Expert Bust #26 Investment Grade

A few qualities I’ve heard over the years for an “investment grade” property (or suburb):

• Lifestyle location
• Safe & friendly
• Special
• Appeals to a wide range
• Affluent owners
• Short walk to amenities
• Cafes, parks
• Street appeal
• Views
• Natural light
• Privacy
• Attractive style
• Sound structure
• Above avg. historical growth

I believe a good investment has nothing to do with those features. My definition of “investment grade”:

• Low risk
• High growth
• High income

But do the features of the 1st list lead to features of the 2nd? Not necessarily, it depends on timing.

Here’s a picture of Cottesloe in the western suburbs of Perth.

Cottesloe qualifies as an “investment grade” suburb using the lifestyle, street appeal, etc. features list. It has some nice houses.

Mount Druitt is at the other end of the spectrum.

Outdoor toilets are back in vogue in Mount Druitt. But now they’re in the front yard with an open plan to encapsulate street views.

Mount Druitt housing is pretty simple…

If you were an investor in 2013 choosing between Cottesloe and Mount Druitt would have been a no-brainer if you based that decision on the list of “investment grade” features. But here’s what happened…

The opportunity cost in just 5 years was 80%. For a $2m portfolio, that’s $1.6m.

Some might argue that over the long-term, Cottesloe will outperform Mount Druitt. But that changes nothing. An investor who bought a mil of Mount Druitt at the start of 2013 would have well over $1.5m after selling at the end of 2017. They could transplant that equity and buy more “Cottesloe” in 2017 than they could have in 2013. It doesn’t matter how well Cottesloe grows from then on, the investor would be better off having started in Mount Druitt – even after selling and paying CGT, agent’s commission, etc.

Investment grade attributes, miss the point. One of those points is risk. Risk can be measured using volatility. More expensive areas have greater volatility than cheaper ones…

source: Core Logic.

Imagine there were 1000 mansions for sale in Cottesloe and only 10 millionaires looking to buy one. If that was the case, then supply would exceed demand by 100-fold. According to the age-old law of supply and demand, prices for mansions would tumble.

Now imagine a completely different market in which 1000 Bogans are fighting over 10 dog-boxes. Demand exceeds supply by 100-fold. In this kind of environment prices would start tearing upwards for dog-boxes.

It has nothing to do with lifestyle, street appeal, views, proximity to amenities, architecture, etc. It’s all about supply & demand.