What to do with your dud investment property
Increasing residential real estate values over the past few years, especially in Sydney and Melbourne, mean most investors who bought a property a few years back would expect to have made a killing.
But not every residential investment is a golden goose; some turn out to be a lemon.
So how do you know if your property is a dud? And if you decide it is, what should you do about it?
Selling is going to cost you (think selling costs, perhaps capital gains tax and stamp duty if you reinvest in another property) but holding on could cost you more in the long run.
Stuart Wemyss, director of ProSolution Private Clients and a property investment expert, defines a dud property as one that has appreciated at less than 7%pa and/or has not kept up with its peers.
Wemyss has financially modelled the impact of selling a dud investment, paying the CGT and reinvesting in a higher-quality property.
He uses the example of a Melbourne property that has produced 5.8%pa growth over about 27 years, compared with the overall growth rate of 7.1%pa for the area over the same period.
He found that even though the property is cash-flow positive and the owner would have to pay capital gains tax, they would be better off selling.
In the example the owner sells for the current value of $650,000 and buys a replacement property that grows at 7.8% a year. After 15 years the investor will be $319,000 better off (net of all costs) in today's dollars, Wemyss says.
Another expert, Michael Yardney, CEO of Metropole Property Strategists, also a proponent of holding for the long term, says that if a property has not performed well over three or four years it's likely to be a dud.
One thing to consider before selling is the relative performance of your existing investment property and the length of time you have owned it, says Wemyss. "If the performance has been very poor over a long period of time, then the evidence is compelling.
However, if the performance has just been OK but not great and you haven't owned the property for a long time, then I'd probably advise you to hold onto it for a little while longer."
Another consideration is the size of your home loan and the amount of equity in the investment property to be disposed of.
"The advantage of selling an investment property with a lot of equity is that it allows you to reduce your home loan (which provides significant compounding savings). However, if your investment has little equity and/or your home loan is small, then it will have little impact," says Wemyss.
If you have an underperforming property the problem could be market related or relate specifically to your property, says Yardney.
It would usually fall into one of four categories:
- Timing: Buying when values are at or near the peak can mean that your property's price may languish for a few years, or even fall for a while.
- Price: If you pay too much, you're likely to have a few years of no capital growth.
- Location: Some suburbs underperform others and even in the better areas some locations are not as desirable as others.
- Poor property selection: If you've bought the right property at the wrong time or paid too much, you'll generally find real estate is forgiving and in time your property will start to perform, says Yardney.
"But if you've bought the wrong property or in the wrong location, sometimes you just need to bite the bullet and sell so you can buy something better."
The key, of course, is that you do buy a better-performing property. And this requires you to do a lot of research and perhaps enlist an expert, which will come at a cost.