Not all information is useful information

Not more than 7 months ago, according to the media, investing in property was no longer a smart way to build wealth. Labor wanted to ban negative gearing, increase Capital Gains Tax (CGT), commentators were predicting that the market would crash by more than 20%, banks were tightening lending standards and so on. Since then, the world has returned back to ‘normal’ and most of these concerns have abated. According to the media, property is now a good investment again.
But what if Labor had won?Of course, Labor losing the federal election in May 2019 did help the property market because it meant any changes to negative gearing and CGT were off the table. However, if it had won the election, I doubt Labor would have been able to get these proposed changes legislated. And even if they did get them legislated, I stand by my view that whilst these changes would have materially reduced after-tax returns, it would not have rendered property investment uneconomical. In the long run, investing in the right property still would have been a viable investment.
Construction of new housing, recession, interest rates…I was reading an article by an investment manager that I respect greatly a few weeks ago. His thesis was that it was too early to call a recovery on the property market because of the fall in construction volume (of new dwellings). He went on to explain that a depressed construction market will create negative consequences for economic growth, unemployment and therefore property.
Whilst I don’t disagree with this author’s economic reasoning, I was left pondering what use this information had to an investor. That is, if I’m contemplating an investment in a blue-chip, investment-grade location, do I care about the fall in new construction (which inevitably occurs in locations far removed from investment-grade locations)?
So, what information is relevant then?In reality, much of the content produced by the media is relatively useless for making property investment decisions. The media tend to only run stories that they consider newsworthy. Newsworthy often means that the information is time-sensitive e.g. what happened yesterday or what will happen tomorrow. This short-term information does not help if you intend to own a property for many decades.
Remember what drives property valuesA good and bad property cost the same to hold. You will pay the same amount of interest in respect to the mortgages. And the income and expenses will be relatively similar. The biggest difference between a good and bad property is capital growth. That is, what will the property be worth in 10, 20 or 30 years? In this regard, when selecting a property, there are three things you must consider:
1. Land valueLand appreciates whereas buildings depreciate. Therefore, it stands to reason that you should invest in properties that are mostly land value which typically includes houses and older-style apartments. Whereas, if you invest in a newly built property, it is likely most of the purchase price will represent building value and only a small land value component. The appreciation in land value needs to more than offset the depreciation in building value for the property’s overall value to increase. But this is unlikely if say, 80% of the value is building (and depreciating) and only 20% land (and appreciating).
2. ScarcityThe property must be scarce both in terms of location and property type.
A scarce location is one where there is a finite amount of vacant land (often no vacant land) plus the location is highly desirable to a broad spectrum of demographics (e.g. young people, families, retirees, etc.).
A scarce property type is one that has limited (even falling) supply and wide appeal. An example is Victorian cottages – no one is building them anymore and they have wide appeal. An example of a property type that has little scarcity is a high-rise apartment – there’s literally thousands of them and they all look the same and supply of new ones is almost never-ending.
3. Past performanceThe best evidence of a good property is past performance. That is, how has the property’s value changed over the past 30 years? Past performance is a good indicator because value drivers tend to be static (i.e. rarely change) and factual, not open to subjectivity. For example, positive amenities (attributes) such as shopping strips, schools and hospitals rarely change.
There’s only a handful of important macro considerationsOf course, when contemplating an investment, it’s important to consider the aforementioned factors – but these are all property-specific. In terms of macro-level factors, there really are only a handful of important considerations, namely:
Population growthLong term population growth is a very important factor. There’s only a limited number of investment-grade locations (so the supply-side is fixed) and if population is growing, this will translate to an increase in demand. This translates into upward price growth pressure. Natural changes in population (births and deaths) are relatively stable. The main changes will be driven by overseas and interstate migration. Some capital cities are projected to benefit from higher levels of migration than others. For example, the ABS (here) predicts Melbourne will be Australia’s largest capital city surpassing Sydney in year 2031.
Money supplyThe flow of money into the property market will have an impact on growth rates. Money can flow into the market mainly through borrowings and from overseas sources (i.e. non-resident investors). It has been well documented that the government has restricted supply from both these sources in recent times. Arguably, the government has been too aggressive with its approach and I predict that bank lending policies will continue to gradually loosen over the next few years. However, if money supply remained constricted for an extended period of time, this would likely have a negative impact on growth.
Diversified employment opportunitiesYou must invest in a location that has diversified employment opportunities. Doing so means no one industry can manipulate the demand for property and therefore demand is sustainable and stable. It has been well documented how the mining industry has impacted property prices in Perth for example.
InfrastructureInfrastructure is important to the extent that it can reduce the impact of living further away from the CBD (i.e. in the outer suburbs). That includes reduced travel times, better access to employment prospects, recreational resources and so forth. As I discussed in this blog, Australia is unlikely to make any material advancements in this regards, and that’s why inner-city, blue-chip suburbs will continue to outperform.
Ignore the rest!Apart from the considerations discussed above (population, money supply, employment opportunities and infrastructure), ignore all other media ‘noise’ when making property investment decisions. A lot of quality media is thought-provoking and interesting. Its just that most of it isn’t very helpful to property investors. If anything, it can encourage you to make mistakes such as promoting short-term thinking and/or procrastination.