Warning: Past performance is not a reliable indicator of future performance… or should it be?

I was listening to an ad on the radio this week and at the end the advertiser read the following disclaimer: “past performance is not a reliable indicator of future performance”.

The government (ASIC) requires businesses to state this disclaimer whenever past investment returns are quoted, so that investors are forewarned that history might not repeat itself.

Different things drive the two asset classes: shares/managed funds and property.

It is important to recognise that the things that drive share values tend to be relatively subjective e.g. a company’s growth prospects, the quality of its business strategy, strength of management and so on. 

These things are highly subjective and can change very quickly.

Therefore, the past performance warning is prudent.

However, the things that drive property values tend to be more factual and static.

For example, the location, size and orientation of the land, the amenities in the area, the accommodation size and style and so on.

These things are almost always a question of fact (not opinion) and rarely change (or if they do change it often takes a decade or more for it to occur).

Past performance therefore is a pretty reliable indicator of future performance

Before buying any property, one of the tests I like to do is to measure its past performance.

If a property has grown at say 12% p.a. over the past 30 years, I don’t assume that it will grow at the same rate for the next 30.

However, I do feel that this past growth is a pretty good indicator that there is a good prospect of the property having acceptable growth (i.e. 5% to 7% p.a. above inflation) in the future.

Look behind the results as numbers can lie

The above paragraph comes with two caveats.

Firstly, it’s possible that, due to changes in the property’s surrounding area that the past growth will not repeat itself.

Therefore, you should identify the factors that likely contributed to the property’s past growth and draw a conclusion about whether these fundamentals are likely to remain unchanged.

Secondly, the reliability of the data you use is important too.

You must make an assessment about whether the past sales data reflects fair market value at the time the sale occurred.

For example, if a property transacts between related parties (e.g. parents sell to their child), it’s very possible the sale will be less than fair market value.

In this case the past growth will be overstated.

If you have concerns about the reliability of the data, then the best thing to do is search for sales of comparable properties.

The acid test

As a rule, before you buy any property, it is very wise to analyse and understand its past performance.

But be careful to not get too analytical as correctly assessing a property’s performance requires a combination of art and science.