Busting six common capital growth myths
Friday, March 2, 2018/
We’ve moved to the next phase of the property cycle — one of lower capital growth in some locations and slumping property prices in others.
But that doesn’t mean it’s time to change your investment strategy.
Real wealth from real estate is achieved through long-term capital appreciation and the ability to refinance to buy further properties and adding to your asset base. Not from rental income, because residential properties are not high-yielding investments.
This means if you seek a short-term fix with cash flow positive properties, you’ll struggle to grow a future cash machine from your property investments — it’s just that simple.
If you think about it, when you retire, most of your wealth won’t be money you saved or rent you’ve earned — it will be the capital growth of your properties.
To ensure you own the right type of property in the current lower growth environment, let’s look at six capital growth myths so you don’t fall foul of them.
Myth #1: Population growth leads to capital growth
While Australia’s robust population growth underpins the strength of our property markets, this alone does not guarantee capital growth. It needs to be combined with affordable properties (not cheap properties, but people with income who can afford them) and a favourable local property supply and demand ratio.
Myth #2: Invest in a capital city that is experiencing strong capital growth
Over the last few years the Sydney and Melbourne property markets have decoupled from the rest of Australia and outperformed the other capitals.
But there is not one Sydney or Melbourne “property market”. Instead there are multiple submarkets based on geography, price point and type of property. And some locations have grown considerably more than others, meaning you can’t just buy any property in these capitals and assume it will outperform.
Myth #3: Buy land, it appreciates
The fact is: not all land is created equal.
Some suburbs will be more popular than others, and some areas will have more scarcity than others, which means over time some land will increase in value more. Of course these are the locations property investors should target, as that’s where they’ll get above average capital growth.
For as long as I’ve been investing the ‘where to buy for capital growth’ argument has been raging: regional Australia vs capital cities; or inner suburbs vs outer suburbs.
And while there are always exceptions, for overall strong, stable long-term growth that outperforms the averages, the inner and middle ring suburbs of our major capital cities are the place to invest.
Let me put it this way: go to any major city in the world — London, Paris, Los Angeles — and you’ll find that the wealthy people tend to live within 10 – 15 minutes drive from the CBD or near the water.
Why is this so?
The cynics would say because they can afford to. And in part that’s true. In general, the more established suburbs with better infrastructure, shopping and amenities tend to be close to the CBD and the water and that’s where the wealthy want, and can afford, to live. And they’re prepared to pay a premium to live there.
Another driving force of capital growth in our inner and middle ring suburbs is their gentrification by affluent young families who are prepared to trade space for place. Some are happy to live in townhouses or renovated semis in modern accommodation on compact blocks, while others are prepared to trade their backyards for balconies to be located close to where the action is.
Myth #4: You can predict capital growth
There is no shortage of ‘experts’ trying to predict the next growth hotspot. And, of course, there are all the online research reports telling you where to invest.
But meteorologists tend to predict the weather better than property commentators predict future capital growth.
Now this doesn’t mean you shouldn’t listen to the experts. You should. But you must also understand the level of accuracy of their predictions and take that into account when investing.
Myth #5: You’re likely to get capital growth if you buy a negatively geared property
It’s true that high growth properties have relatively low yields and are likely to be negatively geared. But many negatively geared properties have experienced minimal capital growth — just look at all those off-the-plan inner city properties.
That’s because negative gearing is not an investment strategy — it’s just the way a property is financed at a point in time. While you’ll require strong capital growth to make up for the early years of negative cash flow, that’s not a given. It relies on sound property selection.
Myth #6: New developments are good news
Many consider the start of a new development or the opening of a new estate as a positive for local capital growth. While they may lead to local population growth, more often than not these developments stifle capital growth.
Large high-rise developments tend to distort the supply and demand ratio and of course the resulting oversupply isn’t something we want as investors.
Similarly, while new housing estates can often represent a short-term boost to the local economy, in general these also lead to local oversupply and a local demographic of young families who tend to stretch themselves financially, meaning these locations suffer most when interest rates inevitably rise.
So what does lead to capital growth?
In essence it is the five P’s:
- People — household formation creates housing demand;
- Purchasing Power — rising wages and low interest rates transforms demand into buyers;
- Position — location is a major factor;
- Property — an “investment grade” property in the right location; and
- Places — the number of places available is related to supply and demand.