Why do some properties significantly outperform others with regard to capital growth?
Why are some properties always in strong demand and sell quickly?
These are what I'd call "A-grade" properties.
But what sets these exceptional properties apart from the rest, and how can investors uncover these hidden gems that consistently outperform market averages?
As our property markets move out of the slump phase of the property cycle, we will experience fragmented markets where some properties will outperform while others will languish.
This will be very different from the days of the property boom of 2020-221 when almost every property in Australia rose in value by as much as 30%.
As I said, 2023 will be a different story.
We've now moved through the downturn phase of the property cycle and all research houses are reporting rising prices around Australia.
But not all properties are selling well or quickly - we’re now seeing a flight to quality across as buyers remain cautious.
That’s why it’s more important than ever for property investors to focus on A-grade property investments.
So let’s look at exactly what an A-grade property is and why it’s so important to only own this class of property.
A-grade properties are not necessarily located in the most expensive suburbs and don’t all come with a multimillion-dollar price tag.
In fact, what makes an A-grade property in a particular suburb may not be appropriate for a different demographic in a different suburb, however, this type of property will always have a depth of buyers who want to buy it, regardless of the market conditions.
In general, when looking for a property, it’s very rare to find the “ideal” property, so buyers usually need to make some compromises.
When they stumble across an A-grade property, they rarely need to make any or many compromises as it tends to “tick all the boxes”.
On the other hand with a B-grade property, they have to compromise on a number of factors such as living on the wrong side of the street, or maybe not having a north-facing orientation; while many compromises are made when purchasing a C-great property like living on a busy through road or having an impractical floor plan.
Now B-grade properties may still have a lot going for them, and during hot property markets they still perform well, but their second location within their suburb or the less-than-perfect attributes of these properties means they will slump more in downtimes when buyers and tenants are more choosey.
B-grade properties would generally be those in the right suburb, but not quite in the area of that suburb that buyers prefer.
B-grade properties might lack parking, have a more complicated floor plan, need renovation or sit outside that highly desired “20-minute neighbourhood”.
Put simply, B-grade properties generally have most of the right fundamentals of an A-grade property but are lacking what it takes to make the A-grade criteria.
Then there are C-grade properties – these are to be avoided unless they’re in a great neighbourhood and your intention is to demolish the property and replace it with something more appropriate for the location.
However, in general, C-grade properties are lesser-grade properties located on busy streets, in or adjacent to a light industrial area, or in a suburb just starting to gentrify.
They can also be in pockets surrounded by undesirable dwellings such as commission housing, commercial areas or high-density growth zones.
These are properties that, even with significant renovation, still wouldn’t meet the standards of an A-grade or even B-grade property.
It goes without saying that the quality and condition of the construction of the house have a significant influence over whether it is an A-grade property or not.
Grade properties are quality builds in good condition.
While cookie-cutter-style houses might be desirable for some, from an investment point of view they don’t make good sense.
While the quality and condition of the house itself are important, the scarcity factor is just as much so because when it comes to selling, if there are a lot of buildings the same as yours on the market at the same time, it could undermine the value.
The era that which the property was built tends to lead the pack and period homes like Victorian and Edwardian are scarce and have high buyer appeal.
Capital growth on this style of dwelling is usually higher than in more contemporary constructions.
- Natural light
A property with a northern orientation is always the most sought-after because it gives an abundance of natural light.
Western-facing yards are still popular and prove a very strong second option.
- Good floor plan
A-grade properties generally have a well-thought-out floor plan which flows throughout the house.
Think dining which flows to an outside al-fresco in the back yard and good-sized bedrooms located together with central bathrooms.
Buyers are willing to pay more for properties with a symmetric and convenient layout.
Properties which are able to offer an element of privacy would be far superior to a property that is overlooked or surrounded by high-density buildings.
And there is more to an A-grade property than just the building itself.
The land characteristics, particularly the land-to-building ratio is also important.
That’s because A-grade properties are not overcapitalise with expensive buildings on small blocks of land.
A-grade properties are generally found next to other A-grade properties, on quiet and well-maintained streets as opposed to on busy roads or in undesirable areas.
Now it’s all very well meeting all the criteria for an A-grade property, but unless it’s in a premium location then it still wouldn’t be considered investment-grade.
Having said that, it doesn’t have to be located in the most expensive suburb but the location must offer proximity to transport, amenities and open spaces - remember the 20-minute neighbourhood we’ve talked so much about?
After all, the ability to work, live and play all within 20 minutes reach is the new gold standard desirable lifestyle.
This includes things such as shopping, business services, education, community facilities, recreational and sporting resources, and some jobs.
You will find these are often in the gentrifying aspirational lifestyle suburbs of our capital cities and people will pay a premium to either own a property in these locations or rent property in these locations.
Many inner suburbs of Australia’s capital cities and parts of their middle suburbs already meet a 20-minute neighbourhood test.
However, very few of the outer suburbs would do so.
When the property market is strong (like we’ve seen in the past few years) nearly all properties sell quickly and at a good price because the highly competitive market creates a fear of missing out (FOMO) among buyers.
- Also read:What makes an A-grade property?
- Also read:Latest property price forecasts for 2024 revealed. What’s ahead in our housing markets in the next year or two?
- Also read:Here’s how to avoid these 12 common reasons property investors fail to build a Multi Million Dollar Property Portfolio
- Also read:Sydney property market forecast for 2024
- Also read:Boom to bust: What makes property prices rise and fall
But during an adjustment phase of the property cycle, like we are currently experiencing, there is a flight to quality and only A-grade properties will continue to hold their value and perform well.
The demand for quality will remain no matter what, so an A-grade property will always have a depth of buyers wanting to buy it regardless of market conditions.
These types of properties, therefore, make the best investments because they will withstand market volatility the best and generate the best capital growth.
While there are still plenty of properties on the market for sale, there is always a shortage of A-grade properties and these are selling quickly today.
In fact, in my mind, less than 4% of the properties on the market currently are what I would call “A-grade” or “investment grade.”
This is nothing new, homeowners and investors rarely sell their A-grade properties – why would they?
This means that if ever you need to sell your property, owning the right type of property, an A-grade property, will dramatically impact your sale result because of the capital growth you will have achieved and the fact that you’ll always have a number of buyers vying for your property.
Regardless of the type of market at Metropole, we always recommend investors buy the best asset they can afford, in other words, A-grade properties in the right property in the right location.
That is one that has a level of scarcity, meaning they will be in continuous strong demand by owner-occupiers (to keep pushing up the value) and tenants (to help subsidise your mortgage); in the right location (one that has outperformed the long-term averages), at the right time in the property cycle and for the right price.
But there’s more… not all locations are the same.
By now you know that the location of your property will do around 80% of the heavy lifting of its capital growth.
And that’s why it’s critical to own properties in A-grade locations.
In fact, it’s a bit like the game of Monopoly.
Everyone wants to buy Mayfair, the most expensive street on the board, but no one really wants the cheap locations at the other end of the board.
No one wins Monopoly owning Old Kent Road, do they?
Then there are other locations on the Monopoly board, some of which were more desirable than others.
1. Discretionary Locations
These are the most expensive locations in our capital cities – the “established money” locations where most of the residents have lived for a long time and where many residents have paid off their home loans years ago.
In general, these locations are the established inner-ring suburbs of our capital cities or suburbs close to water.
Think of Toorak, Brighton or Kew in Victoria, Teneriffe or New Farm in Brisbane, and Darling Point or Bellevue Hill in Sydney
Over the long term, this sector of the housing market outperforms the other segments, in part because of its scarcity, but in particular because, as we know, the rich are getting richer than the average Australian and they can afford to and are prepared to, pay a premium to live in these prime locations.
Interestingly the property cycle values in these suburbs are often more volatile.
During property booms and periods of economic growth, wealthy Australians have the financial capacity to indulge their emotional wants and buy the most expensive properties they can.
Then during the inevitable economic downturns activity in these locations tends to quieten down as is currently happening.
However, over the long term, this segment of the market outperforms the other sectors and in general, these would be considered A-grade locations.
Of course, not everyone can afford to buy at this end of the market, so strategic investors often look to invest in …
2. Aspirational Locations
These are the upper-middle-class areas and gentrifying locations of our big cities which would also be considered A-grade suburbs
These include upper-middle-class suburbs like Bentleigh, and Elwood in Melbourne; Paddington, Mosman, Randwick or Newton in Sydney and Camp Hill or Grange in Brisbane.
These are the suburbs where many affluent millennials are aspiring to move as they enter the family formation stage of their lives.
When this wealthier demographic moves into a suburb they tend to push up property values.
As you wander through these suburbs you’ll see a changing neighbourhood with new developments and infrastructure improving the quality of services for the residents as well as driving economic and job growth.
These developments also create a ripple effect producing economic, social and cultural change.
Then there are …
3. Affordable Locations
This is where most homeowners and many investors look because that’s where they can afford to buy.
However, sometimes investors buy in these suburbs because they are “advised” to buy at the cheaper end of the market.
There is no doubt some affordable areas make good investment locations, especially those that benefit from the ripple effect from adjoining aspirational suburbs and eventually become aspirational suburbs themselves.
I would class these as B-Grade suburbs.
On the other hand, most locations at the affordable end of the property market underperform with regard to capital growth and rental growth because many of the owners are young families who have stretched themselves to their financial limits and are often only a week or two weeks away from broke.
Similarly, the tenants who rent in these locations live there because that’s all they can afford and are unlikely to be able to pay you increasing rents over time since they are also only one or two weeks away from being broke.
As an investor, I would steer clear of these affordable locations – most of these will never gentrify in your lifetime and they will underperform with regard to rental growth and capital growth.
Often owning properties in these locations will be more trouble than they’re worth.
4. Last Choice Locations
In every city, there are suburbs where people live because they really have no choice.
No one wakes up in the morning wanting to live in these suburbs, but social circumstances force them to.
Of course, investors should steer clear of these C- and D-grade locations.
So just like owning the right locations on the Monopoly board, owning an investment property in the right location will do 80% of the heavy lifting of your property’s returns.
Note: Just like in the game of Monopoly, not all real estate is equal.
I know it’s often said that a “rising tide lifts all ships”, but in real estate that’s not really true.
A-grade homes and investment-grade properties in discretionary and aspirational locations are likely to be more stable and hold their values better as affordability bites and affects the lower end of the market.