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Do affordable properties make good investments?

Rising property values and higher interest rates are making properties less affordable and house prices have undeniably come off the boil over the past few months.

This has caused some alarmists to sound warnings that our property markets are about to collapse and others commentators are suggesting that investors should consider affordable properties.

Do affordable properties make good investments?

Sure more people can buy them, but just because a property is affordable, that doesn’t mean it’s a good investment for the future.

Before I explain why, let me give you some more background…

Recently one prominent commentator suggested that there was a big move to Melbourne’s more affordable Western suburbs and I have now seen a number of property marketers push these regions to inexperienced investors.

Even if you were not considering Melbourne’s western suburbs, there are some interesting lessons to learn, so please read on.

Looking back not that long ago, the term ‘sea change’ became popular in property circles to describe urban families packing their belongings and making the pilgrimage to various parts of our extensive coastline.

One of the most popular destinations for sea changers was Queensland’s Gold Coast, which for decades claimed the title of Australia’s fastest growing region… until recently that is.

In a recent study demographer Bernard Salt explained that the Gold Coast has been bumped to the number two spot as Australia’s fastest growing region – with 17,000 new residents over the year to June 2009, compared to the western outskirts of Melbourne, where the municipalities of Wyndham and Melton attracted 18,000 new residents in the same period.

Salt makes the point that although Melbourne’s western suburbs lack the Gold Coast’s glamorous highrise skyline, canal estates and bikini-clad meter maids (with the area instead being most famous for the nearby sewage farm), they boast one big drawcard – affordability.

Salt says that although Melbournians have traditionally favoured the more undulating eastern suburbs as opposed to the flat basalt plains to the city’s west, they’re now starting to appreciate, “the proximity and affordability” on offer in the likes of Melton and a revamped Werribee.

So back to my original question, is this the place to buy an investment property?

The answer is clear – definitely not.

Just like the sea change locations and other ‘hotspots’ were never the right place to buy investment properties in the past.

Sure sea change properties were all the rage not that long ago. But very few people enjoyed the same level of capital growth when buying on the Gold Coast, the Sunshine Coast or Mandurah that other investors were able to achieve when buying well located inner suburban properties in our capital cities.

Undeniably, affordability will become a critical factor in many home owners’ buying decisions, so while these new suburbs may be a good place to live – that’s not where you will find ‘investment grade’ properties.

Remember, investors should be looking for asset growth and we know that in general it’s the land component of a property that appreciates. This means for an investor who is looking for capital growth, they want the land-to-asset ratio to be as high as possible.

Think about it…

When you buy a new house on a block of land in one of the new outer suburbs, you may find the land - the bit that appreciates - could be worth considerably less than half the total property value.

There are plenty of other reasons I suggest investors avoid buying houses in these new estates and they all relate to the probability of poor capital growth.

Firstly, new homeowners in these ‘mortgage belt’ suburbs are more interest rate sensitive, as they tend to have less disposable income than people who live in more affluent suburbs.

Secondly, there’s rarely a scarcity factor about properties in these locations. Many properties look the same and there’s always another estate with more similar houses and more land just across the road. Of course, scarcity is one of the major reasons properties increase in value.

Another reason I would steer clear of these areas is the demographics. While they’re great for young families, there isn’t the same demand from a diversity of tenants as there is in the inner and middle ring suburbs.

It should be fairly obvious by now that ‘physical growth’ of a suburb – that is more people moving in – doesn’t relate to ‘capital growth’ (an increase in value), which is affected by supply and demand.

For my money you can find better investment properties elsewhere.

So where are these investment grade properties that will still increase in value over the next few years?

Well...our property markets are obviously adjusting to the rising interest rates and general market nervousness.

And yes some properties have dropped in price. This has occurred particularly in the upper end of the market – but these were never investment grade properties. The same will happen in many holiday locations over the summer months – prices will fall as fewer buyers bid for the many properties on the market.

And as I’ve just explained, property values are falling in the lower end suburbs, new housing estates and regional Australia - all areas that will be more sensitive to rising interest rates. And prices will fall further in these areas.

But I see medium density middle priced properties, especially apartments in the inner and middle ring suburbs in Melbourne, Sydney and Brisbane – holding their values pretty well. People living in these areas are not as interest rate sensitive.

You know how they say statistics lie?

Well currently the reported median price changes are not a good measure of what is really happening in the market.

Let me explain...

While the general property market has been pretty flat, there are still some suburbs that have had very strong capital growth, while at the same time many suburbs have had their median prices fall.

It’s like me putting one hand in a bucket of ice water and the other hand in a bucket of boiling water and saying, “On average the temperature is fine!”

Some parts of our capital city property markets are hot and others are not.

We’re moving into the next phase of the property cycle – one of increased risk for many investors (because they won’t be carried by rising markets), yet one of great opportunity for those who know how to play the game.

If you want to grow your own significant property portfolio, you need to own properties that provide wealth-producing rates of returns. This means buying a property below its intrinsic value, in an area that outperforms the average over the long term and one to which you can add value so you can create some capital growth. This could be through renovations, refurbishment or redevelopment.