Why are we so obsessed by locality when looking at investing in property? It’s simple: even if you chose the best house (and price) in the best street if the entire suburb is going down for the next 10 years, it’s unlikely you will achieve any gains, let alone outperform the rest of market. However, if you invest in the worst house (at the worst price) in a suburb that outperforms the market, you will probably achieve positive returns.
Yes, the locality will determine the success of your property investment. But how do you know which one? Probably not how you think…
Many investors rely on past capital growth to determine future performance. However, research by Louis Christopher of SQM Research (SQM) has shown that this does not provide any true indication of potential future growth. In fact, in some cases, it is a negative indicator.
After reviewing the past performance of localities in Australia over the past 20 to 50 years (where data was available). SQM found that one the most important growth indicators of a suburb is a measure called family income growth (FIG).
FIG is the rate at which households or the local population are becoming wealthier. Over the last 30 years, the suburbs that have had a local population growing in wealth (at or over a certain rate), are more likely to experience an increase in property values and rental demand. Linked to what some commentators term ‘re-gentrification’, this is one measure that accurately highlights a suburb undergoing this type of positive change.
An increase in wealth affects many aspects of the local community. As people become wealthier they demand better quality facilities, they will create more income for the local government to pay for improvements, and build better quality homes and increase the general desirability of the area. They will also bring trade – because where there are people who can spend money, there are people willing to take it!
Where the increase in local wealth is too slow, the local market will be unlikely to demand an improvement in facilities. They will probably not improve the local aesthetic and are unlikely to affect an increase in rates. This generally indicates areas of lower demand, with few facilities and local infrastructure, i.e. not many reasons someone would want to live there.
However, some suburbs that have experienced strong growth (and will do in the future), can go through a period of slow FIG. This can be a result of high house prices stagnating future growth, restrictions on development due to lack of available land or other economic or industrial changes. The hurdle rate that Eda applies is the figure that has historically indicated a suburb will perform for the next 10 years. Some suburbs that display lower figures may perform but it could take 15 to 20 years.
FIG can also be too high. Where the rate of growth appears too fast, it often indicates lack of depth in the market – which means that there isn’t enough activity to provide meaningful analysis or to give investors an estimate of what might happen to their property investment.
An example of lack of depth could be a small population. In this instance, one very wealthy new resident may greatly affect the total wealth of the area and skew the results.
So, now that you have determined a suburb that is most likely to increase in value it is time to look at risk. Most property investors invest in the asset class to provide a relatively low-risk way to increase their wealth. It is important to understand how to measure the risks most likely to affect the value of your property investment.