4 metrics you need to understand when investing in Real Estate

Purchasing an investment property might seem easier to understand than other types of investments, yet finding the right investment property can be overwhelming.

To help potential investors make more informed decisions, there are a number of metrics which can give the savvy buyer a more informed view of a property and it’s potential value. Knowing what to look for, what these metrics mean, and how they relate to your target property can help take the guesswork out of buying your investment property.

1. Median Price

The median house price is the midway point of all the houses/units sold at market price over a set period. That is, if there were 101 houses sold during a particular month, the median house price (for that month) would be the house price in the middle, that has 50 house prices above it and 50 house prices below it.

This is different to the average (or mean), which would be the total value of all the house sales, divided by the number of homes sold. Technically speaking the median is used as an investment metric because it’s more accurate than the average, because it is less affected by outliers, and reflects the sample size used. It’s also usually calculated by property type i.e. Units vs Houses.

Median prices are usually quoted by suburb/area and by a time period. Suburb figures are usually calculated on the previous 12 months, however be wary of areas with less than 10 sales during that time as there will not be enough data to generate relevant figures. As a general rule, longer periods across which the median prices are calculated often give more accurate indications of value, because of the larger sample size. This is also the case with number of sales, and hence why month-to-month median price analysis is often inaccurate and rarely used as a true indication of value. 

While median prices can assist as broad indicators and allow comparisons between cities, looking at recent comparable property sales in specific areas will always give the clearest understanding of the market you are entering. The best understanding of property values will be a combination of both median pricing – a macro view – and individual property sales in your target area, to give you a complementary and comprehensive micro view. Remember, as with most property investment metrics designed to indicate value, median prices should be considered alongside other value metrics and broader industry and geographic trends.

2. LVR: Loan to Value Ratio

The LVR, or Loan to Value ratio of a home loan or mortgage is a representation of the risk factor which your lender undertakes when giving you an investment loan. Simply put, it;s the amount of money you borrow as a percentage of the property’s value and is an important metric to consider when purchasing an investment property.

 

LVR = Loan Amount / Value of the Property*

Note: The value of the property is determined by the lender’s appraisal, not by the purchase price.

 

The loan-to-value ratio is a critical component of mortgage underwriting, whether it be for the purpose of purchasing a residential property, refinancing a current mortgage into a new loan, or borrowing against accumulated equity within a property – and all lenders assess the LTR ratio in an effort to determine the level of exposed risk they take on when underwriting a mortgage.borrower.

When borrowers request a loan for an amount that is at or near the appraised value, and therefore a higher loan-to-value ratio, lenders perceive that there is a greater chance of the loan going into default because there is little to no equity built up within the property. This is why saving a large deposit is important, as it reduces the loan amount and hence improves the LRV. As a general rule, most loans in Australia with an LVR above 80% will have an additional lenders mortgage insurance or low deposit premium charged to you, the borrower.

So what is Lenders Mortgage Insurance?

Lenders Mortgage Insurance (LMI) protects the lender – not the borrower – in the event that the borrower can’t meet the loan repayments and the net proceeds of an enforced sale of the property wouldn’t be enough to cover the loan. While this might seem to offer no benefit to the borrower, the existence of LMI reduces some of the risk associated with the loan, and hence allows the lender to lend larger amounts or approve loans without the borrower having a 20% deposit.

3. Renters vs Owner Occupiers

Once a property has been identified as a potential investment opportunity, making sure there are enough tenants to rent your property but also enough owner-occupiers to buy your property when it comes time to sell, is an important part of the selection process.

There are differing schools of thought on the ideal ratio of renters to owner-occupiers for any given suburb. Some agents believe suburbs dominated by owner-occupiers are better maintained and consequently tend to receive better valuations particularly when refinancing is involved. The thought process follows that owner-occupiers take pride in the appearance of their home and will often spend money to maintain this appearance. This is an expense that might not make commercial sense to an investor,  but will help uphold the values of all properties in the area including your potential investment property.
Once a property has been identified as a potential investment opportunity, making sure there are enough tenants to rent your property but also enough owner-occupiers to buy your property when it comes time to sell, is an important part of the selection process.

Conversely, landlords generally tend to spend the bare minimum on their investment properties, which can keep prices subdued when the majority of properties in the area are investor stock. So a balance in the ratio of owner-occupiers to renters should be considered, and may have different meanings depending on your situation.

Property website are provided demographic data from the Australian Bureau of Statistics (ABS), which it collated from Census data. It is important to note, that as the data is compiled from the most recent Census, it can be dated. Despite this, the ABS allows provides suburb specific data on home ownership ratios which is accessible online.

Adding Vacancy rates into the mix

As the name suggests, the vacancy rate is the percentage of all available units in a rental property, such as a hotel or apartment complex, that are vacant or unoccupied at a particular time and in a given geographical area. Vacancy rates become important if rental supply is restricted due to a high owner-occupier rate in a given suburb, as this can indicate that rental properties are in high demand[/vc_column_text][vc_column_text]Some locations are so tightly held by owner-occupiers that councils can be forced to increase density restrictions on existing properties, as has happened in New South Wales and Queensland recently as councils are forced to take up extra density to meet the demand of residents, which can be a positive for property investors.

4. Clearance Rates

Clearance rates are a key property market indicator and are generally expressed as a percentage and signify the number of properties sold, or ‘cleared’, at auction for any given period.

Clearance rates can give potential investors insights into the state of the market they are potentially entering, and hence is an important tool for investors. A buyer’s market means a market where supply outstrips demand (there are more houses for sale than buyers), a neutral market is when supply and demand are equal, and a seller’s market is when the demand outstrips the supply.

 

Calculating Clearance Rates

Clearance rate = (Sold under the hammer + Sold prior)/ (All Sold + Passed In + Withdrawn).

 

Sold under the hammer: Properties sold at auction

Sold prior to auction: Properties sold prior to auction

Passed In: The number of properties where there were no bids higher than the seller’s reserve price, so the property did not sell

Sold after the auction: Properties sold after auction

Withdrawn: the auction never happened, as the sellers have changed their mind.
As a general rule, when auction clearance rates are under 60% for a more than a month that indicates a market slowdown, or a ‘buyer’s market’. A clearance rate of 80% or more can  indicate a ‘seller’s market’. 

 

Disclaimer: The information in this article is of a general nature only and should not be relied upon as financial advice. You should seek professional advice for your particular circumstances before entering into any transaction.