How to build more capital and master the market: part 2

In the first part of this blog series, I detailed how you can manage your property investment risks by knowing your numbers and reading the market. In this second instalment, I reveal a secret formula for predicting property price movements and how you can use this to get more properties, more quickly.

Rising prices, falling prices
Let’s say we were to select a given land mass with a fixed number of dwellings. And let’s say that the population so far has been pretty stable. If the population suddenly begins to climb, there would be an increase in competition for the houses that are up for sale. Those with the deepest pockets would secure properties, leaving everyone else waiting and vying for the next property when it came along. Prices would climb!

If we then expanded the land mass and built more houses than we needed at the time, then the competition to get a house would disappear. In fact because there’s plenty to go around, people would attempt to negotiate a better price and prices would fall.

When the number of people looking to buy a house was higher than the number of houses available, there was intense competition for those properties on the market. And when the number of people looking to buy a house was less than the number of houses available, prices relaxed. So if we could read when demand begins to increase or fall, or when supply begins to increase, then we’d have a way to predict the pressure on housing prices!

Supply and demand
A local market can be in any one of three positions at any time:
* When there is more supply and less demand – prices will fall
* When supply equals demand – prices are in balance
* When there is more demand and less supply – prices will rise

If we could just figure out a simple, clear and reliable way to determine when supply equals demand, then we’d have a way to be able to read the state of any market at any time. Of course if we could do this, then we’d have achieved one of this country’s greatest breakthroughs in the prediction of property price movements ever seen.

There’s a property market researcher by the name of John Lindeman who invented a practical predictive tool for investors. He analysed the relationship between housing supply and demand and discovered how to use readily available and easily understood statistical information to reveal the current and predicted state of any suburb’s housing market.

John states that a neutral or balanced property market exists when the number of properties on the market today approximately equals the number of properties sold in the past 12 months. That’s it! Simple!

So where is this ‘reliable information’ readily sourced from?

Properties on the market today are found by looking up current listings on realestate.com.au. You can keep track of how many properties have sold in each suburb by looking at RP Data statistics. Easy!

The neutral market
Let’s see how this works by following an example.

If you log onto realestate.com.au, look in the ‘buy’ section, do a search for your suburb of choice, deselect ‘surrounding suburbs’, and refine the search to only include ‘houses’, then you can get a fair representation of the number of houses on the market at any given time.

As I began writing this, Sydenham, a suburb of Melbourne had 68 current listings for houses.

Reports from various property data providers can then easily tell you the number of properties sold in the past 12 months.

Near the time of writing this, the back of the Smart Property Investment illustrated that Sydenham had a 12-month history of house sales of 76.

Combined, this creates a ratio of 68 (listings) to 76 (sold). Simplified, this is a ratio of approximately 1:1 – a balanced or neutral market. This means that there are enough properties on the market at any one time to satisfy the demand for houses in that suburb. As a result, prices are not likely to climb or fall.

A market in demand
If, for example, we were looking at a suburb where there were 16 houses currently for sale, and we saw that there were 124 sold over the past 12 months, then we’d have a ‘listing to sales’ ratio of 16:124. Simplified, this ratio will become approximately 1:8. Obviously, the number of houses sold over the past year far exceeds the number properties available. Such a result indicates that this suburb is currently in high demand.

A market in demand has certain characteristics. One of which is the lack of opportunity for a buyer to negotiate! In this market, buyers are clambering over each other to submit offers and secure a property quickly. If a negotiation falls over, vendors do not need to wait long for the next offer. In fact, waiting can be beneficial as time works in favour of the vendor being offered more the second time around.

The higher the demand side of the ratio, the greater the demand and the higher prices will climb.

A market in decline
Unfortunately the reverse is also true. If we were looking in a market where there were 124 houses currently for sale, and we found that only 16 were sold in the past 12 months, then we’d have a ‘listing to sales’ ratio of 124:16. Simplified, this ratio becomes approximately 8:1. In this case, the number of listings far exceeds the number of houses sold in the past 12 months. Such a result indicates that this suburb is currently dramatically oversupplied.

In fact, to be exact, there is approximately eight years’ worth of supply. In a market with this ratio, negotiating a great purchase price becomes far easier – vendors are desperate to sell! The longer the vendor holds onto the property, the less valuable it becomes and vendors will be glad to be rid of the problem.

For the investor this ratio can be a really important measure to determine how hard you can negotiate, how hot the market is, or if you’re getting into a market that’s already well oversupplied and might not return to growth for some time.

The higher the ratio on the supply side, the more a suburb is oversupplied and the more prices will fall.

Predicting the future
Logically, a suburb won’t change from a ratio of 16:124 to a ratio of 124:16 in a weekend. It takes time and this works well for the investor. So looking a little deeper, this ratio can be so much more than just a snapshot in time for reading the state of the market in a suburb.

There are two additional and important characteristics to know about this ratio:
* The ratio will change before prices do
* Regularly monitoring change gives us the power to see price movement before it occurs

If we can regularly monitor these statistics, we’ll be able to also read the direction that the ratio of supply and demand will be moving. As a result, we will be getting the right information to be able to read price movement months before it actually occurs – perfect for finding areas of growth before they grow, and to sell before a market declines!

This ratio unto itself is not the be all and end all of buying well in a suburb. It’s simply a high-level method of being able to broadly interpret the demand, supply and general price movement predictions market you’re thinking of buying into. There is no substitute for ‘on the ground’ research.

Even so, the premise of this ratio is sound, and the more you drill down into it, the more you get to understand it and relate it to other information that’s equally reliable and available, the more you will begin to see how powerful it can be for its ability to accurately predict suburb median price movement.

Don't miss my third and final blog in this series where I will detail how you can bring this all together to create more capital in a short timeframe and show you an example of investors who used this method to make $137,000 in five short months.

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