Commentators often refer to the price of property in Australia relative to household incomes. They highlight that property prices have risen two to three times faster than household incomes. They conclude that property growth cannot exceed income growth perpetually.
Obviously, this is unsustainable at a macro level. I’ve written about the factors that contributed to property price growth over the past few decades here. But many of these factors won’t repeat themselves over future decades.
However, I argue that this commentary isn’t relevant to investors if they invest in investment-grade property. My thesis is that if you invest in locations that attract the wealthiest 20% of Australians, it is likely you will enjoy an above average capital growth rate.
Wealth inequality is a terrible phenomenon
Wealth inequality means that the rich get richer, and the poor get poorer in a real and relative sense. It makes escaping poverty more difficult. It robs people of equal opportunities. It’s a terrible phenomenon.
The chart below demonstrates how significant wealth inequality is in Australia. The wealthiest 20% of Australian’s own more than 73% of the total personal wealth in Australia – the 80/20 rule at play.
It would be lovely to think that Australia will create greater wealth equality in the future, but unfortunately, I don’t think it’s likely. In fact, wealth inequality is likely to get worse, not better. Unfortunately, Covid exacerbated it as higher income earners were typically able to work from home. Rising interest rates and inflation are much less of a concern to wealthier and/or higher income earners. All these things make wealth inequality worse.
Therefore, when making investment decisions, it’s prudent and advisable to assume that wealth inequality will continue. If it does, its likely property price growth rates in blue-chip locations which attract the wealthiest Australians, will materially exceed outer suburbs.
Is there a relationship between average suburb owners’ income and capital growth?
The theory is that if you invest in suburbs where the occupants earn above average incomes (based on census data or similar), then those suburbs will experience higher rates of growth because occupants can afford to pay more. Whilst this sounds logical, in reality, income data is hard to measure accurately, and its only one component that determines a property buyers’ capacity. This article explored the shortcomings of relying on income data.
Therefore, investing in property isn’t just about investing in locations that attract higher income earners.
Beware of being too data driven
I have written previously that investing in property successfully requires an approach that is almost equal parts art and science. The science element relates to data and analysis – all the objective factors and considerations.
However, relying on data and analysis alone is too risky, as not all data is reliable or meaningful. Data can be out-of-date or not representative of the factor you are trying to measure. And its only half the picture.
The art element is the property know-how including understanding the market, what typical buyers are looking for, being an expert in a geographical location and so on. For example, sometimes there’s no objective reason why some streets (locations) perennially underperform – sometimes it is that way just because it’s always been that way. That’s the knowledge that only experience delivers. The art element refers to a subjective assessment.
You must employ an approach that balances out the objective and subjective considerations.
Invest in a location where buyers have the highest likelihood of being able to pay more
In a rising tide, all ships rise. Therefore, in a buoyant property market, most properties tend to rise in value almost irrespective of their location.
However, the key to enjoying good long-term returns is investing in a location that will always benefit from strong buyer demand. And that demand must come from a cohort of people that have the financial resources to pay more than the last person. That means the wealthiest 20% of Australians.
If you own a property in a location that is attractive to that cohort, you don’t need to worry about price to income ratios or any of the housing affordability crisis rhetoric. The wealthiest 20% either have above average incomes, they are asset-rich, and will eventually benefit from an inheritance tsunami. Either way, irrespective of factors such as interest rates, inheritance, and so on, over the long run this cohort will have the financial resources to push prices higher over time because the rich always get richer. Wealth inequality is a long-term trend that its unlikely to abate. And this is something you must consider that when making investment decisions.
