project marketers to sell stuff for me before as well. They charge hefty commissions, and often get a greater value than local agents could.

Would i buy from one, hell no. Are they awful, no. I have spent so much time working with builders to get products i'm happy with, yes i ultimately make more money than someone who bought through a project marketer, but they didn't spend much if any time on this. In a rising market the commissions paid will be soon forgotten.

However with regard to your post that because there is further land supply then its a poor investment, on this i disagree. Just because there is more land supply doesn't mean it will get released affordably or quickly enough to keep up with demand.

Would any of your clients be interested in buying block of land for $145,000 and spending $170,000 on a four bedroom home turnkey so total cost of $320,000k including stamps and legals?


What if i told them on completion it would value up at $380,000 and rent out at $375pw?

 

have you held land and house package during a bust cycle? I have

They certainly are higher risk when markets turn, because there is too much of the same product, and land. I used to build 4 L&H packages pa. Now I am talking about large new outer burb estates, not infill, older areas with limited land

not saying they are a poor investment, however go in with eyes wide open

mtr

 

No i haven't, but given I have been developing land estates for others for around 15years i have certainly seen discounting. However If your investment is tenanted, shouldn't be too big a problem. Realistically developers can only discount so far before they are losing money too. Once they get rid of titled stock they stop releasing. Once they stop releasing then supply is gone. Once demand surpasses supply then prices slingshot because developers are 6-12 months away from releasing any significant volume again.

 

I can only speak from experience and large estates are volunerable for reasons I mentioned.

When cycles go bust all areas are impacted regardless, but cookie cutter estates are a tougher gig because there is far more volume of the same product.

 

But where is the volume? People are generally not selling there H&L in a downturn. The developer will discount to get rid of titled stock. But developers tend to not hold large volume of titled stock.

IME it's only been bad when developers have large number of fall overs due to market conditions and then have to discount to resell. Once they sell out they sit on their hands not delivering any more land if they can't make a profit. Discounting new releases OTP will depend on the developers cost base which really comes down to how long ago they bought the land.

I appreciate your experience in WA. I am only doing this in Melb, and I am bullish to Melb growth especially for lower entry areas like H&L due to population growth. I therefore am comfortable with my strategy.

 

you have not experienced bust cycles, desperate investors do sell because they can no longer service debt, this always happens especially if interest rates start rising.

Developers discount stock when markets turn, however land is not easy to sell because there are no buyers.

Investors become desperate and then prices fall. I know a number of investors who have lost their shirt from SS over extending, this does and will happen, greed and believing that property prices will continue to rise is in part the issue

I have been through 6 property cycles and I invest in Melb, Syd, the rules apply

The moral of the story is manage debt so you don't have to sell if prices fall back

 

Agree with the OP. H&L packages are glorified OTP apartments as there is bit more choice of the builder and finishes. Works very well in rising markets. @sash is very good and experienced at lining up his following ducks and is an exception rather than rule:

• Recognizing macro-economic environment
  
• Identifying public and private infrastructure investments.
• Investing in very early stages of estate development.
• Well targeted block sizes and shapes, dwelling characteristics etc.
  
• Actively managing LVRs and low interest rates given the extensive portfolio and therefore the ability to withstand downturns

There is another significant disadvantage that the H&L owner has versus the estate developer in downturn. The estate developer has most probably recouped the money from the early sales given the margins involved in rezoning (In the zone: Insider trading rife in land rezoning racket) and will easily lower the price or ride out the downturn. The H&L investor is one left with the baby, especially if looking at a quick flip.

Compare this with the risk of the apartment developer in case of downturn. The developer has much more skin in the game.

 

Experienced and early adapter of the H&L, already gone in with 10%, 20% discount. Any subsequent follower should tread with caution on these H&L, depending on where the market cycle is..
It is happy time now that Melbourne continues to dominate the property market in 2016
Sydney had their last drinks, guess who's next.
It is my observation that when market stagnates or fall, the OP example becomes more evident in price separation between New V Old.
A new house is not as shiny after 3 years, but a 5 or 10 years makes no difference
The take note here is land appreciates, building depreciates.

 

I like Melb too, that is why I am playing in this market

I am not stating what you are specifically doing is bad, if rent covers mortgage then you have reduced risk. If you purchased in the earlier stage of the cycle then you probably already way in front.

mtr

 

Interesting Chris.....I don't see the value of H&L for the Qld market yet..but the opportunity exists in certain markets.

Question for you...you are obviously a BA who specialises in existing property? So the question is do you have a vested interest in your comments?

Secondly...how many H&L land estates have you really researched?

Did you know that there is sub market of downsizers who want well appointed smaller 15-20sqm homes where they are prepared to pay a premium for? These people no longer want large gardens but want all the mod cons.

 

Ditto!

Yes...you need to pick well SM....you need to buy in the early stages and before the infrastructure is in. Buying in at higher price when all the other punters get in it will be blood bath. We will see that in the Hills and SW Sydney shortly.

What is interesting...is in parts of Melbourne as "Bernard Salt" said before there are baby boomers who are trading from older houses to newer smaller well appointed homes. The trend is being well set...I have heard these arguments before.

As someone said stay the course. We'll leave it that....I plan to stay the course. But you do need to be skilled in getting value and need to think outside of the square.

 

MTR ....yes there are cycles....

But ....the people who consistently worth $15m plus are buy to hold investors. They get there because their assets are diversified and know their numbers well and would have bought well in the first instance...if not they can continue to hold. They are also very adept at reading the micro and macro economics factors.

You are correct in the fact that you need to be ability to manage debt. Unfortunately...very few people know their numbers well and have not stress tested their portfolios.

I also agree that there a quite a few very smug one cycle investors who think they will survive a Sydney downturn as they can't see one coming. It is question of not if but when?

 

ability to source finance a big one for sure.

markets are changing 2017 be interesting, that's why I keep banging on debt levels, things could get nasty

 

Agree.....MTR finance is the main property is only the vehicle!

Absolutely...agree that certain markets have topped out....again there are sub markets...but in Sydney there are very few of these. The inner Melbourne market is just as bad..it is the outer suburbs which are now playing catch-up. By the end of this cycle I should have more then doubled all my purchases pre 2012.

Yes ..some people will go under. I personally think Australia is a far safer market than other countries...among the Anglo-Saxon countries (USA, Canada, UK, NZ, Australia). The safest markets are Australia and UK...why because they have millions of people wanting to live either London, Sydney, Melbourne, Perth, or Brisbane! We are very fortunate.

 

It's all good when the market is still continue to go north. So overall your deal is a 6% yield plus depreciation and 20% increase in value.

I am guessing this 380k will be 320k in 3-5 years time..

And when Melbourne is ready for the next cycle, your new house is no longer shiny anymore.

When market turns south, nothing can stop it.

Some example of H&L in Butler, Wellard, Lakelands Perth in 2013/2014. Whatever profit you made on completion are immediately gone when Perth market turned south.

 

It depends whether you got in early and put a product in at Butler at 345k (4x2x2), Wellard (3x2x2) at 310k, and 305 (3x2x2)! Last time I looked Butler is now sold out of land and land in the region for 375sqm block starts around 280k plus. Land in Wellard now is around 180k.....and Lakelands is about 160k...guess how much it costs to build...for 3x2x2 with specs I used...about 180k minimum...I build my 3x2x2 and 4x2x2 for 165k-170k.....so replacement costs also comes to mind.

Incidently....just those three bring in about 25k in depreciation per annum! Cashflow is positive across all of them.

I don't think you get the fact when you have almost 10k pw in cashflow...it all evens out. That is what sets professional investors from normal people.

Oh I forgot...the CF+ is heading towards 2300pw...or (120kpa)....give or take....does that tell you why I go for new now??

 

Sure, if the valuations are fair dinkum and also if it doesn't rely on getting out quickly to lock in those profits before there is too much supply or the market turns. Needs to tick the long term investment box as well.