Red flags of high-risk properties
Apr 26, 2018
In the current environment of cooler housing markets, lending restrictions, the potential repercussions of the Banking Royal Commission and overall risk awareness, it is more important than ever to identify the red flags when it comes to buying property.
RiskWise Property Research has identified these red flags for high-risk dwellings for both suburbs and specific property types and configurations.
However, the No.1 risk associated with buying any dwelling is taking advice from a “property professional” who is not paid for their services.
RiskWise CEO Doron Peleg says in the housing industry no one works for free.
“As a general rule, if you are not paying, you are not the client, and someone else is, for example a property developer - and that means there is an agenda to get you to buy whether it is for your benefit or not,” Mr Peleg says.
Following is the RiskWise list for suburb-related risks:
1. Poor or unsustainable economic growth
It’s no secret that economic growth is the No.1 factor when it comes to success, says Mr Peleg.
“Therefore, suburbs that are located where there is poor or unsustainable economic growth, such as Perth, are highly likely to underperform the national benchmark,” he says.
“Dwellings, whether houses or units, in suburbs with sustainable economic growth have outperformed the national benchmark in 90 per cent of cases, delivering an average five-year growth of 48 per cent.
“In contrast, only 43 per cent of suburbs with no sustainable economic growth outperformed the benchmark, delivering an average five-year growth of 10.4 per cent. A significant difference.”
A low proportion of new properties has a strong correlation with solid capital growth. Therefore, areas with a large number of dwellings in the pipeline and building approvals are highly likely to underperform the market.
Both equity risk and cashflow risk associated with properties in such areas are significantly higher than areas with a low number of new dwellings.
Mr Peleg says it must also be remembered there is the possibility the value of an off-the-plan property may decrease between the original contract date and settlement. This will result in a capital loss, as the equity in the home could be reduced. The risk is further increased if a pre-settlement valuation for a mortgage loan is less than the original value, as there could be a shortfall in funds to complete the sale. If these funds are unavailable, the buyer might lose the deposit paid for the property.
A low proportion of new units in a city has a strong correlation with high capital growth outperforming the benchmark in 85 per cent of cases, delivering five-year growth of 50.3 per cent. Areas with a high proportion of new units outperformed the benchmark in only 63 per cent of the cases, delivering 30 per cent capital growth in the period.
However, Mr Peleg says, considering only the number of units in the suburb alone is not enough.
“Our research shows that the addition of units to the entire area needs to be taken into consideration,” he says.
3. Lower medians
RiskWise research clearly shows units in suburbs with a lower median price generally underperform those suburbs with a higher median price.
4. High unit-to-house ratio
Where a unit costs more than 60 per cent of the median house price of the suburb, the capital growth is generally lower than units in suburbs where the median price is less than 50 per cent of the house price. Also, the greater the ratio between units to houses, the greater the preference is for houses over units, and therefore, the risk associated with units in greater.
5. High vacancy rate
Properties in areas with a higher vacancy rate carry a higher level of equity and cashflow risk, due to competition for a small number of tenants.
Mr Peleg says property types also carry their own level of risks:
Property type: House/Semi/Townhouse/Unit
“Generally, it is understood there is a preference for houses over units to deliver a solid capital growth,” Mr Peleg says. “However, the risk associated with a unit or other property type depends on the specific suburb, which is why they should be assessed on a case-by-case basis.”
High rise vs small unit blocks
RiskWise research shows high-rise buildings generally carry higher risk than small unit blocks from both a capital growth and cashflow perspective. It is important to note that the risk associated with a high-rise building depends on the specific suburb and other factors such as strata payment and specific property features, all of which should be assessed on a case-by-case basis.
Off-the-plan vs existing properties
It is possible the value of an off-the-plan property may decrease between the original contract date and settlement.
“This will result in a capital loss, as the equity in the home could be reduced,” he says.
“The risk is further increased if a pre-settlement valuation for a mortgage loan is less than the original value, as there could be a shortfall in funds to complete the sale.
“If these funds are unavailable, the buyer might lose the deposit paid for the property.”
He says an off-the-plan property also carries a cashflow risk as the actual rental may not meet the expectations.
Property configuration – number of bedrooms, bathrooms and parking
Different property configurations are desired by buyers and for investment purposes, by tenants. RiskWise research shows a property which does not have the desired configuration (of bedrooms, bathrooms, parking) carries an increased risk of lower demand from home buyers and investors during normal market conditions.
Generally, large properties that are well suited for families carry lower risks and deliver higher return than small properties that are suited for singles.
RiskWise has Three Top Tips for buying property:
1. Perform independent research and be aware of the risks. If things go wrong, you will have to deal with the consequences.
2. Do not take advice from a property professional who you are not paying. Steer clear of advisors offering their services for “free”. You will pay in the long run.
3. Distinguish between the research phase (that should be done by yourself or by a research company) and the execution phase (i.e. the purchasing activity).