Advice wanted: Sell or develop?

[7seven7]

So a friend of mine owns a property in a desirable area in Perth (East Victoria Park). Around a 7km drive from the CBD.

It was bought 25+ years ago and so if sold now, there would be no capital gains tax required to be paid. It has been a rental property for 25+ years and my friend is now looking to sell it (or consider other options). The real estate agent who has managed the property values it at ~$600k. It's on a ~700m^2 block.

As far as we have discussed the options are;

1. Sell the house and basically net $600k as there is no tax required to be paid.

2. Keep the property as a rental and likely spend ~$40k+ fixing it up over the next few years as it definitely needs some work. Based on a house value of $600k the yield is only ~3.5% gross at the moment from rent.

3. Bowl over the house and develop the block (currently not subdivided but I am sure approval will not be difficult). For this option, we are basically trying weigh up if spending $500k or whatever to develop 2 new properties on the block will return more than $600k net profit.

4. Other options?

All thoughts/opinions welcome! Thanks!

 

[Kent Cliffe]

I'll answer the questions in reverse:

3. Development margins are slim with duplex sites. In fact, I have a feeling after tax you may be eroding equity in the project. Run a feaso on developing the site at today's land value, if the numbers don't stack up (which is highly likely) don't do it.

2. Yield may not be great, but say you get 4% growth on current values - very conservative. Assuming you purchased it for $200k that would be a 12% return on initial equity plus the yield of 3.5% gross (about 2.7%+/- net) or 8.1% net rent return on initial equity. So a total return on equity of 20%+. To me that is a good investment, and a great demonstration of compound growth.

1. Can you invest in something returning 8%+ on the $600k to make up for the transaction costs of Selling & Buying?

 

[LoneWolf]

2. Keep the property as a rental and likely spend ~$40k+ fixing it up over the next few years as it definitely needs some work. Based on a house value of $600k the yield is only ~3.5% gross at the moment from rent.

All thoughts/opinions welcome! Thanks!

If this place was brought 25 years ago, why would the yield be so low of 3.5%?

If your friend are in the position to hold and develop, I would suggest that would be the ideal scenario

 

[HD_ACE]

What is the zoning on the property?

Cheers

 

[7seven7]

I'll answer the questions in reverse:

3. Development margins are slim with duplex sites. In fact, I have a feeling after tax you may be eroding equity in the project. Run a feaso on developing the site at today's land value, if the numbers don't stack up (which is highly likely) don't do it.

2. Yield may not be great, but say you get 4% growth on current values - very conservative. Assuming you purchased it for $200k that would be a 12% return on initial equity plus the yield of 3.5% gross (about 2.7%+/- net) or 8.1% net rent return on initial equity. So a total return on equity of 20%+. To me that is a good investment, and a great demonstration of compound growth.

1. Can you invest in something returning 8%+ on the $600k to make up for the transaction costs of Selling & Buying?

Thanks Kent, looks like selling and investing in something else would be the best option. I don't quite follow what you are saying in point #2 though (the property was bought a long time ago for around $20,000 if I recall correctly so the return on initial equity is a bit of a non-factor as there has never been debt or money owed on the property). It has just been 25+ years of rent collections and capital growth on the property value.

We just can't make sense of holding on to the property any more. At a value of $600k and around ~3.5% ROI from rent, the house gives around a $21k/year income before expenses and tax are taken in to account.

In comparison to stocks for example, it is fairly straight forward at the moment to build a balanced portfolio with $600k on an average grossed up dividend yield of ~9% and have arguably the same or better capital growth prospects compared to housing in the long term. Based on a ~9% gross return on $600k, that is a $54,000 per year income.... so about 2.5x the gross return of the rental property. The other advantage is that the shares don't require any additional work or expenses like the property does. Taking in to account commissions and expenses for the property, the $21k probably gets down to $17k or less before tax. So now we are looking at a passive income of $54k against $17k before tax. If this is the case, would there be much of a case to justify keeping the property?

If this place was brought 25 years ago, why would the yield be so low of 3.5%?

If your friend are in the position to hold and develop, I would suggest that would be the ideal scenario

It is ~3.5% yearly gross return based on a current value of $600k, not based on what was paid for it.

What is the zoning on the property?

Cheers

R20 I believe.

 

[HD_ACE]

R20 I believe.

Wouldnt be a duplex block then.
Maybe add a granny flat to create an extra income stream.

I think youl be hard pressed to make 600k without selling.
Might be better to sell and put the money towards something better. Especialy cgt free.

Cheers

 

[westminster]

I'd keep it and ensure I did nothing to it that would jeopardise it's CGT free state.

If adding a granny flat would still allow it to be CGT free then I'd do that.

Whilst the yield is low compared to today's value it's fantastic yield at it's purchase price - providing that the owner hasn't borrowed against it. If it has no debt against it then I would keep it and be happy with the income stream that it brings.

I don't think developing it (even if possible) would give that profit and would most likely cancel the CGT free status he/she currently has access to.

 

[thatbum]

I'd keep it and ensure I did nothing to it that would jeopardise it's CGT free state.

If adding a granny flat would still allow it to be CGT free then I'd do that.

Isn't there some improvement threshold for pre CGT assets before it gets jeopardised?

I don't know what it is, but I agree, it might allow for a granny flat which is probably the best way to go if he intends to hold it for a lot longer, and wants a higher yield. (Since its R20 and not subdivisable).

 

[MTR]

Perhaps it is currently under review and will be subdivided in the future, just about everywhere in Perth seems to be going this way??

I most certainly would not sell a property in Vic Park, I consider this blue chip. I don't really understand why you are not looking at the actual yield today, the reality is it generates a good yield.

I would just access the equity from the property and find a suitable development site where you can at least build 3 and where the figures stack up.

 

[7seven7]

I most certainly would not sell a property in Vic Park, I consider this blue chip. I don't really understand why you are not looking at the actual yield today, the reality is it generates a good yield.

Well I am looking at the yield it generates today and when compared to other options - it is not as good even when factoring in the capital value growth on top of rental income.

What are the prospects for a very old house in a good area and on a reasonably large block like this one? The main issue we see is that the house will likely need some major work within the next few years, probably 4 years worth of the net income from rent.

It seems as though the area at the moment is more expensive than it has ever been so I am not sure how sustainable the growth will be? Keep in mind we are not property developers so have never looked in to borrowing against the house to develop property elsewhere, etc.

As I mentioned in my previous post, I can't see a scenario where holding on to the property will be better in the short or long term than just dumping the money in to a balanced stock portfolio - especially since there is no capital gains tax to be paid.

 

[sanj]

Well I am looking at the yield it generates today and when compared to other options - it is not as good even when factoring in the capital value growth on top of rental income.

What are the prospects for a very old house in a good area and on a reasonably large block like this one? The main issue we see is that the house will likely need some major work within the next few years, probably 4 years worth of the net income from rent.

It seems as though the area at the moment is more expensive than it has ever been so I am not sure how sustainable the growth will be? Keep in mind we are not property developers so have never looked in to borrowing against the house to develop property elsewhere, etc.

As I mentioned in my previous post, I can't see a scenario where holding on to the property will be better in the short or long term than just dumping the money in to a balanced stock portfolio - especially since there is no capital gains tax to be paid.

IMO it comes down to opportunity cost. What are your plans for the money if you do sell the house? Is there anything you cannot do at the moment due to a lack of funds? Is there another asset class that perhaps would hold up values better if there was a downturn?


Certainly on the one hand if you can sell this asset CGT free and it has run up in value pretty strongly recently now would be a pretty good time but it comes down to what your plans are and your need for the money.

Personally with you being a more passive investor and having say 600k (minus selling costs) to potentially realise tax free id consider selling up and putting the money into a commercial property. More work to do initially but less going forward, especially taking into account your upcoming maintenance issues.

What are your goals/needs? Do you value income or capital growth?

 

[7seven7]

IMO it comes down to opportunity cost. What are your plans for the money if you do sell the house? Is there anything you cannot do at the moment due to a lack of funds? Is there another asset class that perhaps would hold up values better if there was a downturn?


Certainly on the one hand if you can sell this asset CGT free and it has run up in value pretty strongly recently now would be a pretty good time but it comes down to what your plans are and your need for the money.

Personally with you being a more passive investor and having say 600k (minus selling costs) to potentially realise tax free id consider selling up and putting the money into a commercial property. More work to do initially but less going forward, especially taking into account your upcoming maintenance issues.

What are your goals/needs? Do you value income or capital growth?

Thanks for your response. There is no immediate need for the money but it seems like there are many better options to invest the ~$600k. The plan would be to likely add $400-500k to a balanced high yield (~9% dividend yield gross) stock portfolio and have the other $100-200k invested elsewhere (undecided at the moment).

I value both income and capital growth but probably income slightly more as I like to take income from one investment and use it to diversify in to other areas.

 

[MTR]

Hi 777

Advantage with property is - greater leverage, massive difference to the bottom line

Property is the flavour at the moment. Yaaaaaaahhhhhh, we should all be taking advantage of this and making money, when you have the positive media hype etc etc you would be foolish not to jump in.

If you are chasing cycles for growth look at Sydney, Perth and Brisbane and to achieve higher yield you will need to be more creative ie develop etc. There are plenty of options but it will come down to risk, experience etc.


Cheers
MTR

 

[Of The Vultures]

If you are chasing cycles for growth look at Sydney, Perth and Brisbane

Is Perth still going up? I thought things had slowed down a fair bit, less people at opens, vacancy rates up...?

 

[WesternRat]

Changes every week. There were a couple of articles last week that predicted a boom due to the RBA expected to lower the rates into the new year - Perth would be on the receiving end of a torrent of FHBs looking to secure their own home.

Listings are still fluctuating around (almost) record lows, around 8700 from last week I believe.

 

[catsteve]

believe its r20?

parts of vic park are R20/40.

zoning could be critical.

Be worth finding out. and checking for zoning changes in town plans.

 

[Colin Rice]

Perth would be on the receiving end of a torrent of FHBs looking to secure their own home.

I have quiet a few FHB finding it difficult to secure a property ATM due to competition/multiple offers above asking so based on that it is still very active.

Vacancy rates have increased but from memory still around 2%.