Jeremy Sheppard explains how to assess a suburb’s potential using demand and supply indicators

Prices move in response to the changes of demand and supply. For prices to rise, demand must exceed supply.

The greater the degree by which demand exceeds supply the greater the pressure on prices to rise. There can be a large number of factors influencing the tug-of-war between demand and supply. Some changes that are likely to increase demand include:

  • New roads
  • Extensions to railway lines
  • New bridges
  • New hospitals or extensions to existing ones
  • Universities
  • Private enterprises setting up in an area or government departments relocating
  • New schools
  • Changes in what people find appealing now days

Some changes that might lead to increases in supply include:

  • Releases of new land or house and land estates
  • Developers replacing low-density properties with higher density ones

The degree to which these fundamental forces influence demand and supply can be measured using a set of key statistics.

Demand to Supply Ratio (DSR)

The DSR is scored out of a maximum of 48. A DSR of 24 is the theoretical balance point between demand and supply.

Markets with a DSR of 24 should experience capital growth roughly in line with inflation. Markets with a DSR higher than the average DSR should experience growth above the national average growth rate.

To illustrate how demand and supply dynamics determine a suburb’s potential, we looked at Minchinbury in Sydney’s west. Located 39km from the CBD, Minchinbury is an emerging growth area.

The DSR for Minchinbury houses for August 2012 was 27 out of 48. This DSR is “above standard”.

What does it mean?

  • Sellers are in no panic and buyers are making decent offers.
  • It’s a healthy market.
  • Demand is ahead of supply but not alarmingly.
  • Buyers are unable to get away with low-ball offers.
  • Sellers are getting the prices they ask for more often than not. Expect growth to marginally exceed the national average.
  • This market placed in the 27th percentile for the country ordered by DSR out of a total of 10,586 markets that had adequate data at the time.
  • The minimum DSR for August 2012 was 6 while the maximum was 42. The median DSR for the same period was 23 and the average DSR was 22.9.

DSR components

1 - Typical value

The typical value was $493,500 for Minchinbury houses for August 2012.

The typical value is the value of a typical house or unit in a suburb. The typical value is not the average, nor the edian, but a calculation similar to medians and averages aimed at providing a more accurate and less volatile figure for the “typical value” of a specific market.

2 - Days on market (DOM)

The DOM for Minchinbury houses was 114 days for August 2012. This DOM is “below standard”.

The DOM is the average number of days properties are advertised for sale before selling. A market where demand exceeds supply is one indicated by a low DOM figure. A good benchmark is about 90 days. Markets with DOM figures below this are considered to have higher demand to supply.

If sellers exercise patience they will not have to wait too long to see interest from potential buyers. Buyers are in no rush and are eventually finding what they’re looking for.

This market placed in the 33rd percentile for the country ordered by DOM out of a total of 10,257 markets with adequate data.

The minimum DOM for August 2012 was 19 days while the maximum was 562. The median DOM for the same period was 137 days and the average was 152.6 days.

3 - Discounting

Discounting was 6.7% for Minchinbury houses. Given that the benchmark is close to 5%, this is “below standard”.

The vendor discount is the average percentage discount from the original asking price to the eventual sale price. This is calculated for properties sold over the last month in the market of interest.

If demand is strong and supply is short, vendors don’t have to discount much to get a sale. So a low discount is a sign of demand exceeding supply.

Sellers must be realistic in setting a price likely to get a sale. Buyers have the upper hand in negotiations but can’t get away with murder.

With uncertainty in global economies, the discounting required to get a sale has been a little higher than usual across the country with the median discount at 8.4% and the average at 8.9%. The minimum discount for the country for August 2012 was 3.3%. The maximum was 21.9%.

This market placed in the 21st percentile for the country ordered by discount out of a total of 10,212 markets that had adequate data at the time.

4 - Auction clearance rate (ACR)

The ACR for Minchinbury was 50% which is “poor”.

The ACR is the proportion of properties auctioned that actually sell. Some properties go to auction but are withdrawn if interest is light or are passed in if bidding is weak.

In a weak market more properties are passed in or withdrawn. In a hot market most properties that are auctioned will sell. The higher the auction clearance rate the higher the demand with respect to supply.

Agents are strongly advising their clients against auctions in this market as attendance will be poor and a sale unlikely.

The average ACR for the country over the same time frame was 44.4% while the median was 38.5%.

5 - Proportion of renters

The proportion of renters was 15.2% for Minchinbury. The benchmark of a healthy market is around 30% or less, this makes the proportion of renters in the area “good”.

The proportion of renters compared to owner-occupiers indicates the supply of investment property. With a low proportion of renters, there is less competition amongst landlords to secure a tenant. Also, owner-occupiers generally take better care of their property than do tenants and are often in a higher socio-economic demographic. So, a low proportion of renters is an attractive statistic.

The average proportion of renters for the country over the same time frame was 26.6% while the median was 25%.

6 - Vacancy rate

The widely held benchmark of a balanced market is a vacancy rate of 3%. The vacancy rate for Minchinbury houses was 0.6% which is “very good”.

The vacancy rate is a measure of how long a property will be vacant. It is calculated as a percentage of the total number of properties in a market that are vacant. If rental accommodation is plentiful or the number of interested tenants is small, the vacancy rate will be high.

A good vacancy rate is a low one. The vacancy rate shows the demand and supply balance for rentals and this usually determines where yields will go in the immediate future.

Many renters are turning up to open inspections.

Investors buying into this market may have the opportunity to increase rents immediately. Landlords are receiving multiple strong offers from respectable tenants some of which offer months of rent in advance. Landlords should not agree to lengthy leases or they may miss out on the opportunity to increase rent considerably.

The minimum vacancy for the country for August 2012 was 0%. The maximum was 17%. This market placed in the 54th percentile for the country ordered by vacancy out of a total of 10,584 markets that had adequate data at the time.

A strong rental yield is a pre-cursor to capital growth.

High yields reflect an imbalance between demand and supply of rental accommodation much like the vacancy rate.

A high yield is usually the result of an extended period of low vacancies.

The needs of tenants are similar to the needs of owneroccupiers. So what tenants find attractive, owners will too.

But tenants are much more mobile than owner-occupiers. It is a lot easier to get a lease than a mortgage.

So if a location becomes attractive to live in, it is usually the tenants that move in first. This pushes up rents. With higher yields investors are attracted to the market and eventually, owner-occupiers wade in too.

7 – Yield

The yield for Minchinbury houses was 4.56% for August 2012. This yield is “above standard”.

If landlords are realistic when setting rents in a rental market like this, they should experience lower-than-average vacancy periods.

This placed it in the 63rd percentile for the country by yield out of a total of 5,187 markets with adequate yield data.

The minimum yield for August 2012 was 1.4% while the maximum was 11.52%. The median yield for the same period was 4.7% and the average was 4.72%.

8 - Stock on market percentage (SOM%)

The SOM% for Minchinbury houses was 0.91% for August 2012. This SOM% is “good”.

The SOM% is the percentage of the market that is currently for sale. If demand is low with respect to supply, there will be a higher proportion of property for sale than usual.

So markets with a low SOM% are desirable for investors looking for capital growth.

Vendors are hanging on to their properties. Buyers are frustrated that there is not much to choose from. This market’s SOM% places it in the 66th percentile for the country by SOM% out of a total of 10,460 markets with adequate SOM% data.

The minimum SOM% for August 2012 was 0% while the maximum was 10%. The median SOM% for the same period was 0.53% and the average was 0.91%.

9 - Online search interest (OSI)

The OSI for Minchinbury was 11.6 searches per property for sale. This is considered “poor”.

The OSI is a measure of the amount of interest in a market compared with the number of properties available for sale in that market. The interest is measured by the number of online requests made of real estate web portals such as Domain, RealEstate.com.au, Home Hound.

A high number of people looking amongst a small number of properties is a market in which demand exceeds supply.

The interest from would-be buyers searching this market online is lacklustre but the number of properties for sale is proportionally higher.

For August 2012, an OSI of 11.6 placed Minchinbury in the 56th percentile by OSI. The minimum OSI for August 2012 was zero searches per property for sale while the maximum was 3,533.5. The median OSI for the same period was 13.8 and the average was 21.3 searches per property for sale.

10 - Statistical Reliability (SR)

The SR is a score out of 8. The SR for Minchinbury houses for August 2012 was 7.2 out of a possible score of 8. This is “highly reliable”.

An SR of 4 is the minimum value considered reasonable for a market to be published. However, investors should not base investment decisions on a low statistical reliability. An SR above 6 is usually considered sufficient.

But regardless of the SR, the statistics should be complemented with manual checks of each individual indicator. And even an SR of 8 out of 8 should be backed up with sound fundamental research.

Data is not always available for every statistic considered in the DSR. And even when data is available it may not be completely reliable. The SR is a measure of the reliability based on factors such as the number of confirming figures; quality of data source; volume of trading; and “likelihood” of figures being genuine.

The overall conclusion (the DSR) is highly reliable but it’s possible an individual statistic or two is not entirely accurate. The median SR for the same period was 5.3 and the average was 5.8. Note that markets with an SR less than 4 out of 8 are not considered nor published.

Suitable strategies

Following is a list of property investment strategies and their level of suitability for Minchinbury.

Cash-flow (probably)

  • A high yield is required. Also, low vacancy rates to maintain pressure on yields.

Low risk (yes)

  • A low vacancy is required to minimise loss of rental income.  
  • Also, a low proportion of renters is required so there is less competition amongst landlords for tenants.

Renovate and sell (possibly)

  • A low DOM is required so the renovated property can be sold quickly once complete to reduce holding costs.
  • Since owner-occupiers look after their properties better than renters, a predominantly owner-occupier market will reduce the chances of over-capitalisation. So, a low proportion of renters to owner-occupiers is also preferable.
  • A high ACR can also help ensure the market is full of eager buyers and will be especially applicable if the renovated property is to be sold at auction.

Discounts or Bargains (probably)

  • A high vendor discount is obviously required. Warning: this is actually a negative characteristic for a market to have. This is a not a strategy you should seek out suitable markets for.

Using options (possibly)

  • A high DSR is required to maximise the capital growth prior to option expiry.
  •  A low DOM is required to quickly flip the property prior to option expiry.

Recommendation

DSR between 24 and 35 inclusive

This is an acceptable market to invest in – more so if a suitable strategy is applied. If buying to hold, confirm that fundamental drivers are likely to increase demand and/or decrease supply further. Preferably, contact an experienced research firm to perform this. www.DSRscore.com.au can provide options.

DSR 36+

If it can be verified that no contradictory fundamental drivers exist, then the investor can proceed with confidence in this market.

Note that each individual property investment within a market can offer its own unique benefits and pitfalls that differ from those of the market in general. Ensure that you conduct thorough fundamental due diligence before investing.

Jeremy Sheppard is director of research for DSR Data and a keen property investor. He created the Demand to-Supply Ratio (DSR) and is the author of 'How to Find Property Hot Spots'. Visit DSRdata.com.au