The one factor, above all others, that will determine your long-term future as a property investor is your ability to successfully invest in areas that are poised for capital growth. It is the real key to creating wealth through property and keeping your banks willing to lend to you.
Capital growth helps you build equity so that you can borrow more, buy more properties, and expand your portfolio.
While there are other ways to build equity (such as renovations and other one-off developments) for successful ‘buy and hold’ investors capital growth is the life blood of their strategies and, without it, their property portfolio stagnates.
But how can you better predict capital growth to improve your chance of building a healthy portfolio?
Understanding what drives capital growth
Two factors are essentially involved in driving capital growth: demand and supply. Prices will rise if demand is high relative to supply and stagnate or fall if supply outstrips demand.
This simple market law should to be at the back of every investor’s mind, no matter how experienced they are. Competition amongst buyers push prices higher, and when there is a limited supply of properties, the competition is at its most intense.
These are the markets we want to be playing in as property investors and, as such, we must educate ourselves so that we have the ‘edge’ over other buyers also looking to play there.
So how do we find the right markets to buy into with a high demand:supply ratio at the time when we’re ready to buy?
We need up-to-date, accurate information on those markets. This will tell us how we can achieve some immediate capital growth to build the equity we need to buy again in the near future.
Of course, the ratio of demand to supply in any given location changes according to many factors, so we need the right information at the right time.
And we also need to balance our decision out by considering rental returns and cash-flow. By identifying suburbs with strong rental returns AND strong demand –to-supply indicators, property investors stand a greater chance of achieving the best of both worlds with capital growth AND cash flow.
These suburbs always exist and it’s our job to find them.
Which indicators help us determine the best suburbs to invest in?
In truth, nothing beats ‘on the ground’ research, which involves doing the legwork yourself: speaking to local real-estate agents, regularly monitoring local sales, and observing first-hand how many people show up at open homes and make offers on properties.
However, there are also some important statistical indicators that can help us confirm what this research is telling us, or perhaps point us in the right direction to start.
While it’s possible to get ‘bamboozled’ by statistics, following are three of the most important indicators that we can use to gauge the investment potential of a suburb.
1. STOCK ON MARKET (SOM)
This is the percentage of the properties in any given suburb on the market. If there are 2000 properties in a suburb and 200 of them are listed for sale, then the current SOM is 1%. .It is used as a good indicator of the supply – the higher the SOM the more the supply, and the less the demand. So a golden rule of thumb is to find properties in suburbs with a low SOM.
To give you some context, the average SOM in Australia as at April 2015 is 0.84%, so a suburb with a SOM of 2% has more than double the Australian average of properties listed for sale.
It is not quite that simple though. When evaluating the amount of stock on the market in any given suburb, be careful to look out for the situation where developers release a new block of apartments or housing estate which the listing agent advertises only as a single 1-bedroom, 2-bedroom and 3-bedroom units as samples.
In this case, three units may be listed for sale on realestate.com, when, in actual fact, the project comprises 50 units in total.
Another ‘anomaly’ to watch out for is ‘staged releases’. This is where an agent advertises 50 new units or houses for sale, but 350 are soon to follow in later releases.
A high number of properties (especially similar properties) listed on the market (i.e. high SOM) will subdue property price growth and has the potential to increase rental vacancy rates if many of the properties are being sold to investors. High density developments i.e. 50 plus in the block, are often marketed heavily to interstate investors to achieve faster sales for the developer. This can result in a glut of rental properties hitting the market at once.
2.DAYS ON MARKET (DOM)
This tells you the number of days a property will typically spend on the market before selling.
When demand is high properties are snapped up quickly because everybody wants them and there is an urgency to buy; in the best suburbs there may even be a queue of buyers waiting for properties to come onto the market, so the seller makes an easy, quick, and profitable sale.
If the DOM is very low, then demand is exceeding supply; and the reverse is, of course, true too, when a high DOM indicates problems in selling due to low demand. Where SOM is high it usually points to an over-supply, so DOM will be high too – and this means less potential for immediate capital growth.
You can see how they are connected and how important both DOM and SOM are to your buying decision. It’s worth remembering again that supply and demand are the only things affecting capital growth.
If you purchase a property in an area with a high DOM figure (i.e. over 100 days) it can mean that demand from buyers is weak – so make sure you negotiate a good buy price.
This is a measure of how much rental income per year a property earns – as a percentage of the property’s value.
If the rent is $500 per week and the value of the property is $600,000 then the gross rental yield will be $500 x 52 weeks ÷ 600,000 x 100 = 4.33%. A better figure when assessing cash flow is the NET rental yield, which is the GROSS yield minus all property expenses.
The main attraction of a high rental yield is, of course, the cash-flow it brings for investors. This makes it easier to get bank loans, purchase more property, and may also help capital growth potential as more investors may purchase in the particular suburb (but not always!)
We must consider the reasons why the rental yield is high. Is it because a new business has just opened and is providing employment opportunities? Or a new communications link is planned? This can create ‘hotspots’ that increase demand for rental accommodation and may help to raise rental prices – but what happens if these situations change? The business closes or the communication link doesn’t get completed? Mining towns are a good recent example of this.
While rental yields are nearly always an attractive factor for buying a property, the outcome for the capital growth is not always as expected. Rental yields can rise not only because of increasing rents, but due to falling property prices too!
Before committing it is important to check what rents and property prices were a year ago – because while high rental yields can be a great indicator of capital growth, the demand from renters does not always translate directly to demand from buyers.
Only buy a property with a low rental yield (i.e. less than 4.5%) if there are very strong short-term capital growth fundamentals in the suburb or the property has good development prospects. Otherwise you risk not achieving a good rental return and also minimal growth over the foreseeable future. Investing in the wrong area at the wrong time has damaged the returns of many a property investor in the first five years of them holding the property.
But these are not the only factors. Before I sign off, just bear in mind a few other key indicators we use as buyers agents to determine the capital growth potential of a suburb:
- Vendor discounting
- Historical price trends
- Vacancy rates
- Auction clearance rates
- Price of neighbouring suburbs
- Growth of neighbouring suburbs
- % of renters
- Online search trends
As an established and experienced buyers agent Pillar Property scans the market for the best possible investment properties for our clients. We can provide invaluable and independent property advice to help our clients purchase the right property, in the right location at the right price.
For an oblgation free discussion call Chris White on 0438265226 or email firstname.lastname@example.org