The million dollar questions you need to be asking

If you are recommending residential property to your client, it is essential that you ask a few very important questions to the property group you are liaising with and recommending to your client, these include the following.

1. What commission are they receiving?

Understandably, this is a difficult and uncomfortable question to ask, and ideally you shouldn’t have to ask the question, as all commissions or referral fees should be disclosed upfront and made transparent.

Anything more than 6 per cent of the property’s purchase price starts to get excessive. Further, if a developer needs to pay such a high commission to move the property, you may need to question the appeal of the property.

2. Has the property been valued by a reputable licensed valuer?

Only use a major bank panel valuer from the area in which the property is located to ensure that you are purchasing the property at a fair/real market price. Property valuation is the practice of developing an opinion of the value of real property, usually its market value. The need for valuations arises from the heterogeneous nature of property as an investment class: no two properties are identical, and all properties differ from each other in their location, which is the most important determinant of their value. The absence of a market-based pricing mechanism determines the need for an expert appraisal/valuation of real estate/property.

A certified practising valuer will conduct a full inspection of the nominated property onsite, carry out research and analysis into the local market, and provide a detailed report providing information and commentary on issues affecting the current market value of the property. A written report will generally include:

> an independent assessment of the property’s current market value;

> an independent assessment of how much rental income you can expect to achieve if the property is for investment purposes;

> capital gains tax valuations if the property is for investment purposes;

> an overview of recent sales, auction results and market conditions in the area;

> general information on the neighbourhood and location;

> the property’s past sales history;

> details of the property’s pros and cons, from a buying and selling perspective;

> an overview of improvements that will add future value to the property;

> all legal and title information on the property; and

> replacement cost valuation, which is necessary for insurance purposes.

3. Who is the property presented by?

If the property is presented to you by the developer directly, it could be a biased opinion.

If a property group, investment property company and/or project marketing firm presents a site to you, ask them to disclose how they are remunerated and what vested interest they have in the site.

4. What research has been conducted on the property?

Research is an integral function of all investment property acquisitions and the information presented will help with making an informed decision. Research may include individual property market reports, which include the region’s economics and statistics for future growth; however, this is dependent upon who is presenting you with the property.

There are key questions that must be researched to ascertain an investment purchase:

> what is the capital growth of the area in the last 12 months?

> what is the rental vacancy rate of the area?

> what is the expected rental income?

> what are the rental yields?

5. Rental guarantees — do you really need them?

Incentives to buy property are not a new concept and caution is needed when recommending apartments with rental guarantees. Six to 7 per cent guaranteed returns for two or three years is an enticing offer, however, such a scheme comes heavily weighted.

Pros:

> certainty of secured income for an agreed timeframe even when the property is vacant.

Cons:

> The offer of a rental guarantee is only as good as the developer giving the guarantee, its commitment to the offer, continued operation and having sufficient financial resources, including a positive cash flow, to fund rental shortfalls of property investors. There have been numerous developers that have folded and left investors in no-win situations.

> Some developers/ property marketing groups factor rental guarantees into unit prices and rents are often higher than market trends. Buyers may not be aware that individual apartments are inflated to cover this expense.

> At the expiration of the rental guarantee period, buyers have to lease the property on the open market. In most circumstances, the true market level for rents in that area could be substantially lower than the rental guarantee.

As a planner, you need to be prepared to answer the following questions:

1. What happens to the guarantee when the company sells all the properties and moves on, or if it goes into liquidation?

2. Who will be the company contact or manager of the rental guarantee scheme?

3. How is the rental guarantee going to be financed?

4. Is the rental guarantee amount fixed and for how long?

5. What happens when rental markets change over time and rents fluctuate in line with supply and demand?

6. Is the rental guarantee ‘built into’ the sale by comparing the sale price with similar properties being sold without rental guarantees?

7. Has the rental guarantee been used to promote an ‘inflated’ investment rental return (yield) from the property that is not likely to be achieved?

The rental market is currently very tight, with vacancies below 2 per cent in most capital cities and regional areas, so why would the developer need to offer rental guarantees?

If fundamental property selection criteria are adhered to, such as, location, price, quality, services, and fit-out for example, then the rental guarantee shouldn’t be needed, especially if loaded into the purchase price.

6. Does the property group develop its own stock to sell?

A number of property groups develop, market and sell apartments, handle after-sales services such as leasing, maintenance and property management, and act as real estate agents when investors are ready to cash in.

A number of property groups with this business model have recently been found to be misleading, lacking transparency and distorting the property market as they bought back apartments in their own complexes for a decade to manipulate inner-city property values.

With this type of business structure, investors are provided biased information from the property group, as their own vested interest is high. It is recommended that investors seek separate independent advice.

7. How does the property group secure the site?

The real estate industry is not regulated under the same jurisdiction or legislation as the financial services industry (although there are discussions to narrow the gap or perhaps merge the industries). There is very little in terms of ‘fee-for-service’ in the property investment or real estate industry. The only groups that receive a fee-for-service in the property investment industry are buyers’ advocates, which charge the investor anywhere from 2 per cent to 5 per cent of the property’s purchase price upfront (that is, prior to purchase, sometimes up to a year in advance or until a suitable property is found). Therefore, a $500,000 purchase could amount to anywhere from $10,000 to $25,000 being paid up-front. Very few investors have the means to put up this kind of money up-front, especially if their intention is to build a portfolio.

The typical way an investment property company is remunerated is by the vendor, which is expressed as a percentage of the sale price of the property. Traditional real estate agencies would generally receive 2 per cent to 3 per cent commission, whereas property investment firms’ commission rates vary from 5 per cent to 8 per cent. These higher fees reflect the costs associated with servicing clients, ongoing research expenses and longer lead times, with settlements taking up to 24 months. There are groups that charge as much as 12 per cent to 15 per cent. However, anything above 6 per cent starts to get outlandish and moves away from benefiting the investor.

Ideally, you should look for groups that only charge a flat rate. This way, the company is not swayed or manipulated to take on a site when it is offered at a higher commission rate. Instead, when a higher commission rate is offered, the additional amount above the stated rate is rebated back to the purchaser at settlement.

This is the most transparent way for an investment property company to secure a site, especially when it is done so via an exclusive (or general) authority between the property investment group and the vendor/developer. Under such circumstances, the property group has a predefined allocation (or number) of apartments in which they have the right to market for a predetermined timeframe (30 to 90 days), whatever number of apartments remain after the timeframe get released back into the general market. It is also the cleanest approach to securing a site, with the assumption that the allocation of apartments has been thoroughly researched and that the research is made available to the investor to verify, and that the site has been identified to deliver the investor with future capital growth, sustainable yields, and that the research identifies how the various risks associated with residential investment property are mitigated.

For this reason, property investors should stay clear of groups that underwrite a site. That is, where the mechanism used to secure the site is an options contract or by the group taking an equity position in the development company.

The reason for this is that it conflicts the investment companies’ position to a firm that is fee hungry. On average, a property developer makes a profit margin of 17.5 per cent to 22.5 per cent of the gross realisation of a site’s sale prices. If a property investment company is charging 12 per cent to 15 per cent, not only is it not stacking things in favour of the vendor but definitely not in the favour of the investor. The only circumstance in which a vendor would entertain such an offer is when they are under financial stress and/or the site is distressed. If a site is distressed in today’s market, where there is a severe shortage of stock (as reflected by the record low vacancy rates across most of Australia’s cities), then the site is distressed for a good reason. It could be because it was over or under-capitalised for the area, the finishes are sub standard, the site is made up of three bedroom apartments where the demographics of the area reflect that one and two bedroom apartments are sufficient.

8. What is their track record?

It is important to understand a developer’s/property group’s past performance, so it’s important that your client sees information that will assist their investment decision. An undue emphasis on past returns can lead to your clients having unrealistic expectations and making poor investment decisions.

When speaking with your property company at least ask for their five-year returns on sites they have previously sold. Also ensure:

> information about returns is balanced with information about risks;

> all past performance figures are up-to-date; and

> important information should not be buried in fine print.

The past performance information has an emphasis on long-term returns rather than a reliance on the short-term, that’s because if your client is thinking about making a long-term investment, recent short-term results won’t tell you much about long-term prospects.

Neil Smoli is the managing director and Tony Monaco is the general manager of the Aviate Group, a property research and investment firm. This article is for general information purposes only.