Here are 5 numbers you can use to assess a property’s investment potential

How do you choose an investment-grade property?

One that will outperform the averages and deliver wealth-producing rates of return?

Well…you probably know by now that property investment is part science and part art.

The art component is the market intelligence that comes from decades of experience in buying and investing on the ground.

And this is crucial because relying solely on the scientific approach (the data) isn’t enough.

The statistics alone won’t allow you to differentiate between a good floor plan or a poor layout, a desirable neighbourhood compared to a less desirable location with a negative stigma or an aspect that receives abundant natural light compared to a poor orientation, etc.

You get the idea…

When it comes to the numbers (scientific) component, I see many investors get swamped by the seemingly endless numbers that can potentially paralyse them into inaction.

In reality, you don’t need to know one million things; you just need to understand a few critical metrics.

While this list is not exhaustive, here are a number of metrics the team at Metropole, uses to assess the investment potential of a property.

1. Past sales history

We look at past capital growth to give us an indication of future growth potential.

You probably know that one of the rules in Metropole’s Six Stranded Strategic Approach is buying in an area that has a long history of strong capital growth and one that will continue to outperform the averages because of the demographics in the area.

Once we’ve confirmed the quality of the location we need to drill deeper into the property itself.

And the best way to gauge its growth potential is to back-track its past performance by getting the history of at least two previous sales (if possible.)

While past performance is obviously not a guarantee of future performance, fundamentals rarely change.

Clearly, context is also important, which is why you want to compare its performance against similar properties in the same suburb.

A 7% annual growth rate is not impressive if the suburb average for the same property type has been 8% over the past 20 years

Occasionally you will stumble on a property with no prior sales history as it has been owned by the original owner for a long period of time.

Of course, this does not mean you should discount it from your considerations list?

This is where a seasoned buyer’s agent with intimate local market knowledge can be worth their weight in gold.

They would instinctively know what the valid comparables are (once again using the art part of the science vs art of property investing.)

The past performance history of those comparables can then be calculated, which can then be used to approximately impute the performance of the considered property.

2. Days on market

Days on Market (DOM) is a measure of how long it takes to sell a typical property in a particular suburb, and more important than the actual number is the trend which provides context.

Clearly, when demand is high and there are more buyers than properties available, the days on market will decrease.

On the other hand, when the market is soft because of economic conditions, perhaps, or because of a flood of new properties becoming available, then time on the market will increase, which will drive down prices.

This statistic helps investors to identify those locations that are strengthening so they can buy before the masses and therefore make the most of the price uplift as the time on the market decreases.

Case in point, look at units in Cairns Queensland.

DOM 12 months ago sat at 64.

Currently, DOM is 82, which means it takes 18 days longer to sell a unit in Cairns than it did at the same time last year.

On the other hand, if we look at houses in Kensington in NSW, DOM has improved from 30 (12 months ago) to 27.

This indicates a tightening market with more buyer activity as houses are selling more quickly in Kensington.

However, keep in mind that no property metric should be looked at in isolation as the property market is a dynamic beast where many factors and influences are at play.

A property can still be investment-grade if all the other metrics are heading in the right direction even though its Days on Market have slightly increased in the past 12 months.

3. Depth of Market

What we’re looking for here is an assessment of the supply vs demand balance within a particular market.

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This is a measure of how long it would take for the current inventory (number of properties on the market) to be absorbed completely (purchased) based on the current rate of monthly sales, assuming there is no more new inventory being added to the market.

A market is considered to be balanced if it has between 5 to 7 months’ worth of inventory (properties for sale.)

If hypothetically all the stock on market (inventory of properties) in less than 5 months that implies there is great market depth – lots of buyers waiting in line, with an inventory turnover of more than 8 months implies an oversupplied market with little depth of buyers.

 

4. Ratio of owner-occupiers to renters

While many beginning investors have their prospective tenants top of mind, an important strand of Metropole’s Six Stranded Strategic Approach is to only buy properties with the owner-occupier appeal.

Since owner-occupiers own 70% of Australian properties they “make the market” and add stability to property values in those suburbs where there is a predominance of established owner-occupiers who bought their homes many years ago and have significant equity in their properties.

This is very different from the instability and volatility we see in house prices in areas dominated by investors - think the inner-city apartment market or the other suburbs where there is little scarcity and many first home buyers have over-committed themselves and have little equity in their homes.

I’ve found owner-occupiers buy with their hearts and not their calculators and tend to happily pay an emotional premium if there is something unique about the property they fall in love with.

By the way…that’s another strand of Metropole’s Six Stranded Strategic Approach: Buy a property with a ‘twist’ – something unique, special or different about it.

But it goes without saying that, like the other metrics I’ve discussed, this should not be looked at in isolation as you need a layer of on-the-ground market knowledge to give it the right context.

Certain suburbs will always have a higher proportion of renters, such as Bondi Beach or Potts Point in Sydney, or Elwood in Melbourne, yet the right properties in certain pockets of these suburbs make great investments.

5. Above-average wages growth

Since property investment is a game of finance with some houses thrown in the middle, it’s important to find locations where the local residents have higher disposable income than average and suburbs where wages are growing faster than the state averages; as in these locations people will be able to afford to, and usually be prepared to, pay more to buy new homes or upgrade their homes.

You’ll often find these suburbs are going through gentrification - a change in the fortunes of the suburb as it is discovered by a higher income demographic, which slowly pushes out the lower-income residents.

Think of Balmain or Redfern in Sydney. Elwood or Fitzroy in Melbourne. Teneriffe in Brisbane or Bradon in Canberra.

Be careful relying too heavily on the data

There is no doubt that it’s important to understand the property fundamentals and research property data, and the longer back the data research goes the more accurate the data is likely to be in forecasting future trends.

The problem is data is often wrong or to put it correctly...the way investors interpret data is wrong.

Let's be frank ...you can make it say almost anything you want.

I've seen too many property investors find a property that they like, once they become emotionally attached, and then find the data to confirm their decision.

That's called "confirmation bias"  - they're using data backward rather than in the right way.

What I'm getting at is that while you need the data in the research phase of your investment journey, to be a successful property investor you need much more – you need on-the-ground experience and perspective.

Data will only get you part of the way, you must complement data with local area knowledge and expertise.

That’s why our buyers' agents at Metropole are ex-selling agents who understand the local market drivers.

They understand why one side of the road is more valuable than another or why one part of the suburb is more in demand than another. This is the type of perspective that money can’t buy.

Property investors who only do their research on the Internet but don’t have the on-the-ground expertise or context have the “science” part of the investment equation covered, but miss out on the “art” part of investment smarts.

Don’t get me wrong, doing your research is a critical step in getting ready to invest, but it is only one of the many important steps. There is no substitute for practical, on-the-ground experience.

The bottom line

In summary, understanding these 5 metrics will give you a head start in analysing the investment potential of any given property.

However, just like any other parameter in the property market, the numbers may not mean much on their own and there is a risk of drawing a wrong conclusion from them if you do not have intimate hyperlocal market knowledge.

That’s because, as I said, successful property investing is part science (understanding the data) and part art (having the ground perspective to interpret the data correctly.)

Perspective comes at a cost - the cost of time, experience, and learning from your mistakes.

You can't buy perspective, but you can "hire it"  by working with an independent property investment adviser, like the team at Metropole to ensure your property selections are the best they can be every single time.