Even before the current rental vacancy squeeze, we were seeing high demand for affordable rental properties across Perth. With conditions heating up even further across the past 12 months, and interest rates falling to record lows, many investors have once again been looking towards strategies to maximise the cashflow of their portfolio.
Granny flats are often seen as a popular income-generating strategy amongst investors looking to maximize rental yields through a secondary income stream. But do they make financial sense for the income-focused investor? And what are the drawbacks and considerations to keep in mind with this strategy?
The rise of the granny flat
Granny flats are the best-known example of what are termed ancillary dwellings. Although it wasn’t always the case, today we think of the granny flat as a secondary, independent dwelling in the garden of an existing home. These properties are popular with a variety of tenants, with their more compact size and affordability lending themselves to single-person households, as well as FIFO workers, young couples, and older adults who want to live in the same neighborhood as their family.
While previously occupied predominantly by family members, regulations were updated in 2011 to allow granny flats to be rented out privately, opening up the opportunity for investors and homeowners to generate a secondary income stream through the strategic addition of these dwellings to their existing property.
A challenging strategy in today’s market
While all this sounds great in theory, adding a granny flat to a property is becoming an increasingly complex and challenging process for investors due to the rising regulations and restrictions surrounding them.
Challenge #1 – Regulations within the R Codes make cheaper building solutions less achievable.
The updated R Codes state that ancillary dwellings need to be “… designed to be compatible with the colour, roof pitch and materials of the single house on the main lot and to positively contribute to its setting … and, where visible from the street or adjoining properties, to the amenity of the streetscape and context.”
This all sounds fine in theory, but it can be widely interpreted.
Councils either neutral or supportive of ancillary units will likely accept solutions such as colour schemes and cladding to match the main dwelling’s brick style. On the other hand, councils opposed to ancillary dwellings could argue the extra dwelling is not in keeping with the streetscape or design of the suburb, posing additional restrictions to the building process.
For most properties, building an ancillary unit in traditional double-brick with a tiled or Colorbond roof is likely to make the project cost-prohibitive when weighed against the potential rental return.
Challenge #2 – Factors that enable ancillary dwellings to work for rentals are usually opposed by councils.
The R Codes state that ancillary dwellings are to be “sharing some of the same site facilities and services” as the main property. Tenants, however, usually want accommodation that is separate from the main dwelling. In practice, this often means additions such as a fence between the two dwellings, separate walkway access and separate designated parking. All this can be challenging or, in some council areas, impossible to achieve.
These rules can also vary significantly from one council to another, making it difficult to design and plan with confidence.
Despite these challenges, ancillary dwellings can still be a feasible and smart option to maximise income in cases where regulations and the local rental market allow for them. However, knowledge of the local rental market is still crucial in guiding this strategy. While these dwellings can be extremely popular in some areas, in other locations having an ancillary dwelling can actually diminish the rental appeal and return of the main dwelling, especially in areas popular with tenants who have pets or who want to store bulky items such as building tools or caravans.
And of course, it’s always important to ensure this strategy stacks up financially. Ancillary dwellings typically cost more to build than the capital value they add to a property, so while they suit investors with a long-term hold and income focus, they may not be the right strategy for investors who plan to sell down the property in the near to medium-term. If you are considering adding a granny flat to your property as a dual-income strategy, we advise engaging a property advisor with knowledge in this area, as well as working alongside your property manager to ensure this is the right strategy for your specific property and local area.
Alternative strategies for income-focused investors
Granny flats aren’t the only option for investors looking to maximize rental yields in the current market. There are a number of other strategies that may be better aligned, or offer greater cashflow benefits, for investors with income-focused goals.
Commercial property has long been a preferred investment vehicle for income-focused investors due to the higher rental yields typically generated by commercial assets.
Investors will often look to diversify into commercial property when they approach retirement and want to generate additional passive income, or if they already have a portfolio of residential properties and want to diversify their wealth creation strategy, balancing growth assets with income-focused strategies.
As a standalone investment, commercial property isn’t typically accessible to the individual investor due to the higher capital outlay involved in securing high-quality assets. However, an increasing number of investors are accessing this asset class through what’s known as a property fund, whereby they pool their money together in a professionally managed unit trust in return for regular income distributions. Investments in these funds can start from as low as $50,000, providing investors with exposure to high-quality assets at a lower cost, with the additional benefit of the guidance of a professional funds management team.
While most people think of developing as a strategy to generate quick returns through the construction and sale of assets, property development can also be a great strategy for income-focused investors. In some cases, and depending on your individual goals, investors may actually achieve a greater benefit from holding some or all of the developed units.
By developing a small group of villas or townhouses, and selling some while retaining others, investors can use the profit from the sale to reduce their existing loan and the cost base of the remaining properties, in turn improving their rental yield. By holding some of the properties, they’d also be saving money on costs to sell such as agent fees, marketing costs, and GST.
Another strategy within this that’s starting to gain increased popularity is the development of dual-key buildings, which allow for two separate, lockable accommodation zones within the same house. These developments hold appeal to the same potential tenants as granny flats, but with the additional benefit of a nicer streetscape that appears as a single dwelling from the exterior. While they work well on larger blocks with ample parking space, this strategy isn’t typically suited to smaller lots or multiple-unit sites. Like granny flats, they also face some council restrictions and won’t be popular in all areas, so you need to ensure that the finished development is a saleable asset which holds appeal within the local market.
PURCHASING A “FIXER-UPPER”
Finally, purchasing an older property can also be a great way to leverage both capital uplift and increased rental yield through what we call a “fixer-upper” strategy. By purchasing an older property with strong underlying land value, and then improving its rental appeal through the right renovations, investors can benefit from a stronger rental yield, while also manufacturing additional equity to improve their debt position, or provide a platform for future investment.
Looking to use property as an income-focused investment, or want more advice on maximizing your portfolio income? Get in touch with our team to discuss the right strategy for you.