Three common mistakes are made by those who promote regional properties as a superior investment to Australian capital city properties.
1 . Recency bias towards downside risk
Throughout history the greatest oversight of investors has been to assume that what has happened over recent times will continue to occur. Human nature dictates that we build a frame of references around our past experiences and project them into the future. Investment history is awash with examples, from tulip mania (1637) to Black Tuesday (1929) to the tech stock bubble (2002).
While the debt binge tide continues to lift all Australian property boats, some regional properties will continue to perform. All tides turn, however, and this is precisely why regional property is risky.
Australians are fortunate. Fuelled by a surge in mining investment, we’ve not experienced recession since Keating’s infamous “recession we had to have” of 1991-92 following the collapse of the Soviet Union. Interest rates are receding to 50-year-lows, and we’re close to effective full employment.
While high interest rates and high unemployment have long been perceived to be idle threats in Australia, investors who fail to heed history will eventually be caught out. If the US economy averts its fiscal cliff and China’s GDP growth powers along then Australia’s implied yield curve will cease to be an ugly inverted asymptote and even our dovish Reserve Bank board will ratchet up the cash rate.
The demographics of affluent suburbs and regional areas are markedly different in Australia. Cheaper, outlying households are heavily reliant on linear salary income and become prone to mortgage stress when the cost of debt capital is increased, which causes regional property prices to drop. Prime-location households tend to have substantial equity, diverse income streams and greater capacity to ride out elevated interest rates for their duration.
2. Long-term real growth in regional properties is poor
A second error that promoters of Australian regional property make is confusing periods of high inflation or credit growth with real value growth. No question, with skilful timing it’s possible to find a cheap property where prices increase over the short term. Over the long term, however, real capital growth in regional properties is poor, which clearly accounts for why the cheap regional property of yesterday remains cheap today, and yields remain high.
A standard rental combined with lacklustre growth results in a high yield, for a yield is simply a spot percentage calculated at any given point in time. A standard rental combined with outstanding long-term growth results in lower yields.
Be clear about this: property "growth" cannot continue to be fuelled by ever-greater mortgage debt in perpetuity. Australia had persistent inflation throughout two decades in the 1970s and 1980s, devaluing associated mortgage debt, and spiralling credit growth in the 1990s inflated property prices. But real growth was often negligible as those who elected to sell and re-buy property discovered.