Cashflow and capital growth are the two key goals of property investors.
Many investors today put too much of their attention on good affordability, high yields, or proximity to capital cities. However, even when these features look good, there may be risks behind the scenes that could cause under performance in the near future. Today we are going to talk about 4 of these risks that you should always keep on your investing radar to play the game safer:
· High vacancy rate
· High Building Approval rate
· High Inventory
· Weak local economy
Risk 1: High Vacancy Rate
Vacancy rate reflects the relation between rental market demand and supply. A low vacancy rate (<2%) means a landlord’s market where it’s easier to rent your property out and the rent will be growing fast. Sometimes our investors put too much emphasis on yields and ignore vacancy rate, and that is not wise.
Let’s assume that a pair of friends A and B both bought an investment property in Dec 2020 in Queensland.
– A bought in Port Douglas for the good 4.67% yield and ignored the relatively high 3.3% vacancy rate.
– B bought in Buderim, for the extremely low vacancy rate of 0.4%, although the yield was relatively low (3.92%).
A believes that although they may have 1 or 2 more weeks of vacancy than B’s property each year, the high yield would cover that loss and make the investment overall more profitable.
The below charts show how the two regions’ median rental prices have grown in the year to Dec 2021. For Port Douglas, the weekly rent didn’t grow until the vacancy rate declined to around 1% in the 6th-month. On the other hand, with a constantly low vacancy rate, Buderim’s weekly rent has been rising steadily over the year, achieving a higher annual growth than Port Douglas. With this strong rental growth, B’s property now enjoys a high yield (4.67%) relative to its purchase price – not low anymore, right?
Risk 2: High Building Approval Rate
The number of new house Building Approvals is the future supply to the sales market, and without increasing demand, large number of new houses could mean oversupply, which would lead to weak price growth.
Let’s assume that a pair of friends C and D both bought an investment property in Sydney in 2016.
– C bought in the Blacktown-North region, considering that it’s a “fast-growing” area, where new house Building Approval stake 13.5% of its total number of houses.
– D bought in Hornsby, considering that it’s well established with new house Building Approvals taking only 1.1% of its total number of houses.
The below charts show how the median house price grew over the 5 years to the end of 2021. In five years, D’s Hornsby house has grown 10%+ more in value than C’s Blacktown – North house.
It’s again the power of demand and supply. Even though Blacktown-North is cheaper, making it more attractive to many, with such large number of new houses coming into the market each year, house prices moved at a slower rate. It is fortunate though that many buyers of these approvals were owner occupiers, had we seen it be primarily investors there would have been even lower gains (potentially declines) with approvals this high. On the contrary, Hornsby’s house market is much tighter with lower incoming supply, with prices rising.
Risk 3: High Inventory
Inventory is a ratio calculated by dividing the current number of total listings by monthly sale volume. It indicates the relation between sales market demand and supply, and the higher inventory, the higher risk of oversupply, and the lower market pressure.
Let’s assume that a pair of friends E and F both bought an investment property in Victoria in Dec 2020.
– E bought in the city of Wyndham in the Melbourne Metropolitan Area, where median house price is $575k, and inventory is 3.7 months of stock.
– F bought in the regional city of Bendigo, where median house price is $415k, but inventory is much lower (1.9 months of stock).
The below charts show how the two city’s median house prices grow over the following 12 months to Dec 2021. With a lower inventory level, Bendigo grew 14% more than Wyndham. We are not saying that Bendigo grew better solely because of the low level of inventory, but the high market pressure does make it easier for price to grow strongly, as existing house supply will be the greatest way to see upcoming capital growth potential.
Risk 4: Weak local economy
In a strong economy, people have more confidence and capacity to make large purchases, such as a house. The housing market will eventually improve as a result. An often used indicator of local economy strength/weakness is the unemployment rate: the lower unemployment rate, the stronger the local economy.
Let’s assume that a pair of friends G and H both bought an investment property in Brisbane, but in different years.
– G bought their property in 2002, when the unemployment rate was high (7%) but declining.
– Having seen G’s property’s growth, H bought their property in 2010, when the unemployment rate was 5%, lower than 2002 but higher than the few years before 2008.
The below chart shows the Greater Brisbane’s unemployment rate and median house price trend over the last 20 years. House price grew fast during 2002 to 2010, achieving a 16.5% per year average, largely driven by the. During that period, Brisbane’s unemployment was largely declining until the GFC in 2008. However, from 2010 to 2020, Brisbane’s unemployment rate has been trended upward, and during this decade, the house market only achieved 2.1% average annual growth. From 2020 to 2021, the unemployment rate dropped rapidly as Brisbane and Queensland economies have benefitted from the state’s effective management during COVID, stimulus and the increasing internal migration from other states.
In 2021, G would have achieved an annualised growth of 12.8% from his investment, but H would only have achieved 4.3% per annum. The huge difference is due to Brisbane’s thriving economy and housing market from 2002 to 2008.
Besides the unemployment rate, you’ll find many more factors that are useful to analyse a local economy, such as number of job ads, internal migration trends, infrastructure investments, retail spending, etc. InvestorKit has another blog talking about local economies.Check it here.
At the end of the day an ideal scenario is high demand and low supply, and the above 4 risks all indicate the opposite, hence they are 4 risks/red flags to have on your radar:
· High vacancy rate = Higher for-rent supply than demand.
· High building approval rate = High for-sale / rent supply in the pipeline.
· High Inventory = Either high for-sale supply or low purchasing demand.
· Weak local economy = Low purchasing demand.
For investors, it’s not low purchase price, high yield at the time of purchase, or being close to a metropolis that makes a good investment, but the market pressure / potential for growth in value and rental income. The 4 red flags we have listed today are some good examples for you to understand how significant a role demand-supply is playing in your property investment journey.
So, keep the 4 risks on your investing radar and go achieve your goals with more freedom on your property investing journey as you substantially increase the chances of success with this in mind!
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