ARE WE IN RECESSION OR NOT? SEEMS SO ! ! !

RBA Governor: Confidence the key

Reserve Bank Governor Speech: “The Road to Recovery”

• The Reserve Bank Governor has also mentioned the ‘R’ word – recession. But while he thinks that the economy is experiencing the first recession in 17 years, Glenn Stevens has been actively stressing the positives as well as the negatives.
• The Governor says that the best thing Australians can do is “to maintain confidence in ourselves and the prospects for our country over time.” Stevens noted further: “Optimism, combined with an awareness of risk, is a fundamental strength.”
• Glenn Stevens has unveiled the “Super Six” – six reasons for Australians to be optimistic about the future.

What does it all mean?

• The Reserve Bank Governor gets it. Hopefully other public officials will also eventually get it. That is, it’s all about confidence. While Australia has been dragged into recession by the global economy, the important point is to highlight the positive factors that will drive the economy forward in coming years.
• This is one of the most important speeches delivered by the Reserve Bank Governor, providing a clear and balanced assessment of just where we are at present and where we are going. It is a speech deserving to be read closely and reported widely.
• Glenn Stevens is no gloom and doom merchant. While the global economy may be a gloomy place, he sees plenty of reasons to be positive, not negative. The fact that the Governor is focussing on the opportunities ahead as well as the risks is incredibly encouraging.
• It may come to be known as the “Super Six” – Glenn Stevens’ six reasons to be upbeat on Australia’s economic future. Political stability, strong banking sector, solid public finances, sensible policy, openness to trade & investment and exposure to Asia are regarded as factors that few other countries can emulate.
• All Australians should celebrate the fact that we have a central bank governor with such pride in our economy. It is a sense of pride that all holding public office should emulate.
• While upbeat about Australia, the Governor has not minced words about the crisis imposed on Australia, referring to the ‘mess’ in the financial systems of the US, UK and Europe.

What did he say?

Selected Comments:

• Confidence: “Turning closer to home, Australians cannot do a great deal to make these improved international conditions come to pass. But we can maximise our chances of benefiting from a new international expansion.
• The first thing is to maintain some confidence in ourselves and the prospects for our country over time. We cannot achieve effortless prosperity either on the back of ever‑escalating mineral prices or simply by bidding up the prices of our houses. It is as well to realise that. But as I have said on previous occasions, Australia’s genuine long‑term economic prospects remain good, and there remain good grounds to think that we will continue to weather the storm better than most.”
• Reasons for the global recession: “The weakened ability of the financial institutions to provide credit to industry is one of the factors at work, but in my judgment a bigger one is the decline in confidence, and the sudden and widespread aversion to risk, among firms and households all over the world. It seems that everyone, everywhere, having seen the instability in financial systems in September and October 2008, and consequently feeling poorer and fearing bad times ahead, simultaneously decided to pull back their own spending, curtail their expansion plans and reduce their debt.”
• Domestic recession: “Whether or not the next GDP statistic, due in early June, shows another decline, I think the reasonable person, looking at all the information available now, would come to the conclusion that the Australian economy, too, is in recession.”
• Recession: “Most of the time, economic activity expands, as population growth, increasing wealth and aspirations to higher living standards lead to more demand, while a growing workforce, higher productivity and technological innovation push up supply capacity. That is the normal situation for an economy. But every so often – on average about once every seven or eight years, but not regularly enough to predict with accuracy – a set of conditions arises that sees demand weaken for a while, output decline and unemployment rise. That is a recession. Usually, though not always, inflation tends to fall as a result of such episodes.”
• The Super-Six: “I suggest that Australia has a very good chance of offering an economic setting in which the following conditions hold.
• First, political stability remains assured – something becoming a bit less common.
• Second, the Government does not own, and has not had to give direct financial support to, the banking system. Australia will be free of the difficult governance and exit strategy issues that such support is raising in a number of countries.
• Third, public finances remain in very sound shape, with modest debt levels and a medium‑term path for the budget back towards balance. Without the massive obligations arising from bank rescues that will inevitably narrow the options available to governments in other countries, Australia should be able to articulate such a path more effectively than most.
• Fourth, sensible policy frameworks – both macroeconomic and microeconomic – remain in place; the financial regulatory system is strong and tested.
• Fifth, we remain open for trade and investment, and have a capacity to deploy both our own and other people’s capital carefully and profitably.
• Finally, there is an exposure to, and an engagement with, an Asian region that still has the most dynamic growth potential in the world, where hundreds of millions of people will for decades to come be seeking rising living standards.
• There are rather few countries that have the potential to offer so attractive a proposition to international capital, and to their own citizens, over the years ahead. It is a proposition that, if pursued sensibly and consistently, offers the most secure basis for confidence in Australia’s future. It is such confidence that, more than anything else, will help to drive us along the road to recovery.”
• How does the global economy recover? The Reserve Bank Governor says that the “mess” in the US financial system needs to be sorted out; monetary & fiscal policies need to provide support; exit strategies need to be employed; and that global imbalances need to be addressed.

What are the implications for interest rates and investors?

• The Reserve Bank Governor’s optimism on the future certainly doesn’t appear to be laying the groundwork for future rate cuts. The latest RBA Board minutes highlighted the significant amount of stimulus being applied, and the Governor is indirectly highlighting the same in his speech.
• The Reserve Bank Governor believes that the economy is in fundamentally strong shape with the main risk being a further erosion of confidence.

Source Craig James, Chief Equities Economist, CommSec

Perils of Off The Plan Property Acquisitions.

Why would an investor buy off plan, rather than buying an established, completed property in the existing market place?

Buying off plan ie before a brick is laid and from the plans, can be good – but the economic factors are key, which is why buying in developing markets can be attractive.

The idea is, you buy at today’s prices, or even lower than the equivalent to today’s prices. As an example consider a property, off the plan at a purchase price of say $450,000. You may pay perhaps a 10% deposit of $45,000 with the rest on completion. By the time of completion in 24 or more months, the natural growth in the market would see an increase in the price of say 10-12% per annum (highly dependant on where the property is, of course) – showing a new value of $550,000 to $560,000. This represents a very good way to see an increase in your money/equity for little effort, and an excellent return on investment, especially if you have only paid 10% down (and in some areas deposit bonds and funds guarantees can reduce this cash outlay even further).

I bought apartments off the plan in Port Melbourne 10 or 11 years ago, and did very, very well – revaluing for excellent capital growth within 12 to 18 months after completion. I have since seen and been involved in great success in similar market conditions a year or two after acquisition in the middle 2000’s – with resultant strong growth. May I also point out that similar results have been achieved with existing stock where strong added value has been achieved by a full and complete renovation and the resultant lift in the property’s identity revealed great wealth increases for the investors.

Sounds good? No?.

That’s what the marketers would have you believe, but in today’s market one has to be ultra-careful.

It can also not go so well – usually when the market turns during this build period ie in several areas of Australia over the last 2 years or where supply now outweighs demand. This is especially prevalent in the speculative areas of WA.

Just to give an idea of how wrong it can go, I get emails regularly along the lines of,
"I bought a new townhouse in xxxxx as a result of an email I received offering the property at a 5% deposit mortgage with 100% financing available. The valuation report on the house showed a value of $485,000 with anticipated monthly rental of $2,500+. I paid the 5% deposit and took out a mortgage of 95% LVR plus costs & fees. The mortgage was over $500,000. The deposit came from my small savings account. I was given a 12 month rental guarantee by the vendor.

I was told I could either sell the property on for a healthy profit on completion, or rent it out for a monthly income of $2,500 covering my monthly mortgage repayments – but 15 months later the apartment/house is still empty, I cannot get anyone interested in renting even at $2,000 per month and I have recently had the property valued at $435,000. What would you recommend?”

My comment? In hindsight, (great sight) the sale price was obviously well in excess of the real price at the time of the purchase, the cost of the rental guarantee had to come from somewhere and it was obviously built into the price. So from seeming like a great deal allowing you to get onto the property ladder with only limited funds, and so called “instant equity”, within a relatively short time of completing you can find yourself with a significant amount of “negative equity”.

Another point to note is why I get frustrated with surveyors, ie the values they give property by looking at broad brush historical data and not understanding the rental/investment market. Again as an investor I will put different values on the property than surveyors will – and so will the market, as the above example shows fairly dramatically.

So you can see huge differences in how buying property off plan can pan out - so what should you look out for? There are some key things I look for when buying off plan, whether it’s in Australia, or any other city anywhere in the world; it makes no difference.

Here are a number of things to check…before committing...

The property must be good value now. That is, it compares favourably in price with similar properties today, and is not based on properties going up in value by 10% for each of the next 2-3 years of the build period. The greatest care here must be that the full costs of land acquisition, construction (labour & materials), consultants fees, taxes, agents fees, selling costs and, of course, profits must be taken into account. The sell price of “off the plan” property, per square metre can far exceed the price of similar sized stock in the existing market (of course, production and delivery costs are high).

Check Supply and demand/market forces – this is vital. What is current buying/renting supply and demand? What will it possibly be when complete? If market is already looking saturated now, will it be any different in 2 years? What development is planned in the area in the meantime? Investors have often been caught out in these critical areas of decision making – by spending time concentrating on the so called discount and stamp duty savings the developer has given them (this is especially prevalent in Victoria, Australia) and forgetting to check whether there is any rental demand !

Further, make sure you check the difference between 1,2 and 3 bedroom properties. There can be big difference in sale price per square metre here and the demographic of the area will play a big part in your choice of dwelling. Are they mainly families in the area or is it a more a singles environment? Which demographic will pay the higher rental returns?

Tax efficient/buying costs – Tax can often be one of your biggest expenses. What are property taxes like in the city, area, state or country you are looking to invest in? What is the most tax efficient way to buy? Perhaps to purchase in joint names as joint tenants or tenants in common or a limited company or perhaps even a sophisticated trust structure? What are other taxes like? These may include but not be exclusive to capital gains tax, wealth tax, stamp duties, income tax, GST’s. What will buying costs be? These can range from 3-12% in different areas – a significant difference.

What will the cost of money be now at the time of purchase? Can I borrow enough to complete the transaction? What will my costs be to borrow the money? My start up and establishment fees. What will my break costs be if I have to sell before I am really ready?

However, much more importantly, what are all these costs likely to be at the point of completion?

Location, location, location – obvious? Yes? No?

One development may be 20% cheaper than another, why is that? Which will go up in value by more? What attractions/amenities are there now/will be there on completion? What is likely to be built around the development in the next 2 years while it is being built – will that fantastic view still be there?

Unsophisticated buyers and the newspapers talk about the (over-all city) market. One must seriously distil this right down past the city, down past the suburb, past the area where the property is and right down to the street the property is in. In fact, it really gets down to the individual property and its attributes.

Payments – what is payment structure? Is this best way to leverage your money? Ie some developers will require payment all the way through the build period, some will only need a 20-30% deposit, and that will be it until completion – big differences to your cash-flow and your return on investment – usually the less of your own money invested, the better.

Independent lawyer and building inspector– I would always get an independent lawyer from the one the developer recommends. Once have a good lawyer can trust, stick with them! I always have an independent build inspection criteria written into the contract to make good to contract specs if there are any variances, with a no cost get out clause to protect me.

Does price cover everything? - eg air conditioning, swimming pool, car parking? Again very important when comparing – are you comparing like for like? Have you factored this in at a price per square metre rate?

What is the size of developer/development? Are they likely to go bust? If they go bust is your money secure? How long have they been around for? How big is the development – I personally prefer smaller developments where there are less likely to have a great deal of investors all with same strategies.

Exchange rates? If have bought in a foreign currency, what is likelihood of changes in exchange rates? Can you minimise the risk? This can make a big difference to what you pay if there are staged payments in foreign currency.

Who are the other buyers? All investors, or owner occupiers/second home owners? I prefer to buy in a development with a good percentage of owner occupiers, whether here in Australia or overseas and with a local market from both from tenants, and thus investors and owner occupiers rather than only out of town investors – as when you come to sell there will be a local market to sell to. This is an important key to long term success of your investment. For instance, in the recent deal we did in St Kilda, an inner bayside suburb in Melbourne, Australia, there were 42 apartments in total. We secured 19 for a number of investor clients, and the rest went to a wide ranging local owner occupier market – giving a good balance, less competition for rentals, and a clear exit strategy at an appropriate time.

And once you have asked all these questions they should help you form an answer!!

As with any property purchase, you should be pleased with the value when you buy, and also have an idea of the way the market is going over the build time – you do not want to have purchased in an off the plan strategy and get to completion date to find out no-one wants to buy the properties at the price you hoped for, as current local supply far outweighs demand, or get hit with higher tax bill or interest bills than expected or go in with an investor strategy and then find out rental yields are much lower than you need to cover costs.

This may seem obvious, but many people make these mistakes.

A key point also is forget all the smoke and mirrors around the deal!

So many deals are sold on the extras, such as guaranteed rental schemes, no (low) stamp duty, big discounts, free carpets(?), free swimming pool etc when all that should really matter is – “What is rental demand for this property and will this rent cover my repayments,” and “Is this property at good value in comparison to others, or in high demand, or in a country/area that is seeing significant economic growth that will show an increase in value over the next 2-5 years?”

Most experienced investors will only look at the numbers – they do not invest with emotions, and will not be swayed by marketing ploys.

It is interesting that most of the investor clients we have buying the cost effective properties that we source in the inner urban areas of the three Metropolises of Australia (Melbourne, Sydney and Brisbane) are experienced investors. Perhaps they cannot get the figures to work in these local areas immediately, but are knowledgeable and clear enough about the drivers might be and what the important factors are when investing.

So buying off plan can be good – but the economic factors are the key, which is why buying in speculative

markets can be attractive, and buying in mature markets can be more risky as is more risk of the market turning.

Done correctly you can do very well and truly make an excellent return – done badly and without proper research and more importantly the right advice and support from an accredited Licensed Buyer’s Agent Expert, you can find yourself with negative equity and a big worry for a long time, till the market catches up, if ever.

I can assist !!!

Respond via this blog and I’m happy to chat about your specific circumstances.

Jack Henderson