New versus old growth drivers

Expert Advice with Jeremy Sheppard

26/05/2015

Hands up if you've ever heard a so-called expert claim some of the following as "growth drivers"?

• It's located just 7 km from the CBD
• It has a train station
• It has good schools

OK, so we're meant to believe these are drivers of growth. That implies above average capital growth, right?

Well, how long has it had this growth driver called "7 km from the CBD"? Has it moved closer to the CBD recently? Or has it been there for decades, maybe even more than a century?

If proximity to the CBD is a growth driver and the proximity hasn't changed, then the location must have had above average capital growth since its inception.

A CBD proximity example

Let's examine suburb ‘X’ which is 7 km from the CBD. And let's also examine suburb ‘Y’ which is 21 km from the CBD.

Assume that because X is only 7 km from the CBD it will have above average growth of 8% pa. And assume because Y is 21 km from the CBD it will have below average growth of only 4% pa. This fits in with the so-called theory that proximity to the CBD is a growth driver.

The long term national growth rate is around 6%. So we’re only talking about a divergence from the average by either 2% more (8% growth) or 2% less (4% growth).

A 4% pa growth means that if properties in Y are now worth $800k, then 50 years ago they were worth $113k. Hmm. That doesn’t sound right. It sounds a bit expensive - even for 50 years ago.

An 8% pa growth means that if properties in X are now $2mill, then 50 years ago they were only $43k. Woa! That sounds more than just a bit cheap doesn’t it?

Hang on. How is it possible that 50 years ago you could pick up a property in suburb X that is 7 km from the CBD, for $43k? But in suburb Y, 21 km from the CBD, you would have to pay nearly triple that price?

You can see that it simply doesn’t make sense. 50 years of above average growth and 50 years of below average growth are extremely unlikely. But for 50 years, the distance from the CBD didn’t change for either property.

So if proximity to the CBD is a growth driver, the growth should have been maintained. But we’ve just proved that’s not possible.

So obviously we can rule out distance from the CBD as a legitimate growth driver - certainly on its own anyway.

Shall we now look at train stations and schools, or do you get the idea?

Positives don’t always drive growth

If a positive attribute about a property location has been around for a long time, then it has already been well and truly factored into current prices. Its ability to drive growth has long faded away. The law of supply and demand has balanced out the initial change in the few years after it came about.

When people who don't understand the true drivers of capital growth fumble for a reason to promote an area, they publish seemingly important information. But quite often it is nonsense.

They frequently get desire and demand mixed up. A 14 year old boy desires a Ferrari but doesn’t have the buying power to influence Ferrari prices. Desire to live close to the CBD doesn’t affect prices either – only the demand of actual buyers will do that.

The proximity of suburbs to the CBD within a metropolitan area has little to do with above average capital growth. Having a train station may influence growth, but only if it is a new station. It’s the same story with schools, parks, shops, employment, transport nodes and more.

So what does drive growth?

Supply and demand are the only factors affecting price change. When demand exceeds supply, prices rise. If you want to find property markets with great prospects for future capital growth, look for locations with a high demand to supply ratio (DSR).

It is very easy to find high DSR property markets. Using a free membership to DSRdata.com.au I found the following list in less than a minute. All of these markets have excellent capital growth potential.

Top investment markets

Source: DSRdata.com.au

What if I do find recent changes?

If you can find some recent changes and those changes are positive like a new train station, then you can assume they will have a positive influence on demand. However, how much of an influence needs to be determined objectively. This is not easy to do.

How can you say a new train station will double demand or increase it by 20% or 50% or some other number? Without a number to gauge demand or supply, you can’t know the degree to which a change will affect prices.

The same is true for the DSR. However, at least you can say the DSR for Mt Kuring-gai units is higher than the DSR for Waterfall units – but not by much. The DSR is a consistent measuring stick. Its objective and it’s numerical which makes comparisons easy.

By all means look for these changes and planned changes. But if you want some idea of the degree of change, you’ll need an objective measurement.

Conclusion

It only takes a minute to check the DSR for a property market and it doesn’t cost a cent. It could save someone thousands.

Don’t be fooled by the fancy facts half-experts try to push. Most of them are only a little smarter than the average investor. If you know someone who is reading over one of those research reports, do them a favour and pass this message on. The more people we can educate the less damage the half-experts can do.

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Jeremy Sheppard is the property data nut-job responsible for the DSR at DSRdata.com.au

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Disclaimer: while due care is taken, the viewpoints expressed by contributors  do not necessarily reflect the opinions of Your Investment Property.