There is an identical disclaimer in the fine print for every investment or retirement product: “Past performance is not indicative of future results”.
It’s there primarily as a risk mitigation tool, but it’s also deeply true and something I strongly advise real estate investors in particular to consider.
To avoid doubt (and, perhaps, debt), let’s be clear. The historical five-year trend for a given real estate market where outperformance occurs does not mean that it will always happen again over the next five years.
I can cite the data that proves it. I can also point out indicators you should be watching – a collection of data points and trends that can collectively signal pent-up pressure that usually precedes a market that is about to rise.
What happens now?
First, let’s take a step back and look at the underlying big picture. Sydney and Melbourne are cooling after unprecedented price growth, while Adelaide has seen strong growth and Brisbane, Canberra and Hobart are doing well, along with many regional centres.
Interest rates are likely to rise further in the next three to six months as the Reserve Bank attempts to rein in inflation.
Understandably, many believe this will lead to some hard selling in the market, which mum and dad investors, full of cash after staying at home for the past two years, are well placed to capitalize on.
But should they be guided by this thought?
The clues, as always, are in the detailed analysis of the data, which underpins every advice I pass on to my clients.
Not in generalized assumptions such as the one that says the last five years tell what the next five years will do. Let me explain why.
The five-year fallacy
Compare Sydney and Hobart’s track record over the past decade.
Figures from Australian Property Monitors (APM) show that from 2012 to 2017, Sydney recorded a staggering median house price growth of 64.7%, the highest of any capital city with an enticing annual average of 12.9 %.
Over the same period, Hobart grew by 14.1% at a lower return of 2.8% per annum.
If you held equity in 2017, in which market would you have invested? Let’s see what happened next.
Since 2017, Sydney has seen a total growth of 41% (8.7% per year), while Hobart has grown by 83% (16.6% per year).
So if you picked Sydney in 2017 based on five-year trends, you did well.
If you looked, as we did, deeper into the crystal ball of the property market and saw Hobart begin to heat up, you’ve gotten early entry into a market that has gone gangbusters ever since.
None of this should be particularly surprising, since markets historically follow cycles from boom to slump and back again.
But we still see investors and even top experts basing their predictions on historical trends which obviously are unreliable.
Follow the data
So what should real estate investors be looking at? I created InvestorKit because I love the challenge of interpreting the many streams of real estate data, looking for nuggets of intelligence that help our clients stay ahead of the market.
The best-case scenario for yields is to enter a market in the initial phase of building up pressure rather than at the end of a decade of strong growth, when it can quickly cool off as we have seen at Sydney and Melbourne in recent months.
We analyze a variety of key real estate market indicators such as asking price, days on market, monthly listing and sales volumes, and building approvals.
We also calculate inventory, which divides the number of current listings into the monthly average of sales volume; a falling number is an indicator of a heating market.
Additionally, an increase in the vendor’s discount – the difference between the original asking price and the actual selling price – may indicate a faltering market.
The movement of an indicator may not mean much in isolation, but when you see multiple streams of data simultaneously showing signs of a market under greater pressure, you start to pay attention.
Putting it all together becomes even more exciting when you see it combined with positive sentiment, a very tight rental market with low vacancy, and an economy with rising job openings, booming infrastructure projects. and falling unemployment.
In our world, that’s the perfect picture.
Of course, there are no guarantees in real estate investing, and indicators are just that. But you will always have a better idea of any investment opportunity by following solid data rather than trusting what happened yesterday, hoping it will happen again tomorrow.
Especially as markets need to return to their long-term averages, which in many Australian markets are typically between 5 and 8% per annum, over a 30-year period.