Capital growth predictions are often inaccurate. Can you accurately predict the capital growth of an area and why is this such a difficult thing to do?
Can you accurately predict capital growth? When you are looking at investing in an area, can you do a research on that area to understand what the growth of that area is going to be? And can you predict that with any level of accuracy?
Hey, i am Ryan from OnProperty.com.au, helping you find positive cash flow property. And this month we are talking about researching a suburb for the entire month. This is a big blackhole in terms of what people know about investing in property and so I reallywanted to teach you some techniques for understanding a suburb, for researching a suburb. And so the month of November will be completely dedicated to that.
So let us get onto the question. Can you predict capital growth? The answer is yes and no. There are some things that you can look at and some things that you can do to predict capital growth with some level of accuracy but it is not extremely accurate and you definitely cannot predict capital growth to the point of saying it is going to grow by 6.45% in the 12 months. And the reason that it is difficult to predict capital growth in the future is all the data points that we look at – things like capital growth trends in the past, things like income levels or vacancy rates or population growth or decline, these are all correlations to capital growth, not causation of capital growth. So population growth does not necessarily cause capital growth but as population grows capital growth may be likely to grow at the same time. So it is very important to know the difference between correlation and causation. The easiest example to explain this is to say that in the summer time ice cream consumption increases but also shark attacks increases.
That is a correlation between the two. They both have a similar sort of graph where in the summertime it peaks in terms of usage or consumption of ice cream and shark attacks and then it decreases throughout the winter. So they are correlated with each other but ice cream consumption does not cause shark attacks or shark attacks do not cause ice cream consumption. They are not causation. Causation is when something causes something else to happen so that I ate ice cream and that cause sharks to attack me that would be causation.
Correlation is just when two things seem to happen at the same time and they may be related but we are not 100% sure. So the reason that it is very difficult to predict capital growth is because we are dealing with correlation, things seem to work in tandem but we do not actually know if one causes the other. A great example of this is a rising in income levels coinciding with capital growth in the area. A lot of people think rising incomes mean the area is going to grow as more rich people move into the area that causes the area to grow. But that is not necessarily true. Rich people living in an area do not automatically make that area more desirable.
They do not automatically make that area more valuable. Rich people have disposable income that they can spend on renovations on the exterior of their property or improving the street and if rich people – I guess, spend more time to make their house look awesome then that could definitely increase the value of an area or maybe businesses discover that rich people live in the area and thus more businesses come to the area to get a piece of those rich people’s money. Because of the new businesses in the area, the area becomes more desirable therefore it can increase in value. But as you can see, all these different steps in terms of something to cause an area to increase in value, that is why it is very difficult to predict capital growth moving forward.
What are some things that you can do to help you predict capital growth?
One of the best things that you can do is investigate the area and look at not just some of the statistics of an area but also look at the trends of those statistics. So some of the statistics that you might want to look at are past capital growth history and you can check the average of 10 years and compare that to the last 3 years or 12 months and see whether or not the area is likely to grow. You can look at population growth or decline. If the population is declining then that is a bad sign for an area.
You can look at vacancy rates. You can look at vendor discounts of an area. You can look at days on market and the trends with all of these to get an idea of what is happening in the area and is there demand for properties in the area. If vacancy rates for the area are extremely high and potentially increasing then that is likely to mean that there is not enough demand to meet the supply of the area and that is why we have high vacancy rates.
So you can look at all these data points and you can assess is the demand exceeding the supply in this area and therefore is the area likely to increase? And a great tool you can use is called dsrdata.com.au and they give you a score out of a hundred with 50 being the theoretical equivalent of supply equaling demand or demand equaling supply, so right in the middle.
So anything above 50 is a good sign that there is high demand in an area and the area is likely to grow and anything below 50 is a sign that there is actually more supply than demand in an area so it probably will not grow at above average rates or may actually decline.
So that is a good tool. But obviously it just looks we had a few things so there are I guess a lot of things that you need to take into account if you are trying to predict an area.
What I like to do when I am researching areas is actually look for risks in those areas that I call red flags. And so identify risks like high vacancy rates would be an example of a risk. And go through the area, look at all these data points and look at the red flags in the area and then go forth and do further research in to the area to say is this red flag actually going to cause a risk of this area to not grow in the future? And I find that the easiest way for an everyday person to assess the capital growth potential of an area is not to look for the perfect sum of all the statistics but to look for areas that have fewer than average red flags and red flags that you can see will not be a huge issue moving forward. So I think that is really important to look at.
You can also go into details and look at things like the future development in the area, infrastructure, what is the government’s spending in the area. You can look at suburb qualities like how many schools, hospitals and things like that. But again it is all correlation. Schools in an area do not cause an area to increase in value, not necessarily; hospitals, not necessarily. It is kind of correlation. They kind of correlate together but it is not guaranteed.
So at the end of the day there is always going to be some sort of speculation when it comes to predicting capital growth. The person that I think has the best grasps on predicting capital growth and actually analyzing data and making wise decisions and I guess seeing through the data to what it really means is a guy called Jeremy Sheppard, who is the creator of that dsr data tool that I talked about and in one of his articles on yourinvestmentpropertymag.com.au. He says, “I deal in capital growth every week. I have examined literally millions of data points and I am still not getting to publish a prediction of growth with confidence.” So if Jeremy is struggling to predict growth with confidence then how are we as average investors going to do that?
And so I think if you are trying to predict that this area is going to grow about x amount per year for the next 5 years or if someone is telling you that that is going to happen, then just see it as just that. See it as an estimation or prediction and not necessarily the truth that this is actually going to happen because there are so many dynamics at play that it is basically impossible for us to understand.
But for the everyday investor I have created a brand new course on how to do suburb research. It is called Advanced Suburb Research and basically what I do is I take you through a one-page checklist that I have created and will provide to you with all the key data points that you need to look for in an area. Things like capital growth trends, population growth, vacancy rates, etcetera and I would go through and I would show you how to fill out this checklist.
All the tools to use and all the data that you would be able to collect is available for free online so I will show you where to get it and we will go through this list and I will show you what you are looking for with each data point in terms of the value of the data. What is a good vacancy rate, what is not. But then also, trends; are we looking for rising vacancy rates or declining vacancy rates and what does that mean for us.
So basically I will take you through that checklist, provide you with a checklist for you to use and show you exactly how to analyze a suburb, do research on a suburb and understand how many red flags are there in a suburb, how many risks are there. So you can get an idea what are the solid suburbs to invest in with low risks and a good chance of capital growth and what are the suburbs that have high risks and that you may want to avoid.
So to check out that course, go to OnProperty.com.au/suburb and I will be talking about that course all month as we go through different things to understand about suburb research and things like that with the goal that there is going to be a percentage of you – probably a small percentage, that really want to take their suburb research to the next level and really want to begin to understand how do I know whether or not a suburb is likely to grow, how do I know the risk factors in a suburb.
So we will go through a lot of things this month but this course is really designed just to give you that one-page checklist. You can get everything on one page and quickly compare areas to each other. And so I will be talking about that course more and more as the month progresses. So it may be of value to some of you, it may not to the others and that is fine. You will still get lots of value out of these free videos and again you can check out that course. Just go to OnProperty.com.au/suburb.
So until next time guys, stay positive!