How do you evaluate the investment potential of a particular property?
Well, that’s what I’m going to share with you today as I share 5 metrics that we use at Metropole when discussing the investment potential of properties that we’re considering showing to our clients.
But I’m also going to share 1 metric that you probably think is important, but we think is very misleading.
In assessing a property’s investment potential, we have a checklist of more than 100 metrics. I’m only going to share 5 with you today. But they’re going to give you a good balance of the science and art of property investing.
If you don’t understand what that means, you’ll understand a lot better after today’s show.
Then, as always, I’m going to share today’s mindset message with you.
Here are 5 numbers you can use to assess a property’s investment potential and one you shouldn’t
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.
- 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.)
This is where a seasoned buyer’s agent with intimate local market knowledge can be worth their weight in gold.
- 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 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 market decreases.
- Depth of Market
What we’re looking for here is an assessment of the supply vs demand balance within a particular market.
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.
- Ratio of owner-occupiers to renters
While many beginning investors have their prospective tenant top of mind, an important strand of Metropole’s Six Stranded Strategic Approach is to only buy properties with 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 a little equity in their homes.
- 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.
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.
But let’s be frank — you can make data say almost anything you want.
I’ve seen too many property investors find a property that they like, one they become emotionally attached to, 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.
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.
One commonly quoted metric that a lot of people investors look at, which we tend to ignore
Median price data, which is the most common data reported in the media (other than auction clearance rates) and researched by property pundits, is actually very unreliable and can lead to costly investment mistakes.
So here are 5 things you need to understand before you draw any conclusions from the regularly reported changes in median prices:
- How is the median price calculated?
The median house price is essentially the sale price of the middle home in a list of sales where the sales are arranged in order from lowest to highest price.
So in a list of 11 sales, it would be the sale price of house number 6, which has 5 lower-priced sales below it and 5 higher-priced sales above it.
This is different from the average, which would be the total value of all the house sales, divided by the number of homes sold.
- A change in the median price does not necessarily mean a change in your property’s value
While median prices are a useful tool for understanding the price changes of properties that have transacted in a market, a 10% increase does not necessarily mean that your property is worth 10% more.
In fact, your property could have dropped in value during this time.
What it does reflect, however, is activity in the market.
- Median prices are a more valuable indicator in some areas than in others
Changes in median price statistics are more meaningful in determining property price growth in some areas than others.
For instance, suburbs where the properties are largely homogenous and therefore of similar pricing are likely to see the median price as a more accurate reflection of true value changes.
- Different data providers measure different statistics
Ever wondered why different data providers’ median prices are different?
That’s because there are three key differences between all the providers.
- The data they collect,
- The time frames they report on – daily, monthly or quarterly
- The accuracy/complexity of the index methodology they rely on.
- Statistics are more reliable if looked at over the long term
Investors should pay less attention to short term trends and understand that median prices (as with all statistics) are more useful when viewed as a change in trend over a longer time frame and not at over a month-to-month period.
This helps you get a better understanding of an area’s performance.
Median prices are really best used as an indication of the composition of sales rather than a good indicator of changing property values.
The bottom line
In summary, understanding these 5 metrics will give you a head start in analyzing 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 on 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.
Links and Resources:
Some of our favourite quotes from the show:
“While past performance is obviously not a guarantee of future performance, the basic fundamentals of a location or a property don’t change.” – Michael Yardney
“I’ve found owner-occupiers buy with their hearts and not their calculators and they tend to happily pay an emotional premium if there is something unique about the property they fall in love with.” – Michael Yardney
“The problem is data is often wrong or to put it correctly – the way investors interpret data is often wrong.” – Michael Yardney
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