Value investing for property

9th Nov 2016By: Margaret Lomas

When you are share investing, ‘Value investing’ is an investment strategy where stocks are selected that trade for less than their intrinsic values. Value investors actively seek stocks they believe the market has undervalued.

When it comes to property, many people think they are value investing when they get a bargain – they’ve either negotiated well, or found a seller who needs an urgent sale on a property and picked it up below what other properties around it may have recently sold for.

In my opinion, getting a bargain buy is not the same as value investing – if that bargain buy is on a property which exists in an area which has no intrinsic growth drivers, and therefore no capacity to deliver price growth and suitable rental yield over time, then the benefits of that bargain are extremely limited. Buying, say, $10,000 below the intrinsic value in a market which subsequently doesn’t grow, or does not even keep pace with inflation, only gains you that initial $10,000!

Value investing for a share investors involves the belief that the market overreacts to good and bad news, resulting in stock price movements that do not correspond with a company’s long-term fundamentals, giving an opportunity to profit when the price is deflated.

Translate this into the property market and the same rationality can be used to find areas with good value, and equally, those which are overvalued with little to offer the future.

If you keep in mind that fact that property cannot be quickly traded, and therefore those short- term movements which typify a value share investor’s buy and sell decisions are not possible with property, there are certainly ways in which a property investor can tell if an area is undervalued, and likely to become more reasonably valued in the short to medium term.

The basic rules are simple:

  • A hot market, like Sydney, is clearly over valued and cannot, in the short to medium term, provide a return worth the risk involved. The yields are too low, driven down by the quickly rising values in the past year or so, to make holding anything other than a financial drain. The prices are too high to spread risk – one property in the Sydney market can cost many times that of several in more affordable markets, and so exposure to risk is high, all placed in a single asset, and:
  • A cold market, such as a country town far from any city centre, a town with a single industry or an area with stagnant population may seem affordable, and the rental yields are often attractive, however the value is not there because there is little or nothing to drive possible growth.
  • And so, leaving out the two extremes, within the rest of the market lies undervalued property with the potential to quickly gain value and make the investment a better one than the average property investment.

Just as with share investing, to find these areas, you must examine the fundamentals, and then gauge these fundamentals against the chances of a change in the short to medium term. And this isn’t as hard as it may sound.

There are several characteristics which an area can have which are sure signs that the future is promising, such as:

  • A population growing faster than the national average
  • An unemployment rate which is trending down, with jobs available across a diversified industry base
  • A median household income which is growing faster than inflation
  • A local government which is underpinning the population growth with strong, planned infrastructure, allowing communities to flourish and
  • Little land available for additional development, and low developer activity.

Alongside those fundamentals there must exist affordable property which has not yet had any identifiable boom. Often such areas are found as fringe suburbs in capital cities or ripple areas next to those which have already shown significant price increases. They will be areas which are under the median price of those around them, where the greater proportion of residents are owner occupiers. Often they will be emerging suburbs, formerly less desirable, where demographics are changing, such as former state housing areas.

The value in these suburbs is in being able to see when the tide is turning. Not all affordable suburbs grow into great investments, but many do and the trick is in seeing the changes in neighbouring suburbs occurring, then buying close by to wait out the urban sprawl. When the up- and- coming suburbs inflate beyond affordability, the ripple occurs as those wanting to get into the area begin to buy close by instead.

A great example are the areas in Melbourne’s South East, in and around Carrum Downs and Cranbourne. Having seen nearby Paterson Lakes and Seaford experience significant recent values growth, these poor cousins can be bought for up to half the value, and provide higher relative yields. As the older homes are purchased, developed and even subdivided, the ‘creep’ will begin and the lines between the desired and the less desired suburbs will begin to blur.

The same effect is already starting in both the Logan Shire in Brisbane (growing fast in some areas and not so fast in the less desirable ones) and the Moreton Bay Shire in Brisbane, where a significant price differential exists between say, Kallangur (recently boomed) and Deception Bay and Rothwell (still low and not on many radars).

As the infrastructure continues to develop and housing becomes less affordable these suburbs will enjoy the ripple effect. And while you wait for that to occur, handsome 6% rental yields await!

Value lies in not getting a good price, but in buying at even the market value into an area which others haven’t yet picked as being desirable. It lies in being able to carry out a strong analysis of the fundamentals, and buying before the crowds realise the value was there all along.