Have the distressed property auctions started?

Rising interest rates are expected to place 750,000 Australians into mortgage stress by June. Inevitably, some of their properties will make their way back on to the market, which could tempt investors. But does distressed property make a good investment?

As sharemarket returns lose their lustre, it’s only natural that investor attention turns to the property market.

Early indications from the Real Estate Institute of Victoria support this; the institute is expecting a jump in the number of properties coming to market in the coming months.

Historically, agents have seen about 700 auctions listed on the average weeks through February and March but this year the levels are soaring. Following a record of 700-plus auctions listed for 23 February, more than 1000 properties are expected to be offered at auction over the following two weekends.

Not all of these sales will be made in the happiest of circumstances. Just as margin calls became a fact of life for many investors in January, the notion of the distressed sale is becoming increasingly common. Figures on mortgagee repossession cases heard by the Supreme Court are on the rise. Between 2005 and 2007 these have risen by 12% in NSW, 35% in Victoria and 107% in Western Australia.

The idea that these sales are just happening in the outer suburbs is just not true, according to Peter Kelaher of PK Property Search and Negotiations. “You absolutely do see distressed property at the top end of the market,” he says. “Often you find that a marriage has gone sour and both parties just want to get out of the property.”

Steve McKnight, author of From 0 to 260 plus Properties in Seven Years, agrees. “It’s often done on the quiet because people have reputations to protect. Just because someone lives in an expensive suburb doesn’t mean they can manage their money well.”

Not all distressed sales offer good value, so potential bargain hunters should consider themselves forewarned. Properties that are advertised as distressed tend to attract more than their fair share of interested parties, who push up the price in pursuit of a quick profit.

McKnight explains: “There’s a lot of psychology at work when people hear of a forced sale, but it doesn’t always mean that you will get a good deal. When they are advertised you always get a lot more interest than if it were for sale privately, which usually means the property will go for more.”

Peter Kelaher adds: “It’s not unlike a deceased sale. They tend to attract a lot of people. In the 17 years I’ve been in real estate I’ve never seen a deceased estate go for a song. They’re always sold above market value. You need to be completely across property values in the area.”

It’s the cases where the motivations of the vendor haven’t been plastered all over the board out the front that can produce the best results. Architect Kon Kotzapavlidis had been viewing properties in Melbourne’s leafy suburbs for several months before coming across a property in Camberwell. What he noticed first were the bare cupboards.

“It turned out that the owners had already bought a new place. The property had been to auction but then failed to meet the reserve of $400,000. They agreed to sell for $380,000 on 90-day terms but that fell through a week before settlement. By this stage the owners had been in their new house for almost six months. A week later we offered $350,000, they accepted, and the rest is history. We recently had the place valued at $600,000.”

In his case, all it took was a bit of detective work and dash of good luck to find a good deal. But if you are actively seeking out distressed property and you aren’t interested in hanging around the courts or scanning the social pages for news of a divorce, then be prepared to roll your sleeves up.

You can find out a lot about the circumstances behind a sale buried in the contract. For instance, a dead giveaway is when the vendor is referred to as a bank authorised to sell. This is almost certainly a mortgagee-in-possession sale. Alternatively a solicitor can find out pretty quickly if a second mortgage has been taken out on the property.

Caught up in the thrill of the chase, there are a number of mistakes commonly made by investors. The first is not to be cognisant of property values in the area. Unless you are up to speed with what the market is doing then you might as well buy blindfolded. Once you know where the market is, you can then get a better idea of where it is going.

Peter Kelaher says: “You’ve really got to be very careful when buying distressed property that the outlook is going to improve. There is a great deal of distressed property west of Sydney that I fully expect to weaken even further after another rate rise.”

Another hurdle can be the rates. If a homeowner can’t meet their mortgage payments then it’s unlikely they were up to date with the rest of their bills. If the council rates and water bills are in arrears you may just find yourself liable, so make sure this is addressed at settlement.

Unusual covenants on the property can be another headache. Easements (typically sewer lines running through the property) might affect your ability to develop the property. And what was a ripper deal quickly becomes an albatross around your neck.

One sector that might produce opportunities for investors is the holiday home market. But you can forget about the exclusive regions such as Portsea, Palm Beach and Eagle Bay. These areas are tightly held and sales are unlikely to waver as interest rates ratchet up.

It’s a different story on the holiday hotspots of Noosa and the Gold Coast, where Jonathan Rivera, the state director of property for Colliers International, believes apartment prices could soon be under pressure. “In locations where there has been more higher-density unit development for holidays, as you can see on the Gold and Sunshine Coasts, overextended investors may well sell up in relieve their financial difficulties.”

Whatever your views on distressed property, one thing is for certain: Banks have no qualms about protecting their investments whenever an investor’s ability to service their debt becomes compromised. And as long as inflation remains outside the Reserve Bank’s target rate, the threat will remain.

– with additional reporting by Rebecca Harrison.

This story first appeared in Eureka Report