Knock down rebuild is not always a capital idea

Cross posted with permission from Capital Appreciation

Over the past decade the knock down rebuild (or KDR) phenomenon has been very popular in Canberra and other parts of Australia. Knock down rebuild essentially involves buying and demolishing an old house on a good block, and then rebuilding your own new home. In Canberra, knock down rebuilds have spread like the plague – try googling the terms knock down rebuild Canberra just to see the number of builders, architects and companies looking to get a piece of the knock down rebuild action.

The most popular locations for knock down rebuilds in the ACT have been the inner south and inner north suburbs. In these suburbs there is an abundance of old modest houses on large sized blocks in highly desirable locations. During the property boom over the last decade, knock down rebuilds have begun to change the face of these older suburbs, and I’m sure we are all familiar with the telltale sign of a knock down rebuild in the capital: the tall metal fencing that adorns the property boundary and the roadside trees.

While knock down rebuilds have been very popular in Canberra over the last decade, their popularity seems to be waning along with the rest of the real estate market. During the property boom, properties with knock down rebuild potential would typically go to auction, which generally resulted in high prices significantly above the unimproved land value. However, over the past year such properties aren’t generally going to auction. Instead, they tend to be sitting on the market for longer and are selling for closer to the unimproved land value.

One property result in last week’s Canberra Times that caught my eye was 34 Fergusson Crescent in Deakin. This property sold in early 2010 for $840,000 as a simple 3 bedroom, 1 bathroom home. However, in 2012 it has sold for only $827,500 after about six months on the market, but this time as vacant land. So the previous owners have lost a lot of money over two years pursuing the knock down rebuild process. All up it’s likely to have cost them around $100,000 or about $1000 per week, once you include costs for the ACT government stamp duty on the original purchase (because it doesn’t look like they rented the property prior to demolition), demolition costs, other ACT government planning and approval fees, building and/or architect planning fees (yes they had building plans), the real estate agent’s sales commission, plus any bank loan fees and interest. The bank loan interest is the unknown in the equation.

If the previous owners did borrow most of the money, then their true losses could balloon to closer to $200,000 for the failed knock down rebuild.

Another knock down rebuild story in Deakin that has not quite gone to plan is 18 Barron Street in Deakin. This property last sold in 2009 for $735,000 before it was knocked over in 2010 and replaced with a new 3 bedroom, bathroom and ensuite home. It’s now been on the market at $1,150,000 for nearly one year now after failing to sell at auction. The vendors haven’t moved on price either, presumably because they need a sale at that price to break even.

I’m sure there are plenty of knock down rebuild success stories in Canberra. Either owners enjoying the comforts of their new homes or investors, builders and developers who have profited from knock down rebuilds. However, in the current market a knock down rebuild is a risky process. In both of the above examples it’s likely that the vendors never imagined the property market turning against them, and in the first example, costing them a lot of money. Some that have bought knock down rebuilds in Canberra in the past have relied on rising property prices to gain further leverage from the bank when they go to build.

Remember the old ‘Equity Mate” ads! But this approach will not work now and could be the reason for the first example above going to sale as a cleared block of land. The other problem with knock down rebuilds is that they tend to cost more and take longer to complete than initially imagined. As a result they can end up costing more than equivalent properties already listed for sale.

Comments

  1. One of the better ways to utilise this strategy was to knock down build multiple. This would often result in a cheaper site per scalable item and off load to yard haters.
    I’m convinced we need to get prices down to a rent support yield level before strategies like these will work like they used to

  2. Yes, the “dual-occie” strategy worked reasonably well prior to 2009, but was most profitable for builders (who had lower costs and who bought below the average price). You could always observe builders at Canberra auctions around this time – they were the one who had a hard limit and stopped bidding up the price quite early in most cases, only interested in bargains. Then the government drastically increased the change of use charge, discouraging construction at a time when you’d think they’d want to be encouraging increased urban density (as all their other policies and the Territory Plan itself did). Why? I suspect the consortiums behind the new outer suburbs had something to do with it, or it could just be another example of policy-making stupidity.
    But a straight 1-for-1 KDR is never going to work as an investment strategy, it’s for the owner-occupiers wanting a better house. Very handy for replacing all those ex-govvies in the inner north though!

    • innocent bystanderMEMBER

      +1
      pretty hard to make money out of KDR unless you subdivide and you are the builder or a very good project manager who can build cheaply. And the builders weren’t buying bargains they were paying fair price – the ones paying more than that were usually “naive developers” r/e agents lurve them

  3. Just near our place there have been several instances of what you might call “self KDR”, where you knock down the house you are living in and build a bigger and better one in its place. I guess you avoid paying stamp duty but you may have to pay rent for maybe a year while the demolition and re-building take place.

  4. unhealthyskeptic

    my vague memory is that ACT gov tinkered with land tax structures around 2006 to discourage land banking as such this may have been a driver for the phenomenon. Back when I did not get my act together to bid for slum on a 1000m2 block on the flat in narrabundah that sold for mid 300k.
    This would also encourage people to bid for existing dwellings.
    Oh and I’d rather stick a poker in eye than build in East O’Malley.

  5. Sydney:
    $1,235,000 in Nov 2009
    http://maps.google.com.au/maps?q=9+Cannons+Parade,+Forestville,+New+South+Wales&hl=en&ll=-33.764985,151.213117&spn=0.0071,0.009645&sll=-33.764448,151.212472&layer=c&cbp=13,191.08,,0,0&cbll=-33.764134,151.212546&hnear=9+Cannons+Parade,+Forestville+New+South+Wales+2087&t=m&z=17&panoid=bJa78Egy5dkFOfV7bMcjPA

    http://www.onthehouse.com.au/buy/property/42190438?PageNr=1

    now being sold for $1,350,000
    http://www.mackinnonestateagents.com.au/property-House-NSW-Forestville-1837172

    where the house base price starts at above $200K
    http://www.bellmarch.com.au/Product_Detail.aspx?par=48&Cat=49&Prod=137

    it’s really hard to compete against neighbouring Non-KDR properties with more rooms, garage spaces that are $200+ cheaper
    http://webcache.googleusercontent.com/search?q=cache:VkZqvmL6j9IJ:www.realestateview.com.au/Real-Estate/3-cannons-parade-forestville/Property-Details-buy-residential-3660939.html+&cd=2&hl=en&ct=clnk&gl=au
    which was sold in ~3-4 weeks
    —————————-
    I’ve posted the above anecdotal evidence on different MB forums so I’ll add some new thoughts today. The original house/land was purchased at an auction more than 2 yrs ago by a buyer of a non-Australian and non-Asian and non-European decent. A buyer whose ethnicity I cannot reveal for obvious reasons. Nevertheless, I as a western tourist, was offered heroin on a busy Shanghanese Nanjing Lu street by a person of the same ethnicity…
    …so if money laundering is involved in the above presented KDR example then it’s completely irrelevant example for this topic.

    Hopefully my thoughts are not too controversial (for tolerant Australia).

  6. This sort of thing has been happening in Clayton Victoria for 30 years. Agents even in the 70s-80s encouraged people to buy IPs there because of the uni and hospital. As a result there has been 30 years of: demolish the old weatherboard house, replace with 2-3 (whatever the council allowed) “2 storey unit mcmansions” on the one quarter acre block. Make sure you have 4 bedooms to maximise the amount of students you can rent to. The more the merrier, therefore you can maximise your rental income (architects encourage this). Most of the knock down rebuilds have been done by developers/builders. They may sell one of the units to help with paying for the expenses. Otherwise they build and rent out themselves. Competition (between developers) in this area (during the boom years) was sky high.
    Also, due to high house prices, there have been a CRAPLOAD of subdivisions in Clay and Clay Sth. That is families, subdividing QTR acre block, building a new house in the backyard, living in it, and renting out the old family home at the front, it is cheaper to subdivide the existing home and build (can cost up to $300K) instead of paying $400-600K on a new home. With high AUD, not many students coming now. Monash UNI made redundant 300 staff in international student dept 2 odd yrs ago. Uh, Oh, U guessed it OVERSUPPLY. Let me tell U, I have been driving around this area for 20 years AND.. I have never seen so many for sale and for lease signs in my life! 10-20 years ago, you were guaranteed rent in an IP there for at least 9 mnths of the year. Most were rented out fully, and not a for lease sign to be seen. Now, last time I checked there were 13 for lease signs in the area. Houses are vacant for months on end. Even if there is a surge in students when dollar reaches below parity, there is still an oversupply. Also, there have been some apartment blocks that have been empty for about a decade. I know this cause a friend used to do a letterbox drop and noticed some boxes were closed up. Would be interesting 2C how this will change when international student industry picks up again. In the meantime, if you are renting, and refuse to bring your rent down, expect to make a loss.

    One more thing, unrelated to above post. To see how our economy has dumbed down and changed over the past 20 years, look no further than Browns Crt, Clayton. that is where Clayton technical school used to be. remember tech schools where you learned something useful, be creating and work with your hands? Then they closed tech schools in 1990s(?) sold off the land 2 developers, bulldoze school, replace with…the biggest 2 storey mcmansions you have ever seen. Quite huge, it is next to a park and it stands out. Most old houses in that area are single story and quite modest. Everytime I drive past I remember the school and what has replaced it and my heart sinks down to my butt. It was built way before this GFC but it was a sign of what was to come in our economy and our future.

    Flawse, are U reading this? 🙂

    • Alot of new appartments being built on dandenong rd in clayton and ALOT of subdivisions still underway, even though the ones completed in the last year are not selling or renting

    • ” In the meantime, if you are renting, and refuse to bring your rent down, expect to make a loss.”

      Is it better for owners to leave the house empty than accept lower rent? I have offered $15 less than the asking on 2 places, both refused and both sitting empty for the last 6-8 weeks after my offer.

      I am thinking it is a pride thing now, these guys would get slaughtered the the stock market

    • thomickersMEMBER

      I know what you mean about Clayton, its a blood bath… And believe it or not the AUD is only a small factor in reduced number of foreigners.

      Lots of students have parents who have a commerce/business background. The Stockmarket is down by 20% for the year which is the biggest alarming indicator for Monash Clayton’s foreign student inflow woes.

  7. “Is it better for owners to leave the house empty than accept lower rent?”

    Let’s see, all approx values (for 1 IP only, say you bought your IP in 1980 and paid it off already):
    If house is empty:
    Water bill (service charge) $570 pa
    Rates: $1200 pa
    Land Tax: $900 pa
    Home Insurance $500 pa
    Maintenance fees $2000 pa

    Comes to $3170 pa without maintenance or $5170 with maintenance (I have not included accountants fees and tax, if applicable). If you are a pensioner, you would live frugally and maybe have some savings in the bank to cover it, but as cost of living rises, I wonder if people can keep this up? Developers- no probs, the ones my family members are familiar with have like, 10-20-30 houses or something (apparently). They seem wealthy on paper. Hell there could be a crash and they would survive it. (maybe not go broke,but still live comfortably). But, I do not know, how many of them borrow to demolish and build. My friend needed to get rid of a tree that was ruining her parents home, had to remove it. Council protects tree, very difficult. Beauracracy is ridiculous. While trying to fix this problem, she stumbled on some info and found out the developer that bought the land & built units next door had a loan with St George. She was surprised as the developer was well known around the area as wealthy. U R right on subdivisions though. I reckon most are by builders waiting for AUD to tank and think there will be a tsunami of international students in the future. Remember, this area for decades was always known as a surefire investors hub. Architects (one my friend saw) advise people to subdivide and build big, capitalise on it. I imagine developers, RE agents do the same. Problem is going forward will not be like the last 30 years. Also, as we slowly lose our “paper worth”, same thing is happening overseas. What if overseas students simply do not have the money to study here regardless of the value of the AUD, because their families have been hit by the GFC. The international student industry relies on wealthy foreign families. What if that wealth is deteriorating?

    Furthermore, I noticed a house in Clayton being bought and sold 3 times in the last 7 years!! I noticed that happening a few times with other properties. During bubble times,it is also a speculators hub. Notice the for sale/for lease signs on Browns Road (that apartment block between the hospital car park and that Fregon Reserve (cant spell it). That was built from memory in 2003-04. All of those apartments were sold very quickly at the time. (U know, get in before it is too late). When you look at it now, there are like 3 for sale signs and 2 for lease. Meaning the investors who bought at that time are heading for the exits.

    Also I noticed a lot of houses being bought in 2009, the for sale sign quickly replaced with for lease. Obviously not FHB. …More recently, reluctant landlords. Houses for sale turned into houses for rent when house for sale does not attract the $$$.

    Getting back 2 your Qn. the only benefit I see in keeping a house empty is to keep maintenance costs down, or for speculators hoping the market will turn. As for WHY are they STILL building, can’t they see the signs???? U R right, it is pride….and ignorance. Terrible combination.

    My Gosh my posts R so long even w/the sms “grammar” I knew that getting a frickin’ account for this site would lead to this. With talkfinance and MB I was just a reader for many years. Now I am posting and I just go on and on and on….So much to say. that is why i rarely contribute it is so time consuming. Bah!

    • Oh wait, I did not count the investors who have a mortgage, that is another reason why they would be reluctant to reduce the rental on their IP. Maybe pride, ignorance and IPmortgage stress…but then, having SOME income is better than none? also you cannot negative gear unless you are renting is that correct? I am getting confused and I am going to go and have a lie down.

    • Very interesting article. I know that, a few years ago, the University of California, San Diego was having trouble recruiting staff because houses in La Jolla were so expensive. Today, those houses are looking decidedly cheap in comparison to Sydney. (Of course, to make a truly fair comparison you would need to take account of property tax, insurance, etc.)

  8. Oh, but there is a new dodge in town- participating in the rental assistance scheme (can’t remember the acronym)
    I waqs looking for a new place to rent and ran across a new unit building, advertising the latest appliances, at close to what I pay now. But- this rent wass for the rental assistance scheme. Now, in order for my husband and I to afford to qualify, one of us would have to give up work, and halve our income. We would not then be able to afford to rent in such a place. I cannot beleive that there are people who would be able to both qualify and afford the rent, but the owners have been persuaded tht they will get a sweet little government payment for it. Perhaps if the two bedroom unit contained 2 adults and 2 or more kids, but I find it hard to beleive they would be approved for this development.