Let us continue with the presentation on the comparison of old properties versus new properties. For Part 1 of Is it Possible for New Property to Outperform Old Property, we’ve tackled on different points: depreciation, tax, capital growth, cash flow, renovation, and vacancy. The discussion delved on how established properties perform over the new ones and vice-versa on these categories with examples. We’ll do the same for this second part.
Side by side
If you want to make a good comparison of the old and new properties, place them side by side. One side is old, while the other one is new. Their land is alike in all aspects – meaning it has the same size, frontage, slope, soil quality, and orientation. Both the land has the same value, that is, $350,000 (that’s for land only).
Assuming that on top of one block is an old property, while another block is the new property. Then, the older dwelling is pegged at $250,000, while the new dwelling value is $500,000.
The total value of both properties would be:
Old property
- Land value = $350,000
- Dwelling value = $250,000
- Total Property value = $600,000
New property
- Land value = $350,000
- Dwelling value = $500,000
- Total Property value = $850,000
The new property is $250,000 more expensive than the old property or approximately 42%. Let’s see how that difference changes over time.
Fast forward ten years and both blocks of land have doubled. And at the same time, both buildings have depreciated by 25%.
Old property
- Land value = $700,000
- Dwelling value = $187,500
- Total value = $887,500
New property
- Land value = $700,000
- Dwelling value = $375,000
- Total value = $1,075,000
The new property is only $187,500 more expensive than the old one now or 21%. So, the gap has closed in half, from 42% to 21%.
Reduced stamp duty
One of the most extensive claims that property developers conclude about the so-called advantages of the new property is the stamp duty savings. Picture yourself purchasing a land and house package. Say, it is for $600,000. But you are buying the land first. The house is not yet built here. You will have to contract the developer to build the house later.
The investor pays the stamp duty on the land’s transfer of ownership. For example, as the land is valued only at $250,000, it will have a small stamp duty fee. The standard estimate is about 4%, so for this case – it would amount to $10,000. As soon as the land is under your name, you then pay the developer to build a house on it. The house building cost is $350,000, in this example.
New property
- $600K Home and Land package
- Buy land $250K
- Stamp duty = $10K (4% of $250K)
- Build house ($350K)
Versus
Old property
- $600K property ($400K land + $200K house)
- Stamp duty = $24K (4% of $600K)
When you purchased the property with the house already built, you would have to pay stamp duty to transfer ownership of $600,000 worth of property. The stamp duty will be $24,000 — that’s $14,000 more stamp duty you’re paying (vs. the new house).
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But then again, this is not as simple as that. When you buy the land first, you will have to take care and pay the interest on the loan secured to purchase the parcel of land, while waiting for the house to be constructed. During this time, you are without any rent. There are also other holding costs like the interest on the progress payments in getting the home constructed. There could be project delays, too.
Stamp duty savings:
- $24K – $10K = $14K
- Minus $5K interest (6 months @4% interest on $250K)
- Interest on progress payments ~$2K
- Net savings = $7K
In buying a house, you’re only paying the interest for the period it usually takes to find a tenant. That time takes typically weeks, not months. Perhaps, there is also the probability that the property bought already has a tenant “installed.”
So, in the end – this suggests that the stamp duty savings are not that significant. Many would think that several thousands of dollars are genuinely substantial. However, it’s all relative because if you compare to the lower capital growth that the new properties provide, a $7,000 stamp duty net savings is just minor.
Developer strategies
Let’s talk about the strategies of developers. As we all know, adding value is what helps developers make money. The principal strategy that they use to maximise their end profit is spending the least money to add the most value on the cheapest land.
A profitable project:
- Land $1.5m
- $500k build
- Total spend = $2m
- Sell for $2.4m
- Profit $400K
ROI 20% ($400K/ $2m)
A MORE profitable project:
- Land $800K
- $500k build
- Total spend = $1.3m
- Sell for $1.7m
- Profit $400K
ROI 31% ($400K /$1.3m)
The block is now almost half the price, but the house construction costs the same. So, the added amount as a ratio of the total spend is undoubtedly higher. The developer is paying lower for the land. Thus, the result is higher profitability.
If one gets a really good bargain with a cheap land, this makes for a more pronounced profitability.
An even MORE profitable project:
- Land $400K
- $500K build
- Total spend = $900K
- Sell for $1.3m
- Profit $400K
ROI 44% ($400K/$900K)
The difference is quite evident:
“Investors need the highest possible land-to-asset ratio.”
“Developers need the lowest possible land-to-asset ratio.”
This is one of the reasons why investors should look at developers as the antagonists. So, if you are an investor, think twice about buying from a developer, nor should you buy a new property.
As with stamp duty savings, the higher the stamp duty savings is, the worse the land-to-asset ratio is, and consequently, the property is worse as it is less likely to grow.
Depreciation is also an indicator of a low land-to-asset ratio. The lower the land-asset-ratio means a higher depreciation.
“Interestingly, the highest indicators of poor future growth are the biggest selling points pushed by the ‘new property’ advocates.”
Check out “Crunching the Numbers: Positive Cash Flow vs. Negative Gearing“
Growth
There’s another cause why new properties normally have lower capital growth than the established ones. Capital growth happens when demand exceeds supply. When there is a newly-built house, this is generally considered an additional supply.
“Additional supply is a hurdle for growth.”
While demand is the investor’s friend, supply is his enemy. New properties are considered a supply, the investors’ foe. Now, why would anyone want to fund his opponent’s activities? It’s like paying for a premium for a low investment and, similarly, paying someone to harm your possibilities for growth.
Risk of oversupply
The thing for new properties is this: They are usually released in huge numbers, a cluster. They’re also generally in locations where many other developments can happen in the future. In several cases, this has already long been planned by the developers and concerned agencies.
The nearby vacant area is a red flag for oversupply. Check the satellite imagery for vacant lands with new dwellings. As for the units, it is best to see the local council and ask if any development applications have been accommodated lately.
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Perspective
A new property in a hot market can’t outdo an old property in a cold market – this is not the point here. However, if everything else is equal and the two properties’ only difference is their dwelling age, the old will surely outdo the new property.
Research
Imagine yourself in the developer’s stance for a minute. What you’d hear from a developer’s research is possibly biased. Yes, they conduct research, but it is not leaning towards keeping properties for capital growth. It is more about acquiring for development.
- Huge site
- Bought low-priced
- Packed dwellings
- Fast
- Cheaply
- Sell high
One wants to acquire a large area as cheaply as possible and build as many new properties on the development site quickly, at the lowest possible cost. Afterwards, sell them at the best price possible. Visualise a situation where you are trying to maximise profitability on each strategy. Does capital growth show in such feasibility, more so after the selling period? Why do you think you need to include it in the feasibility? How does an investor benefit from the capital growth after selling the property?
“It’s a lot straightforward to market a project as having growth potential than finding one.”
A developer’s project feasibility doesn’t rely on the property delivering capital growth after being sold. A property developer’s research is NOT leaning towards “holding.” It is inclined towards these: buying, developing and selling. After all, they’re running a business and not a charity.
“Don’t misperceive investment research with developer marketing, despite how similar they may seem.”
