Understanding how property growth behaves is critical when making buy, hold or sell investment decisions. Unfortunately, I have seen lots of people make terrible decisions based on misinformation or misunderstanding. Therefore, if you are a property investor, you must understand this concept. And if you are an investor with a low asset base, you can use this knowledge to your advantage.
History always leaves clues
I’m a big proponent of evidence-based investing because it removes a lot of risk. Evidenced-based investing involves only adopting methodologies, approaches or investing in assets where there is overwhelming evidence that demonstrates it works. No throwing darts. Only invest in sure-things.
Below I have set out a few examples of property growth both for individual properties and markets.
Individual examples of property growth
The chart below (click to enlarge) sets out the sales of an apartment in Richmond, Victoria between 1985 and 2019. As you can see, there was very little growth between 1985 and 1997 and very strong growth between 1997 and 2010. The average growth over the whole 25 years period averages out at over 8.8% p.a. – which is pretty respectable. This is a very good example of how property behaves i.e. it grows in cycles lasting 5 to 10 years followed by a flat cycle. Click here for an example of a house in Carlton that I cited in another blog that also illustrated this concept.
I appreciate that this data isn’t statistically significant, because it’s only a couple of properties. However, after 17 years of looking at property growth on almost a daily basis, I can assure you that this growth is indicative of how the vast majority of investment-grade property behaves over long period of time.
Example of state-based growth
The chart below (click to enlarge) sets out the distribution of median house price growth since 1980. You will notice that a growth cycle typically lasts 7 to 10 years. And a growth phase is typically followed by a period of (7-10 years) of little growth. The average growth rate over the past 38 years of each capital city ranges between 7.30% and 7.96% p.a. That is, in the long-run, there is not a large variation.
Understanding the market and its performance
When assessing an investment property’s historical performance, it is important to ascertain whether it is due to asset-specific or market-wide influences. For example, I know that investment-grade apartments in Melbourne have not performed well over the past 7 to 10 years – as perfectly depicted by the Leslie Street chart above. Therefore, investors must consider this when assessing the performance of their assets. For example, if you purchased a quality apartment in Melbourne 5 years ago and haven’t enjoyed much capital growth, it is possible that you have a perfect (investment-grade) asset, but you just haven’t held it long enough yet. That is, no growth is a market-wide phenomenon, not asset-specific.
But you can’t have blind faith in the headline numbers. You must understand what has driven performance. Using investment-grade apartments in Melbourne as an example, these are some of the things I would consider when looking at recent growth and forming a view on future growth:
- New apartment supply peaked a few years ago at 35,000 apartments per year. Ten years prior to this, the average annual apartment supply was in the range of 10,000 and 15,000.
- Tightening in laws permitting sales of apartments to non-residents in the past few years has dramatically reduced demand for new-build apartments.
- Tighter credit has significantly reduced borrowing capacities meaning fewer people can qualify for a loan. This makes it more difficult for developers to sell apartments.
- Approvals for apartments in Melbourne and Sydney have reduced dramatically (see chart by Pete Wargent here). This will have an impact on supply for the next few years.
- New apartments show a lot of wear-and-tear after as little as 3 to 5 years. They lose their initial ‘shine’ very quickly. This makes older-style apartments look more attractive by comparison. Also, given changes to laws, recently built apartments offer no depreciation benefits to secondary buyers.
- Melbourne’s annual population growth is approximately 125,000 – so it won’t take long to soak up any excessive supply.
Work your way down
In summary, you need to understand the performance of different markets (states). Then the performance of different assets (apartments, houses, townhouses, etc) within each market. And then distinguish between any suburb or geographical considerations. This knowledge helps you assess past performance and, more importantly, form a view on expected future performance on which you can base future investment decisions.
What should you do with this information?
You can use this information to your advantage in two ways:
(1) Have patience and discipline
You must have patience. Property is a long-term asset and you really need to hold an asset for 30 years to enjoy the significant benefits it offers. Entry-level investment-grade assets in particular do take longer to deliver returns. Therefore, it is unfair to buy a property and expect to see results after only a relatively short period of time. It’s a little bit like declaring a winner at an ALF game at quarter-time (although you can probably safely do that if you’re playing Carlton! 😊).
Also, you must have the discipline to stick to, and believe in, the fundamentals of an asset. If it has performed in the past, has a strong land value component and is a scarce asset (i.e. its investment-grade), it will work out in the long run. Have faith. You’ll be rewarded for it in the long run.
(2) Fundamentally sound approach with a strategic tilt
You can use this information to be more strategic with the implementation of your investment strategy. Let me be clear. I am not suggesting you speculate and do things like invest in an unproven location on the hope/view that growth is going to pick up. Definitely not! You must always stick to a fundamentally-sound, evidenced-based, proven, low-risk approach (methodology). However, you can be strategic in your implementation.
For example, let’s say that your investment strategy included investing in two properties; one apartment and one house. In that case, I would suggest that buying the house in Brisbane has merit (because median house growth has been pretty flat since 2011 so it’s probably ready for a growth spurt, especially given improvements in overseas and interstate migration). And I would buy the apartment in Melbourne given this sector (i.e. older-style apartments) has been quite flat for a number of years and supply of new stock is contracting which should eventually drive growth in investment-grade apartments.
Take advice from someone that is holistic and independent
I acknowledge that I have a vested interest in what I’m about to write – but that doesn’t make it untrue or less valuable. My experience tells me that there’s great value in receiving advice from someone that doesn’t have a vested interest in you (1) investing in a particular asset class (e.g. property) and (2) in which market you invest in (and the type of asset you buy). That is what I have shaped my business in this way – because I believe it positions us to add the most value. Develop an astute strategy, be strategic with its implementation and know the right professionals to trust on the ground to ensure you invest in the right assets.
So, you can either try and figure all this out yourself and hope you get it right, or you can engage an independent expert.