Outer city property outpaces regional and inner-city rivals

Property investment remains firmly in the spotlight and the media is littered with tales of eye-watering prices being paid for tiny unliveable homes in the inner city.

Similarly, the skyrocketing gains being achieved in some regional areas have captured national attention as COVID-19 sparks a 21st Century sea and tree change.

It’s enough to lead you to believe that if you’re not in the centre of town you should head for the hills to maximise your returns but as always, it pays to do your homework and drill down into the detail.

In truth, it’s property in the outer city – that sweet spot where land size, demand and infrastructure investment collide – that is your best bet for achieving solid capital growth in the long term and maximising your rental returns and tax deductions along the way.

The starting point is understanding that the land is the only part of a property that grows in value; the house simply depreciates.

Let me give you an example. The Melbourne median house price increased from $38,000 in 1979 to $908,000 in 2021.

That’s an annual compounding return of 7.8 per cent per annum before inflation and about four per cent after inflation.

But the median price doesn’t give you the full picture.

A property in 1979 on 1,000 square metres and 15km from the city would actually be worth between $1.4 and $2 million today depending on the precise location, and the true return is between five per cent and seven per cent after you factor in inflation.

Those returns become even higher if you ‘leveraged’ your investment and only had to put in a 10 or 20 per cent deposit plus costs.

The reason is that price growth in real estate is the result of demand and supply, and land is a finite resource with limited supply.

Demand is the ultimate driver of housing prices and population growth fuels demand.

The outer city has more rapid population growth and greater infrastructure investment than the inner city or regional areas, which creates more demand and eventually affordability issues.

The solution is to unlock more supply further out of town and increase density, and that’s what triggers the uptick in value.

That scenario cannot and does not happen with property in the inner city, while in most regional areas, there is generally still plentiful land supply (coupled with lower migration), so pouring money into country bricks and mortar won’t necessarily be a guaranteed investment winner.

Obviously a range of factors including record low interest rates is fuelling demand for property far and wide but the fundamentals need to stack up over the long term.

According to ABS data, we saw record-breaking internal migration in Australia in 2020 as city-dwellers took flight to locations offering more space, but there is every chance many will return to their city roots when COVID-related restrictions on movement ease further over time.

One or two years of property price growth is not a reliable indicator of where property values are heading in the future and the gloss could quickly come off regional areas with limited infrastructure, schools and entertainment options.

Finally, most people can’t pay cash for a property and inner city houses are generally older and more expensive.

You could pay $1 million for an inner city property being rented for $600 per week versus paying $500,0000 for a property in the outer city rented at $450 per week.

In addition to the rental returns, you are likely to have higher maintenance costs and little to no depreciation benefits on your million-dollar inner city investment property.

With depreciation factored in, that home would cost you at best $5,000 per year to hold, versus a new outer city property costing you nothing to hold and in fact offering you a tax refund of at least $5,000.

That’s a difference of $10,000 per year to be factored into your returns!

The bottom line is that you can essentially buy two outer city properties for the price and yearly outlay of one inner city home.

It’s easy to get swept up in the hype and tales of massive returns in a matter of months but much of what we’re seeing today could turn out to be shooting stars.

Sound property investment takes solid research, careful consideration, patience and a long-term perspective.