New homes in large, purpose-built estates don’t provide above average long-term capital growth: Michael Yardney
How would you like a brand new investment property with a secure long lease, no property management hassles, zero vacancy risk and guaranteed rental income?
Sounds good doesn’t it?
Well … a few types of investments seem to advertise these benefits.
One group are serviced apartments and I’ll give you my thoughts on these in a future blog, but another is Defence Housing Australia (DHA), which advertises all of these benefits. They also build or buy houses, lease them to military families and then sell them to property investors.
While this sounds great to an uninitiated investor, in my opinion it comes at too high a price, which makes these very poor investments.
Let me explain…
1. New house equals poor gains
In general, DHA promotes newly constructed homes often in master planned estates in regional Australia.
Being new, your investment comes with a long list of depreciation benefits and of course doesn’t have that lived in look, so this seems like a pretty good deal, right?
Unfortunately, there are more negatives than positives when it comes to buying a new home such as those the DHA has on offer.
First there’s the fact that new houses almost always cost more than comparable established homes in the same area, meaning you are buying them at top dollar.
This is particularly true for DHA homes, where you pay a premium for what is sold as a “total package”; you get the tenants and even a pre-appointed property manager with the house.
While this type of “guarantee” panders to the inexperienced, insecure investor, it’s worth remembering that property investment is about building an asset base through above average long-term capital growth – something new homes in large, purpose-built estates simply don’t provide.
Fact is these properties tend to be in regional areas. I have always avoided investing in regional towns because of their heavy reliance on one or two industries to sustain their local economies and population.
Remember, when those industries take a battering, it’s not long before local house prices start to bear the brunt.
Instead, I look to invest in areas where property values will be driven up by a large and growing population base, a diverse economy and scarcity of supply of well-located properties.
Clearly there is little scarcity to push up the value of DHA properties – they’re built by the hundreds in some towns.
2. Difficult to sell
One of the big obstacles to capital growth for DHA properties is the lack of a secondary market.
Demand from owner-occupiers is what pushes up the value of most properties.
But if you bought a Defence property and chose to sell, or even worse had to sell, you’d cut out 70% of potential buyers because your property would not suit an owner-occupier because of its long lease.
This adds up to one big fly in the proverbial ointment when it comes to owning DHA properties. A minimal secondary market for this type of property puts these investments on my “stay well clear of” list.
By the way … mortgage insurers aren’t fond of DHA properties, and this makes it difficult to get a mortgage for more than an 80% LVR.
3. High management fees means reduced rental returns
OK, you may pay too much, have below average capital growth and can’t easily sell your property, but at least you’ll be guaranteed a tenant for up to 12 years.
This means no extended vacancy periods where you could end up struggling to meet the mortgage repayments.
Then there’s the “make good” clause that means at the end of the lease period, the DHA ensures it will replace the carpets and give the house a fresh lick of paint.
Sounds good doesn’t it? So what’s the catch?
Well, as usual, this “peace of mind” comes at a cost.
Specifically, the cost is in DHA property management fees charged at a whopping 16.5% or more than double that of a regular property manager.
‘Fine’, I hear you argue, ‘I’ll just employ my own property manager!’
Unfortunately you can’t. It’s compulsory to hand full management of your investment over to the DHA.
Start crunching the investment returns and suddenly those guarantees lose a bit of their luster.
4. The rental guarantee is up, now what?
What happens at the end of the lease? Well the DHA may renew it – or not.
But what if you want to sell your property then? How will a home that’s had long-term tenants in place and is surrounded by other long-term rentals appeal to owner-occupiers? What if other investors in the estate also plan to sell at the same time?
Not an ideal situation, is it?
Look before you leap
There’s lots of ways to make money in property and there seems to be just about as many ways to get property investment wrong.
Before you make any investment decision first have a plan, a property investment strategy and know what you’re looking for from your property investments.
Then, if you’re considering a DHA investment, here are some questions you should ask:
How much more would I be paying for a DHA house than other comparable properties in the area? What is the mark up for this new home and the “bells and whistles” that go with it?
How does the supply of new properties compare to demand for houses in the area from owner-occupiers?
How much of my rental return will I be forfeiting in excessively high management fees?
Will the security of a guaranteed tenant and the benefit of depreciation allowances compensate for the slower capital appreciation I can expect?
When you start to weigh it all up, mounting a defence for military housing as an investment prospect is a difficult ask. Trying to build a wealth-generating portfolio through niche property investing is a bit like playing roulette and hoping to win big. The odds are not in your favour.
Michael Yardney is a director of Metropole Property Strategists, who create wealth for their clients through independent, unbiased property advice and advocacy. Subscribe to his Property Update blog.