The auction reserve busters

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A hallmark of a piping-hot housing market is when everyday family homes in need of renovation – as opposed to trophy mansions – sell for more than $1 million above reserve. We are experiencing a truly reserve-busting market in Sydney and Melbourne.

For instance, a "dilapidated" Victorian-era house in inner-western Sydney sold this year for $3.35 million; a breathtaking $1.77 million, or 84 per cent, above reserve.

Developers were reportedly competing fiercely for this cottage given its near-city location, large block of land and two apartment buildings on either side. Nevertheless, the vendors had been apparently willing to sell for much less if the bidders, including would-be developers, hadn't been so keen.

On the same weekend in late February, a two-bedroom, unrenovated terrace in East Melbourne sold for $2.621 million; $1.121 million or 75 per cent over reserve.

And late last year a "renovator's dream" in a Sydney middle-ring suburb sold for $3.91 million; $900,000 or 30 per cent above reserve. It's now on the rental market. The examples just keep coming. Just ask a real estate agent.

It's perhaps the percentages over reserves that make particularly telling reading – providing a key to the much-wider story about the state of the housing market in the eastern capitals.

The housing market is, of course, increasingly grabbing headlines due to a powerful array of factors.

These include the Reserve Bank's latest decision to leave the bank cash rate at a record low of 1.5 per cent; APRA's efforts in recent weeks to get banks to reduce the flow of investment and interest-only loans, and to tighten lending standards; and the relentless overshooting of auction reserves. And prices have continued to sharply rise prices in the eastern capitals in the 12 months to March.

Other headline-demanding factors include the high level of household debt; debate about negative-gearing deductions and discount CGT; and growing concern about the difficulties of young people to afford their first homes. (See A reality check for accessing super early, Smart Investing, 29 March.) In a comment this month on housing prices, Reserve Bank Governor Philip Lowe emphasises the risks from "high and rising levels" of debt and he notes that growth in rents is the lowest for two decades.

Both owner-occupiers and property investors need to act with particular caution at this time in the housing market – particularly in Sydney and Melbourne where the price gains have been strongest. (Median housing prices in Perth and Darwin actually went backwards over the past 12 months.)

Given the extremely low rental yields and slow rental growth, it is clear that many negatively-geared investors – with a shortfall between rental income and deductible expenses of mainly rent – are expecting that capital growth will make their investments worthwhile. But how realistic are these expectations? The answer to this critical question much depends on individual circumstances.

Homeowners who are looking at buying a residential investment property should keep in mind that they already have a typically high proportion of their wealth in this asset class, through their existing family home. It is crucial that buyers and prospective property investors should take into account their ability to service their debts in the event of rate rises and/or a personal setback such as loss of a job or serious illness.

Whenever the property or share markets are running hot, a challenge is to resist getting caught up in the euphoria by making emotionally-driven, herd-following decisions.

Any decision to buy should be based on painstaking research and consideration of your full circumstances including your long-term goals and financial position. Also consider whether you should take independent professional financial advice before buying to occupy or invest.

Written by Robin Bowerman, Head of Market Strategy and Communications at Vanguard.

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