Don't rely on the median dwelling price as a measure of the market

Ask anyone nowadays what the property market is doing and they will do doubt refer to the median as a justification of how the market is performing. Unfortunately focusing on the median is like trying to watch a game of footy at the MCG from the Eureka Tower Skydeck. You can see it’s a game of footy but you really have no idea what is going on.

The median is only a guide at best because although it provides a general reflection of the market it tells us very little about what is really happening at ground level.

When we look at the median the numbers can be skewed and manipulated in so many ways.  Let's take a look at the median of two suburbs in Melbourne’s west - Point Cook and Newport.

Point Cook’s median grew from $345,000 in 2006 to $450,000 in 2011. Although the annual compound growth rate was not staggering it was still a respectable 5.46%. But here is the rub.

In 2006 Point Cook had 4195 freestanding houses and in just 5 years that number more than doubled to over 9000. Point Cook has experienced an explosion in construction in recent years but building a new home does not come cheap.  This is because Australia is experiencing a skills shortage driven by an exodus of many workers to the mining states in addition to many young people not wanting to get their hands dirty and avoiding manual work.

The demand for new housing combined with the shortage of supply of people who can build them is resulting in a dramatic increase in the cost of construction of new homes. The result is when we see a lot of new home construction in one area the growth in the median is driven by capital improvements to the land not the appreciation of the land itself.

Newport on the other hand lies around 15klms closer to the CBD and while the median value of houses is significantly higher at $673,000 the annual compound growth over the last 5 years has been an impressive 9.84%.

The story in Newport is strikingly different to that of Point Cook. In 2006 the suburb had a total of 3430 freestanding houses but by 2011, according to the census data, this number had actually fallen back to 3120. Newport has a shortage of land and the decrease in freestanding houses is most likely because the only way to meet demand is to knock down some houses and replace them with units or town houses.

While there is no doubt some houses in Newport have been renovated in recent years in the main capital growth has been a result of land appreciation as apposed to capital improvements.

The property at 25 Charlotte Street, Newport, is typical of a house in Newport that has experienced a good level of capital growth. This property was purchased in Jan 2006 for $317,000 and sold a couple of months ago for $500,000. The property had no renovations done during this time.

As a result of these two different drivers we need to interpret the growth in median in Point Cook and Newport in different ways. Growth that is driven by capital improvements will deflate slowly as the improvements slowly depreciate over time. However because land is a finite product when the median is driven by land appreciation it will be in a much stronger position to hold its ground into the future.

Mark Armstrong is a director of iProperty Plan, which provides independent analysis and tailored advice to investors and home buyers.