Property Values – Invisible Growth

I received a land release notification across my desk recently for the Point Cook area in Outer Western Melbourne. The prices for some of the blocks have increased considerably since the previous release. With prices now around $400k being quite common I thought it was a good time to reflect on how and why some suburbs are seen to be better than others.

I call this the “Invisible Growth” factor.

In my experience some property investors have high expectations for capital growth that in the past has been easy to achieve. Properties in the right areas were expected to double in value every 7 years, but with growth not as quick or consistent as it used to be, this result would now be expected over a 10 year period. Naturally, that doesn’t mean we won’t experience high growth again and it could be that we see shorter periods of intense growth rather than protracted periods of sustained increases. That doesn’t stop the expectations though.

So, it’s not unusual to have conversations with our clients who tell me that they are better off buying closer to the city where they can maintain a higher capital growth return. Of course, most of the time it’s horses for courses and naturally, if you focus on one thing you can miss another. It’s the same with property. If you focus on old growth patterns you can miss what is really going on.

Take Point Cook for example. When we started selling properties in Point Cook, people raised their eyebrows and were concerned at the location and doubted that there would be high growth. We were selling properties around $350k in those days. Nowadays, you would be hard pressed to buy land for that price. Indeed, the latest land release prices start around $400k.

Curiously, there has been no fanfare about the increases but they’re there.

With each new land release, prices increase so values rise along with the development of the suburb over time. This process continues until no more land is either released or available. That’s because as more and more people are attracted to the development they create a demand causing increased prices. To that end, Banks and Developers control the supply in their best interests.

From the demand we can see that each sale in subsequent releases creates higher values for that particular suburb. If you want to build in Point Cook, the land price will be higher today than it was last year. No matter how you look at it, that’s growth.

But there is more going on here than meets the eye.



What fuels the Invisible Growth factor?

It will come as no surprise to hear that your ability to live where you want or buy where you want to is determined entirely by the Banks. How they treat your suburb and the risk weighting they give it, will impact on your chances of living there. The Banks can also control your ability to borrow at any point in time by setting and manipulating their own Credit Criteria. This in turn changes the dynamics of entire suburbs. It also impacts on where you can buy.

So it stands to reason that your borrowing capacity is the most important thing you need to know as an investor. It gives you the edge to move on opportunities as they arise and to make the most of the market. On the other hand, the Borrowing Capacity in an area also has an impact on what suburbs are attractive to a Banks situation as well. Let’s look at that issue.

At its core, Borrowing Capacity is determined by Disposable Income.

Logically, higher disposable incomes provide greater Borrowing Capacity as they present less risk to the Bank. This extra capacity could be used to improve the family home or it can be used to buy an investment property. What effect do you think it would have on property values if this extra capacity is directed towards improving the family home? Interestingly, most investors will choose early on to purchase an investment property in a suburb that is close to where they live. There is a natural inclination to gravitate towards familiarity. Call it a quirk of human nature. Ask yourself where your first investment property was in relation to your family home – my guess is not far!

While not well understood in the market, it’s clear that the difference in borrowing capacity is a major factor for living or buying where you do. Smart investors make sure they take advantage of this little known piece of information.

Why do you think every State in Australia has affluent suburbs?

The simple answer is that these suburbs have people with extra disposable income that was used at some point to buy into there. Borrowing capacity allowed them to buy into the area where other likeminded people live or to put it another way, they can out bid and “out buy” other rivals for the same property. Incidentally, the property value is irrelevant when someone with capacity wants to buy. The suburb benefits by having competing bidders. This increase in value from these types of purchases can be quite small but it can also be substantial.

The borrowing capacity is the most important thing. Why? Because you can outbid another person at auction or make a higher offer. The ability to borrow comes with higher disposable incomes. The reasons why people buy where they do are irrelevant. Their borrowing capacity simply gives them the ability to buy where they want. Someone with lower disposable income will have different options based on capacity. The values of those suburbs where the disposable incomes are small won’t be under pressure to increase until the inhabitants have a collectively higher income position to improve their property.

Continuing improvement brings new money and new opportunity. The relationship between borrowing capacity and suburbs that represent good value is critical.

Our methodology is to follow the Banks preferences. We look for areas where there is a disparity between the household disposable income (capacity) and the relative values of the suburbs. We call these Value Areas.

So what we want ideally is a property located in a suburb that has upside to its Value.

That is, it has a price below what someone with high borrowing capacity, based on what the disposable income of the average person living there could pay up to, with the interest rates available at that current time.

These Value Areas provide opportunities for growth using common methods of calculating borrowing capacities. By concentrating on these income surplus areas we can take advantage of “invisible growth”.

To find out more about our Property Selection Methodology and the criteria we use to advise our clients on where to find medium to long term sustainable growth, please come see us at out next Wealth Acceleration Workshop.

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