Population surges not always a good indication of a solid investment

By Catherine Cashmore

Tuesday, 24 January 2012

When considering real estate investment one of the rules you’ll often hear quoted is “follow the population”.  An increasing population indicates work opportunities, investment in infrastructure and demand for housing – however, it doesn’t always result in the best long-term capital growth if this is the objective.

It’s always important to analyse the reasons behind any surge in population and conduct a risk assessment on the longevity of the move before committing to a purchase.  For example, mining towns attract rapid population growth and infrastructure development; however, because that growth is reliant on one industry, the risk of a quick reversal of the wheel is ever prevalent – even in mining the good times don’t last forever – hence investment in a mining town is all about “timing the market”, rather than “time in the market”.

For an example of a longer trend in population growth that can also be risky for investors, you need look no further than the city.  Back in the 1800s just 3% of the world's population lived in urban areas. By 1900, the number of people choosing to reside in a city swelled to almost 14%. By 1950, 30% of the world’s population were choosing city living above rural lifestyle and in 2008 – for the first time in recorded history – half the world’s population were living in towns and cities. Earlier this year, China recorded a 50/50 split between city dwellers and “ruralites”, and by 203 (assuming we’re not hit by a monumental plague) the number of people opting for a city lifestyle will swell to almost 5 billion – that’s 70% of the population.  Frightening statistics – especially when you take into account the challenges we already face feeding the earth’s 7 billion.

The top 25 “mega-cities” now account for over half the world’s wealth – 50% of which comes directly from within India and China – which are incidentally Australia’s largest migrant populations (now on the brink of outnumbering the European-born residents.) Here in Australia we have a population growth rate of 68%, well above the global average, which according to the “population reference bureau” is projected to grow around 38% by 2050.  We come second only to Saudi Arabia, which projects a growth rate of 74% by 2050.

Roughly 89% of our population live in urban areas, 64% of which reside in the capital cities – by 2050 this will increase considerably.  We’re seeing changes on a monumental scale and the effects on our housing, infrastructure and topography will be unprecedented. The borders of our cities will have to expand to eventually soak up the smaller satellite towns surrounding the capitals – for example, it’s feasible that Melbourne’s metropolitan area will one day include Geelong and Ballarat – and density in the inner suburbs will feature strongly.  Obviously it indicates investment in rural locations for purposes other than lifestyle is unwise as demand is likely to remain weak.  However, investing in a climate of rapid expansion requires a little more due diligence than simply “following the population” if the aim is to build the kind of wealth that results from long-term trends.

The approval of “mooted” residential developments is the first risk that must be evaluated to protect against periods of oversupply of any one type of accommodation.  For example, the massive projection of high-rise apartments in Brisbane and Melbourne has played a significant part in slowing – and in some cases reversing – the profit investors expected to achieve over the last three years principally because of the record numbers under construction.

The same scenario happened in Melbourne’s Docklands when it was established.  The apartments were flogged by sales agents taking their cut directly from the developers pushing prices up in a wave, however supply was never tight enough, or the developments attractive enough, to ensure ongoing demand.

There may be broad acceptance that apartment living will be the choice for a growing number of inner-city residents – and numbers moving into inner-suburban localities bear witness to this – however there’s currently no indication that high-density, high-rise apartments will ever attract the level of capital gain you can expect to achieve when a market is driven principally by owner-occupier demand.  Residents living in these apartments are mostly renters – not owners – therefore the demand is principally driven by one market – namely the investor market.

We’re often told Australia has a critical shortage of accommodation around our major employment centres – however this doesn’t mean you can purchase any accommodation and reap the rewards.  Our shortage of accommodation should not be confused with the general buyer market, which is principally a “shuffling of the cards” and not an indication of how many need a roof overhead – or an assertion that they’ll be prepared to purchase anything.

A better indication of Australia’s critical housing shortage comes from our vacancy rates, which remain well below the long-term average.  Investing next door to these job centres may attract renters – but it’s unlikely to attract the kind of growth you can expect to achieve in an owner-occupier-dominated market. Move in the wrong direction and it’s easy to walk into an investor-fuelled speculative bubble.

Jobs are transitory and many don’t want to – or can’t afford to – purchase close to their workplaces, therefore they choose to rent and make their “expensive” purchases in areas less industrialised and more appropriate for family accommodation.

Mining towns are good examples of this.  The buyers they attract are investors who want to gain positive yields from the number of workers requiring accommodation.  The capital gains are fuelled by increasing numbers of investors jumping onto the band wagon.  However the workers do not want to settle long term and therefore choose to rent, not buy – when the work dries up, the majority won’t be hanging around and losses occur as fast as the gains. Stories of investors falling foul of the market are common because they’re projected to the front pages of the media, however when the reasons are analysed it’s always possible to see where mistakes were made. There are no guarantees with any type of investment – but there are safe guards you can set in place to insure against the risk of loss.

Other risks resulting from simply “following the population” occurred during 2009, when masses of purchasers moved into the outer-suburban new estates buoyed on by the post GFC first-home buyer incentives. For example, in the year 2009-10 the areas attracting the fastest population growth were all located on Melbourne’s outer borders – Wyndham, Melton, Whittlesea, and Carndina.  The level of growth was unprecedented and capital gains were fast. Developers of new land estates inflated prices under the surge of demand, with some suburbs rising over 20% during the year. Yet the gain was short term – as soon as the incentives were pulled back most purchasers experienced a short-term loss. The pain was well publicised in the press during subsequent months.  Defaults went up, and the demand could not be sustained from the area attributes alone.

There are no fast and hard rules when it comes to property investment; most advice will have exceptions based on the idiosyncratic characteristics of the suburb.  However as a general rule try and seek out those areas where turnover is low with a good proportion of owner-occupiers to renters and a diverse range of accommodation.  Happy owners generally hold onto their properties during a market downturn and therefore short-term losses from an abundance of supply are minimised.  These areas are generally populated by generations in their middle years.  Families and mature couples in secure long-term employment benefiting from growing equity.  Risk minimisation is important, therefore sticking close to the suburb median is important to insure against market fluctuations – spending more doesn’t necessarily mean you’ll gain more.  Finally, always invest within your means: having good buffers to protect against job loss and absence of cash flow is primary.