The investment property roll-on effect

Property markets move around investor buying and selling patterns. Here’s how to pick them.

Summary: Property investors have a strong impact on house prices as they buy and sell, seeking out the best growth opportunities they can. Prices often spike as investors switch from one city or region to the next, and this is known as the roll-on effect. The key from an investment perspective is being able to pick where the next investor roll-on effect will occur.
Key take-out: Investor-led growth spikes are most likely to occur – and have a bigger effect on prices – at times when housing finance is freely available.
Key beneficiaries: General investors. Category: Residential property.

There are more than one million private property investors in Australia who, between them, own around two and a half million investment properties out of the nine million that are usually occupied.

This means the weight of their numbers in certain localities can be large enough to cause decisive changes in housing prices and rents when a significant number buy or sell. I call this ‘the property investor roll-on effect’. To understand how it works and where the effect is most likely to take place in future, it’s important to understand that there’s a fundamental difference between owner-occupiers, who view property as a home which is only sold when their personal situation changes, and investors, who see property as a form of investment.

Owner-occupiers view housing debt as a liability

Logic would seem to suggest that the more successful an investor is, the less he or she needs to borrow for further property acquisitions. Yet although investors own less than 30% of all occupied dwellings, their slice of the housing finance pie is much larger than this, as Figure 1 shows.

There are a number of reasons for the apparent anomaly. Owner-occupiers don’t receive rent from their home and they can’t claim the interest they pay on it as an expense, so they aim to reduce and eventually remove their home debt as soon as possible.

Housing prices grow over time and household incomes rise while interest rates have fallen, so the need for owner-occupiers to borrow decreases whenever they move and improve, and it usually reaches zero when they make their last home purchase. This is normally late in life, with the sale of the family home leaving them debt free and having enough left over for a retirement nest egg. But while owner-occupiers see housing debt as a liability, investors view debt as an opportunity.

Investors view housing finance as an opportunity

Clever investors realise that the more they owe, the more they can own. Not only do they offset the cost of their borrowings (which we call interest) as an expense against other income they receive including rent, there’s a far more critical opportunity that borrowing to buy provides investors. Debt creates wealth because it allows investors to leverage their property investments. Leverage means gaining the benefit of price growth that takes place on the total value of a property, not just on the small deposit contributed by an investor.

Figure 2 shows how leveraging worked for Rochelle, who purchased a house in Fern Bay, New South Wales, three years ago for $460,000 with just a 10% deposit of $46,000 and borrowed the rest.

After three years the median house price in Fern Bay has risen to $649,000 and this has lifted Rochelle’s equity to $235,000. This would present her with a profit of $189,000, or a gross return on her initial investment of more than 400% if she sold today and maintained interest-only repayments on the loan.

Of course, there’s no point in borrowing most of the purchase price of an investment property unless its market value grows substantially. Even worse, if the property’s value falls in real terms, the investor is leveraging a loss and stands in danger of owing more than the property sells for.

Not only do investors require constant rental demand to maintain the income flow they need to offset their expenses, the success of their investment is ultimately measured by the capital growth that has occurred. This quest for growth ensures that investor-owned properties are bought and sold on average every five years, which is three times as often as owner-occupiers. Not only do investors turn properties over more frequently than owner-occupiers, their reasons for buying and selling are also completely different to those of owner-occupiers.

Investors need high rent demand and price growth potential

Although high price growth is the holy grail of property investment, it’s hard to find. Figure 3 shows the high house price growth in Sydney during the 2002 and 2003 boom years wasn’t repeated until 2009, with many years of negative growth in between. Brisbane’s boom in 2001 and 2002 has never quite been replicated since, although there was double-digit growth in 2007. Perth had a few massive growth years from 2004 to 2006, but since then there has been no overall house price growth until the recent boom.

Even though it can be claimed that the price growth in these three cities provided a quite acceptable average result over time, the problem is that many investors don’t usually know when and where the price spikes are about to occur, or when growth is about to stop altogether.

An investor buying in Brisbane after 2002, in Sydney after 2003 or in Perth after 2006 would have had to endure an excruciatingly long wait for growth to re-emerge, which in many locations isn’t yet over. The reason each of these cities boomed at different times was due to the investor roll-on effect, which occurred as investors took their profits after each growth spike and bought elsewhere. The key to making use of this effect is to buy in those cities where investors are about to purchase and avoid those where they’re about to sell.

Let’s see how this has played out in the recent past, so that we can identify the dynamics which will enable us to predict where and when the next investor roll-on effect may occur.

Investors cause roll on effects as they sell and buy

Figure 4 shows the how each capital city has taken its turn in the property spotlight as the leading growth city since 2001 and, more significantly, that this high growth has occurred at different times for each capital city, with the lead changing every few years.

The significance of this phenomenon for investors isn’t just that it confirms my observation that high growth is a sweet but short experience with many intervening years of little to no growth, but more importantly it demonstrates how the high growth spikes move from one city to another in turn.

When I attempt to identify the cause of these spikes, I can see that it’s not due to owner-occupiers. There’s no evidence which suggests that huge numbers of people have been migrating to each of the high growth cities shown in Figure 4 in succession, creating a massive increase in housing demand as they move. The spike is largely due to the investor roll-on effect, which is caused by investors selling out in cities when they think prices have risen to the point where further investment isn’t profitable or possible, and then buying in a cheaper city where growth hasn’t yet started. This surge of buying and selling was the primary cause of house price growth in Sydney and Melbourne in 2002 and 2003, and the reason that price growth rolled on to Hobart, to Perth, then to Adelaide and Brisbane, then to Melbourne and back to Sydney again.

As Figure 5 shows, the investor roll-on effect occurs in regional housing markets as well and for exactly the same reasons.

The graph shows that each period of short but high price growth in the Brisbane house market was followed a year or so later by price rises in Gladstone, while the  Brisbane market cooled down again. Then, as the Gladstone house market cooled down in turn, price growth occurred in the Rockhampton house market. The fact that Gladstone’s house market is now rapidly slowing down may indicate that investors are about to roll on to the Rockhampton market and cause price growth there once again. This has nothing to do with the actual demand for housing, but everything to do with the way investors behave.

The roll-on effect isn’t an immutable cycle that will repeat itself time and again, but it demonstrates a constant pattern caused by investors’ profit-motivated mindsets. And because this behaviour is predictable, it can enable you to forecast where such events are likely to occur in future. To do this, we need to measure the indicators, or those numbers that enable us to understand where and when large numbers of investors will make similar sell and buy decisions.

Where will the next investor roll-on effect occur?

For the investor roll-on effect to take place, a certain combination of circumstances needs to be occurring in locations where investors are likely to sell out, and also in those where they’re likely to make a new purchase. You can easily do this research yourself, and Figure 6 shows you how to locate those cities or localities where investors are likely to sell.

When you’ve located a city or locality where it appears likely that investors are about to sell their properties, you can find other cities or locations that will most appeal to them, and where they’re likely to buy. Because the sale of one property and the purchase of another takes several months to conclude due to time on market and settlement periods, there’s always a window of opportunity where you can locate a potential buy-in housing market before prices start their upward climb.

When will the next investor roll-on effect occur?

Because of the profit-motivated mindset of property investors, the roll-on effect can take place any time, but investors aren’t free agents and rely heavily on housing finance. This means investor-led growth spikes are most likely to occur – and have a bigger effect on prices – at times when housing finance is freely available.

Figure 8 indicates that such a period may be upon us, as the amount of housing finance provided for the construction or purchase of dwellings for rent or resale by investors has been trending upwards since 2008-09 and could well reach its previous record total of $95 billion (set in 2007-08) next year.

Investors acting on their own without any real growth in housing demand being evident are engaging in speculation and stand the risk of sustaining losses as a result. The investor roll-on effect isn’t like this, because it isn’t the sole cause of price changes but tends to amplify any trends that may already be evident in a particular area of the housing market. In other words, the high growth spikes in our housing markets are nearly always the result of investors buying in and come to an end when they sell out.

Knowing when and where this is likely to happen reduces your chances of buying at the wrong time in the wrong location and increases your opportunity of generating significant profits by buying at the best time in the right area and selling when the growth is about to stop. 

Sources: Housing Finance Australia 5609.0, ABS; Capital City House Price Indexes 6416.0, ABS; House price data provided by APM

John Lindeman is the chief property consultant at innovating housing market analysts Property Power Partners: This is an edited version of an article that appears in the latest issue of Australian Property Investor magazine and is reproduced with permission.

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