Regressions, digressions, means and growth

[Peter Parker]

Last week's Steve Navra presentation in Melbourne featured a graph that, though I am not sure it was Steve's intention, led me to consider the statistical theory of 'regression to the mean' and its implications for investment.

1. For those unfamiliar with this, it basically means that over time many eccentric characteristics will regress to a mean. This has applicability in many fields from genetic characteristics to investment returns.

More about this in my blog entry here: http://petersponderings.blogspot.com/2005/05/how-mean.html

2. I then considered a theory opposite to 'regression to mean' which could be called digression from the mean. In common parlance these are described as vicious (or virtous) circles where actions feed off and reinforce one another and over time one moves away from an average and towards either extremes.

Two examples that relate to finance (but not to property) are here: http://petersponderings.blogspot.com/2005/05/unmean-digressions.html

3. It then occurred to me that a significant body of property promoters claim that following their methods should provide growth results consistently better than average. There is a widespread view that a prime property location is one of the keys to superior growth due to scarcity value which pushes up prices.

A quick historical assessment of an area's capital growth since 1788 is the current price of land. Since today's highish priced properties have had superior growth, they must have an enduring quality cheaper properties lack. Hence according to this view it's benficial to buy these high-demand properties (typically in prime inner-suburban locations) for continued higher than average growth.

See http://petersponderings.blogspot.com/2005/05/unmean-digressions-ii.html

Supporting this proposition means that you're backing the dispersal of results from the mean and not the 'regression to the mean' theory. But I suspect that various factors like fashion, affordability and outlying areas 'catching up' tend to bring growth rates (if not prices) of different types of properties closer towards the mean again. This is particularly so if one does as Jan Somers does and adds yield to growth to get a total gross return (of approx 15%pa, although not all returns are equal).

As you can tell I have a wariness against claiming sustained above-average performance. However it may be possible to consistently do a little better than average just by excluding the obvious 'lemons' or high risks like overpriced OTP apartments or houses in very tiny towns. In relation to these there is no relation between cost price and market value. Saying either is 'below cost' or 'below replacement cost' is meaningless if no one is willing to pay that much or live there.

Nevertheless the above points pale into insignificance compared to the next point.

4. One insight I received from the graph mentioned at the beginning is that the ocurrence of growth in the first year or two after purchase is more important than any small variation in growth rates in the longer term (this contradicts my second blog posting re countries' GDP).

And I'm sure the graph shown had a kink, showing its growth regressing to the mean after an initial spurt. If I'm correct, getting an initial spurt is the key to making your money work harder quicker, and is more important than if its long-term growth is average or slightly above in the later years.

For this reason, a 25% capital growth in the first year followed by 0%pa in the next four years might be more helpful (and allow earlier portfolio expansion) than a steady 5% growth each year. This confirms the 'make money where you buy' and the 'time value of money' maxims and makes good negotiation and buying at a fair price (maybe through 'rental reality') more important than variations in later growth (which is hard to forecast).

5. A not unrelated topic for multiproperty portfolios is the distribution of capital growth. Assume three equally-priced properties, each on stand-alone loans. Could there be some advantages if one grew 30% and the other two 0% over if all three had grown by an even 10% each? You'd only be worrying about one revaluation and one loan redrawing instead of three, so it appears to be neater.

The main implications seem to be that i. a spread of properties is desirable and ii. not all properties need grow for the overall portfolio to be successful (though the unsuccessful ones should have redeeming features that justify their continued inclusion, such as stable cashflow or long-term prospects).

Regards, Peter

 

[keithj]

5. A not unrelated topic for multiproperty portfolios is the distribution of capital growth. Assume three properties, each on stand-alone loans. Could there be some advantages if one grew 30% and the other two 0% over if all three had grown by an even 10% each? You'd only be worrying about one revaluation and one loan redrawing instead of three, so it appears to be neater.

The main implications seem to be that i. a spread of properties is desirable and ii. not all properties need grow for the overall portfolio to be successful (though the unsuccessful ones should have redeeming features that justify their continued inclusion, such as stable cashflow or long-term prospects).

Hi Peter,

Regarding your point 5 I wrote a bit about Modern Portfolio Theory here.

MPT states -
- risk is proportional to reward
- risk is proportional to volatility (high volatility = high risk, eg cash is low volatilty & risk, shares are volatile therefore high risk)
- that diversification is good
- diversification in assets with different peaks & troughs evens out the cycles to a low volatility (& therefore risk), above average return
- investing in diverse higher risk (& therefore higher reward) assets can be less risky than sticking to lower risk assets
- adding higher risk (but not crap) assets to your portfolio can reduce the overall risk, but increase the return

It seems counter intuitive, but a graph of diverse volatile assets shows above average returns with lower volatility.

MPT was originally based around stocks, but can be applied to IP (& preferably portfolios containing shares & bonds & IP etc) - it's worth a Google.

Cheers,

Keith

 

[XBenX]

Peter,

Some heavy duty thinking there... I guess the only way to prove it either way (or attempt to) is to crunch the numbers and see if there is actually a regression to the mean of above average sample properties...

If you found properties did exhibit a digression from the mean then you could then analyse the features of the property that caused it to do this... and Id be your best friend =)

Would make a nice paper for a DBA or some other researched based postgrad work...

Would be interesting stuff to look at - I fear my Stats skills and the programs Id use would be terribly inadequate and out of date though...

 

[MichaelW]

Since today's highish priced properties have had superior growth, they must have an enduring quality cheaper properties lack. Hence according to this view it's benficial to buy these high-demand properties (typically in prime inner-suburban locations) for continued higher than average growth.

See http://petersponderings.blogspot.com/2005/05/unmean-digressions-ii.html

Supporting this proposition means that you're backing the dispersal of results from the mean and not the 'regression to the mean' theory.

Peter,

This assertion just didn't sit too well with me. I would have considered this type of property to operate within its own statistical sample set based on its characteristics which sets its own mean. Its OK to group all properties together and expect a return to the mean, but within this large sample set there are subsets each performing in their own way. Even if this subgroup of properties returns to its own mean, this mean may be on a much higher growth rate than less desirable properties, which in turn return to their mean.

If high quality properties are tracking to a mean line with a high current level and high future trend and low quality products are tracking to a mean line with a lower current level and lower future trend, then the mean of the whole group will be somewhere in the middle.

IMO, the trick is to pick the subgroup which has the higher future trend. To do this, you often have to pay the price of entry which is the higher current level. Its a simplistic analysis I know, but thats about all I'm capable of.

Cheers,
Michael.

 

[TomL]

If high quality properties are tracking to a mean line with a high current level and high future trend and low quality products are tracking to a mean line with a lower current level and lower future trend, then the mean of the whole group will be somewhere in the middle.

Thats EXACTLY how I envision it. Markets within markets with their own price drivers - desirability, affordability etc are all different in various spots.

They dont ALL regress to the exact same mean - well, I guess there will always be some sort of overall mean, but I dont mean that mean,

Thats just mean.

I'll shutup now.

T.

 

[Merovingian]

If I'm correct, getting an initial spurt is the key to making your money work harder quicker, and is more important than if its long-term growth is average or slightly above in the later years.

Well this makes sense. From an investor's point of view, the steady acquisition of property is paramount, during the fledgling property investment years. Gaining equity from property in a short time frame allows one to leverage their dollars quicker and hence build wealth quicker.

On the flip side, long-term average, steady growth of one's portfolio would be paramount to those who intend to live off equity as well as their passive rental income.

Assume three properties, each on stand-alone loans. Could there be some advantages if one grew 30% and the other two 0% over if all three had grown by an even 10% each? You'd only be worrying about one revaluation and one loan redrawing instead of three, so it appears to be neater.

Well, this depends on the values of one's properties, and which ones had growth. Of course, if one had two $470,000 properties A and B, and one $230,000 property, C:

1. 30% growth in C and 0% growth in A and B would yield $69,000.
2. 10$ growth in all three would yield $117,000.

Scenario 1 is better than 2 by $48,000.

Just though I'd point it out...

 

[Peter Parker]

Well, this depends on the values of one's properties, and which ones had growth.

Thanks Merovingian. I had assumed but did not state that they were purchased at the same price. This has now been corrected

Tom and Michael: Agreed about the existence of various subgroups. Investing books or seminars that restrict themselves to using metro-wide trends in median prices over a comparatively short time (20 years common) are doing the audience a disservice.

A few days ago I was re-reading Chris Lang's 'Unlimited Success in Acquiring Investment Property'. Page 39 quoted an 'Age' Report citing varying growth between suburbs since 1980. Prahran (which includes Toorak) grew by 579% and was fastest growing, while St Albans was slowest at 194%. The Melbourne average was 221%. The figures were to 1989 so took into account the 1987-1989 boom.

Furthermore, Page 47 quoted stats stating that Toorak was the most expensive suburb in Australia with a median price that had just passed $1m.

From this snapshot, it would appear Toorak posesses all the attributes of a suburb capable of extraordinary future capital growth, with a proven record and enduring desirability. Assuming that high-demand prestige suburbs enter a path of consistently above-average growth rates that assure continued success, there's no reason why it won't continue to do disproportionately well in the future is there?

Yet I pick up the latest API and it shows a median price for Toorak of just $1.5m.

A growth of 50% in the last 16 years is an exceptionally bad performance for a sought-after suburb. Although median prices can be misleading for many reasons, on the face of it, it appears Toorak only just kept up with inflation, and would have delivered negative overall returns if holding costs were factored in. But buying a couple years earlier, in 1987 instead of 1989, or a bit later would have helped a lot and made the investment more worthwhile.

Also it may be that (strange as it may seem) Toorak is undervalued (it was recently overtaken by Portsea) and that it will shortly resume rapid growth. But there's no certainty in this.

Also 20 year time frame is insufficient to factor in changing fashions and to see what effect they have on median prices. Instead it's important to look over the longer term, and to try to correllate these to trends in society and what people want.

Yesterday I spent some time looking at old For Sale newspaper ads for a selection of Melbourne suburbs; inner, middle and outer, rich and poor. I pretended I was seeking a 3 bedroom house.

Now this has pitfalls. For instance looking at asking rather than sold prices, not examining sales on the exact property and not factoring in capital and construction improvements (the average 2005 house being bigger than the average 1955 house). The sample was skewed as auctioned houses could not be included and the samples itself were tiny (just enough to work out what price would be representative of the area but sometimes as low as one or two).

Already having the current API for the Feb 2005 suburban medians, I decided to look at The Age for the first Saturday in Feb 1995, Feb 1985, Feb 1975, Feb 1965, Feb 1955 and Feb 1946 (wanting peacetime rather than wartime prices).

The suburbs I chose were INNER: Brunswick, Hawthorn, MIDDLE: Heidelberg, Clayton and OUTER: Dandenong, Werribee.

A 3br house could be bought for the following amounts:

(2005/1995/1985/1975/1965/1955/1945)

Brunswick: $377k/$125k/$70k/$23k/4750pounds/2550pounds/2250pounds

Clayton: $305k/$110k/$75k/$26k/4750pounds/na/na

Dandenong: $215k/$72k/$55k/$30k/3800 pounds/na/na

Hawthorn: $610k/$260k/$80k/$28k/6000 pounds/3750 pounds/na

Heidelberg: $409k/$115k/$70k/$40k/7000 pounds/4500 pounds/na

Werribee: $207k/na/$65k/$30k/na/na/na
(note that in 1985 Westmeadows and Wantirna were priced similar to Werribee)

The object of a more rigorous version of this exercise is to demonstrate that rates of growth do vary over decades and are not necessarily consistent. Confirming this may verify that growth rates can regress to the mean and sustained above average growth over many decades is rarer than one may think.

There are a few patterns that I suspect are evident (to do with the premium people pay for new areas and their subsequent low capital growth relative to older suburbs in the decades following, and quite poor performance of CBD apartments) but this will have to wait until later (land component appears to be significant here).

Regards, Peter

 

[MichaelW]

Peter,

Excellent post! Please do continue with your analysis and post your conclusions here. You're covering a topic very near and dear to my heart. IMHO, its the holy grail of real estate investing. If only we could determine how to measure a particular suburb's likely potential capital gain with any true degree of confidence, then we'd likely double or more our potential growth and resultant wealth creation.

At the moment, I look to indicators of "potential strong future growth" as described by Peter Spann and Steve Navra and others. e.g. Peter says that you should look for the suburb where people are moving in to, ie. demographics analysis to see what is the new hot ticket. He and Steve both suggest properties in the "just above median" price range so you get the "owner occupier" set which seem to perform better. Steve also says stick to the eastern seaboard as you get more fluctuation in prices which is of more benefit when you're looking to lock in gains with valuations and equity drawdown as deposit on the next IP. So, its an above median, up-and-coming suburb that I'm looking for within 20km of the CBD on the eastern seaboard.

Once you've picked the suburb or postcode then all the usual property checklist measures come in to play. These include proximity to schools/transport/beach/shops, motivated seller, "opportunity to add value", large land content etc, but for me picking the postcode and timing that postcode's growth cycle is the key. Then the individual property considerations are a no brainer. Even if you pay fair value for a run of the mill property, the "big picture" is in your favour and its well positioned for great growth. If you buy well then that's just the icing on the cake.

Thanks for all the great analysis,
Michael.

 

[Peter Parker]

Excellent post! Please do continue with your analysis and post your conclusions here.

Thanks Michael! More follows presently!

You're covering a topic very near and dear to my heart. IMHO, its the holy grail of real estate investing. If only we could determine how to measure a particular suburb's likely potential capital gain with any true degree of confidence, then we'd likely double or more our potential growth and resultant wealth creation.

He and Steve both suggest properties in the "just above median" price range so you get the "owner occupier" set which seem to perform better.

Such a relationship is not necessarily straightforward, particularly in the larger capital cities.

Cheaper outer 'mortgage belt' suburbs have high proportions of owner-occupiers. In contrast some dearer inner suburbs have high proportions of renters. An example is Elwood http://www.realestateview.com.au/cgi-bin/media_press_release.pl?ID=17 .

The proportion of renters may be more dependent on factors like proportion of units or proximity to public transport than the average price of the suburb. Also driving the rental proportion up is that at the moment most people can afford to rent in more suburbs than they can buy in.

Suburbs like Elwood indicate some corellation between high land prices and unit development (otherwise subdivision wouldn't be worthwhile).

Unit development almost implies more renters, so the owner occupancy ratio could fall. It is possibly the sort of people that are thought to live in rental accommodation and aesthetic considerations that are the most powerful in encouraging NIMBY type attitudes in the dearer suburbs.

Steve also says stick to the eastern seaboard as you get more fluctuation in prices which is of more benefit when you're looking to lock in gains with valuations and equity drawdown as deposit on the next IP.

It appears to be true that on average Perth has had a less volatile pattern of boring steady growth (though someone there in the late 80s might disagree!).

This could be due to all sorts of factors. Unlike Adelaide, Perth has had a long record of above average population growth. Perth also attracts more than its fair share of immigrants. Due to the faster growth than Sydney and Melbourne, new housing stock forms a large proportion of the total. As this appears to have a slower rate of capital growth than homes in established suburbs it could have a stablising effect.

In such situations it would be better to look at suburb by suburb comparisons rather than rely on the average for the city as a whole. Such comparisons could reveal more volatile results in markets such as Mandurah, Rockingham, Busselton and Margaret River (slow growth for many years followed by spectacular rises). Or, if you want some silliness, try Kalgoorlie circa 1993, when its median house price exceeded Perth's for a brief time.

Volatility in itself could be a double-edged sword.

In the hands of a skilled practitioner who uses a set method to determine value (eg Steve) it could be a blessing and result in extraordinary short-term growth spurts.

But in the hands of someone whose sole strategy is to buy a house every couple of years and hope for long-term growth then it could be a curse.

In short, I see nothing inherently wrong with buying in WA.

Once you've picked the suburb or postcode then all the usual property checklist measures come in to play. These include proximity to schools/transport/beach/shops, motivated seller, "opportunity to add value", large land content etc, but for me picking the postcode and timing that postcode's growth cycle is the key.

One thing that I think could be pertinent but is not widely discussed is the difference between the upper quartile and the lower quartile averages.

Suburbs where the housing is all the same (or which was all built in the space of a few years) have very little difference between these means. An example is Frankston North where the LQ is $162k and the UQ is $178k (see latest API). Other examples (though less extreme) are Hoppers Crossing and many smaller country towns.

Surely when the range is so narrow, the opportunities for value-adding without over-capitalising would be small, unless you just continually offer $140k for each property that comes onto the market and eventually get a desperate seller.

Higher inter-quartile differences seem much more interesting. They could indicate a suburb that has distinct pockets of varying quality (contemplate what you'd have if all parts of Frankston or Heidelberg were lumped into the same stats). There may be new developments that push the stats up, so might not mean very much at all.

Or they may also have an opportunity for the bargain shopper (though the average might be high, the lower quartile might be affordable). There could be better value-adding prospects as from the UQ stats we know that people will pay dearly for a property in the area, so it must be the property, not the location that's holding its value back.

Thus there could be a case for buying in areas where there is are large price differences between properties (provided you've satisfied yourself of the reasons for these). I have not done any work on this so like everything else here, it's just idle speculation.

Peter Spann's 'follow the money' point is a good one (people make the statistics happen, not the other way round).

The Social Atlas (big book based on census data and out every 5 yrs) and an ABS guide on the municipalities social indicators have some interesting stats that I think are worth looking at. Of these, those which I consider most important are:

* % family with kids
* % family with no kids
* % single

* % in bottom quartile income
* % in top quartile income

* % seperate house/% flat (type of property people prefer)

* % homes owned / being purchased
* % homes govt rent
* % homes private rent

* % Batch degree
* % Trade Cert
* % No quals
* % unemployment

* % no cars (influences importance of proximity to transport)

* % $120 - 299pw income (ie pensioners & soc sec recipients)
* % $500 - 699pw income (ie FT service industry jobs)
* % $1500pw income (top earners)

I have identified some areas that have a lower socio-economic profile but higher house prices. Others have a more middling profile but with somewhat cheaper house prices. I would be inclined to invest in the latter than the former, all other things being equal, as I think the latter could be undervalued and have better growth prospects.

Another thing to consider are these stats over time (see the excellent Towns in Time reports).

A couple of years back I was considering Moe and Morwell. Then I saw that in 1981 their average income was about the same as the state average. Since then there has been a big shift to the bottom quartile and the top quartile had collapsed. This concerned me becuase this must surely put an upper limit on rental income growth (and probably also values).

Given there had already been an investor-driven buying boom there and the population growth stats were not good, this info caused me to give these places a miss in favour of WA.

Regards, Peter

 

[madmurf]

Hi

Other than steady growth why did you invest in WA and which parts of WA.
Units, Housing?

Cheers

 

[Peter Parker]

Hi
Other than steady growth why did you invest in WA and which parts of WA.
Units, Housing?

At the time I started the WA areas I invested in represented good value compared to what I could purchase in post-boom Victoria (from early 2003).

Having spent most of my life there, my knowledge of towns and suburbs there is better than for any other state. Though non-financial considerations shouldn't come into it, the possibility of combining purchasing/inspection visits with family visits also appealed.

My IPs are in two large WA regional cities. I wanted a portfolio with a mixture of cashflow and growth IPs, and which overall was approximately neutrally geared.

There was a need to buy the best that can be afforded (by both myself and the mainstream rental market), while avoiding having everything in one town/city, overgearing and facing heavy negative cashflows. In addition these purchases should not impede flexibility to change employment if desired (which it was, about 6 months ago).

Cities selected needed to have strong rental markets, good amenity and a local population high enough to support essential services required to manage and maintain the property. The properties themselves should be low maintenance (ie brick), attractive to tenants and well located.

Prime to all this was juggling serviceability with LVR to ensure that the buying decisions made did not preclude later acqusitions when I see fit. This determined a particular cashflow/CG mix (everyone's circumstances will vary, and some people may not need any CF IPs, others on low incomes will need all CF IPs).

One city was chosen for its strong rental market and high rental yields. Market prices had not seen the investor-driven boom then prevalent in the east, although they were steadily rising. I considered that at the time I bought the market was neither cheap nor dear (though certain classes of property were (and are) overpriced in my view and I wouldn't touch them). Comparable sales of like properties have shown modest increases.

Another (coastal) city was chosen for the amenity offered versus prices (which had hardly moved in a decade). The population was steadily growing and many projects were underway. Yields were lower than the first city, and the propety is slightly negatively geared. However I considered the area way underpriced for what you could get, and interstate investors had already started moving in the cheaper suburbs. Comparable sales of like properties have shown strong capital growth. It is the equity growth of this property that is likely to fund a deposit for the next purchase.

The first IP was a unit in a small group of 4 with a body corporate. The subsequent purchases were semi-detached or duplexes with no body corporate (a good thing plus a higher land component). The ideal for redevelopment would obviously be a house on its own block, and this may well be considered for future purchases. I have always been averse to buying in large multi-unit blocks (at any one time one will be for sale and another for lease) and nothing I have read or observed has convinced me otherwise.

Regards, Peter

 

[Bill.L]

Hi all,

Wonderful thread and analysis Peter.

An interesting concept of returning to the mean when looked at in the context of inner vs outer.
When looking at your figures, it shows that over a 20 year period from '65 to '85 ?, Clayton (outer) had a greater % gain than Brunswick (inner). I am not surprised as at the time many of the inner suburbs were regarded as slum areas where no self respecting person would live (as much for the pollution as anything else). Conversly the "outer" suburbs like Clayton had nice new housing, relatively clean air, young growing families, new schools etc...etc.

Peoples perceptions (on a community wide scale) change over time, and what is popular today, maybe out tomorrow.

These changes in peoples perception is what makes investing not as easy as many of the different books and gurus make out. To believe in the straight 7% p.a. growth over the long term could easily bring undone those who forget that in a 20 period (1945-65) Brunswick only went up at 3.8% p.a.

Keep up the good work Peter, it is greatly appreciated.

bye

 

[Peter Parker]

When looking at your figures, it shows that over a 20 year period from '65 to '85 ?, Clayton (outer) had a greater % gain than Brunswick (inner). I am not surprised as at the time many of the inner suburbs were regarded as slum areas where no self respecting person would live (as much for the pollution as anything else). Conversly the "outer" suburbs like Clayton had nice new housing, relatively clean air, young growing families, new schools etc...etc.

Agreed. The following projects shows the extent to which the 'smart money' was pouring in to the Oakleigh-Clayton-Glen Waverley area and not into the inner suburbs.

- c 1957: Victoria's first motel (Princes Hwy, Oakleigh)
- c late 1950s: First modern shopping centre (Pinewood Mt Waverley)
- 1960: First regional shopping centre (Chadstone)
- 1960s: First suburban uni (Monash, Clayton)
- 1960s: Waverley Park oval
- 1960s rail line to Monash Uni (proposed but never built)
- ? Monash Medical Centre, Clayton
- ? South-Eastern Freeway

Anyone with a slightly smaller budget could well have been attracted to Springvale/Noble Park on the basis that they are close enough to benefit from the facilities above and have good transport links.

Yet where are Noble Park and Springvale today? Although they (like almost everything) benefited from the 1998-2003 boom, they are not what would be called premium suburbs and remain unloved by various commentators.

Peoples perceptions (on a community wide scale) change over time, and what is popular today, maybe out tomorrow.

These changes in peoples perception is what makes investing not as easy as many of the different books and gurus make out. To believe in the straight 7% p.a. growth over the long term could easily bring undone those who forget that in a 20 period (1945-65) Brunswick only went up at 3.8% p.a.

Very true; this is one of the things I was getting at.

Some books/seminars appear to suffer from:

* 20 (or less) year time horizons (not long enough)
* A lack of intellectual rigour in parts
* Susceptibility to thinking in straight lines and extrapolating charts
* A failure to consider social shifts, changing tastes and their unforeseen effects on the relative performance of suburbs (Brunswick & Clayton being good examples).

Thus I have a bias towards long-term growth rates 'regressing to a mean' and regard with skepticism gurus that say that their nominated suburbs (which they happen to know best) have enduring characteristics that will consistently have above average growth for the next zillion years no matter what.

Regards, Peter

 

[NigelW]

And I'm sure the graph shown had a kink, showing its growth regressing to the mean after an initial spurt. If I'm correct, getting an initial spurt is the key to making your money work harder quicker, and is more important than if its long-term growth is average or slightly above in the later years.

For this reason, a 25% capital growth in the first year followed by 0%pa in the next four years might be more helpful (and allow earlier portfolio expansion) than a steady 5% growth each year. This confirms the 'make money where you buy' and the 'time value of money' maxims and makes good negotiation and buying at a fair price (maybe through 'rental reality') more important than variations in later growth (which is hard to forecast).

Regards, Peter

Spidey

I think you're right, but not for the reason you suggest. Isn't the reason why getting a big equity kicker earlier rather than a more even spread simply the time value of money, ie 25% growth in year one is heaps better than 10%pa for 3 years.

Of course this assumes you can put the 25% growth to work...

Isn't a logical conclusion then that buying properties which you can renovate to get that equity kicker is a sound plan (even in flat markets???).

Excellent thread - thanks for kicking it off!

Cheers
N.

 

[Peter Parker]

I think you're right, but not for the reason you suggest. Isn't the reason why getting a big equity kicker earlier rather than a more even spread simply the time value of money, ie 25% growth in year one is heaps better than 10%pa for 3 years.

I think it can be more than that, though it depends on what you do with the money; $1.00 now might be worth only 90c in 3 years time due to inflation.

But if it means equity to purchase another property in 1 instead of 3 years then it *might* be worth much more than that (subject to the growth performance of the new property; if it stagnates then may end up costing you more and even erode the gains from the first!).

Isn't a logical conclusion then that buying properties which you can renovate to get that equity kicker is a sound plan (even in flat markets???).

Yes, but only if the extra value is more than what it costs you.

And here the benefits of doing up may be greater if there is a significant price difference between the top and bottom quartiles. If there isn't (as with examples previously given) then there's a risk that all your reno work may not be appreciated by the market and it will be to no avail.

The other implication could be that it may be sound to look for 'undervalued' suburbs, on the basis that their growth rates could regress to the mean and are more likely than 'overvalued' areas to give you a fast 25%. That is is the amenity and other characteristics of the area check out OK.

The opposite view that some take is that 'cheap property is cheap for a reason', and is therefore best avoided. Therefore you should always buy in the most expensive suburbs (which by definition have had the highest capital growth) as this growth will keep on outpacing the rest ad infinitum.

Though rarely disclosed, this stance seems to assume a believe that markets are perfect, pricing information always equals value and that there cannot be such things as 'overvalued' and 'undervalued' assets.

Today I again looked at comparative suburb prices, though this time in Perth circa 1979. The pattern was that suburbs considered cheap in the early 2000s were not far below average in 1979. These same suburbs however enjoyed better than average growth in 2003-4. Thus growth rates fluctuate, and like with stocks, this year's (or cycles?) best performer might not be much of a predictor for what will happen the next cycle.

Rgds, Peter

 

[Peter Parker]

a method to prove regression to the mean

Post #7 contained as its major part a comparison between house prices in inner, middle and outer suburbs taken over many years.

The comparisons were done every 10 years and the sample size and type was not enough to be statistically rigorous.

To demonstrate the extent to which growth rates regress to the mean (if at all) a more rigorous approach is needed. I would suggest the following:

- use of sale prices (auction AND non-auction) rather than asking prices
- exclude new homes from figures
- do analysis for only one type of property (eg 3br house)
- (preferably) measure growth over sale of the exact same house
- do stats every year (not every 10 years)
- compare growth rates with metro average
- compile a graph showing variation of each year's growth (above and below metro average) over many years (at least 50).

The table could be as follows (done for each suburb of interest)

Yr |Suburb growth % | Metro growth % | Diff % (Suburb - Metro)
1946
1947
1948
-
-
2004


The difference would be graphed. % Difference on the Y-axis, year on the X-axis. 0 (ie suburb's growth = metro average) would be half way up the Y-axis.

This sort of graph would indicate whether a suburb is a consistent outperformer, a consistent underperformer, or is roughly the same but has different times of under and over performance relative to the metro average.

Nevertheless it should settle the point once and for all.

Rgds, Peter

 

[Merovingian]

The difference would be graphed. % Difference on the Y-axis, year on the X-axis. 0 (ie suburb's growth = metro average) would be half way up the Y-axis.

Sorry, you just lost me here. Could you please elaborate on this bit?

Call me stupid...

 

[Peter Parker]

Sorry, you just lost me here. Could you please elaborate on this bit?

X-axis is across the page, Y-axis is up and down.

In the most common investing graph (the one showing rising asset prices over time!) the year is the X-axis and the $ price is the Y-axis.

Rgds, Peter

 

[Merovingian]

X-axis is across the page, Y-axis is up and down.

In the most common investing graph (the one showing rising asset prices over time!) the year is the X-axis and the $ price is the Y-axis.

No that's not what I meant. It doesn't matter now, I got it shortly after posting my previous post. (Temporary mental blank).

Thanks anyway. This thread is definitely one of those 5-star "save for later" threads.

 

[XBenX]

Spiderman - there is stat software that does this analysis and much more - Im struggling to remember it SPSS I think - google confirms that - its rapidly replacing parts of my memory =)

I dont have a copy anymore and Im sure there is something better being used now...