Why investing in new land estates is a bad idea

We all hear how new cars lose about 20 per cent in value the second we drive them out of the dealership. However, a large percentage of us still buy cars new, understanding that they are heavily depreciable assets, which is the first sign of a bad investment. 

We do this because we don’t see a vehicle as an investment, rather a lifestyle choice or necessity. 

There are ways to justify it beyond dollars and that is a personal choice. I don’t agree with it, but I don’t argue with it either. 

However, the same can't be said for property investment - we don’t invest in property for lifestyle, and we certainly don’t invest in property for necessity. 

Yet somehow a considerable percentage of mum & dad investors are still sold by the shiny ads and clever marketing of these new toys with shiny fittings. 

So what does this have to do with new land estates? And what is so wrong about investing in them?

Let’s make this clear, people invest in new land estates because it is the product that is most heavily shoved down their throats by the institutions with the most money to do so – large land developers.

They are certainly not the best investment. And I will explain why they are actually the worst.

They are sold the idea of saving money on tax or making money in the long run when the only people who are actually making money from the sale of a new land estate lot is the developer who developed the lot, the builder who builds the house, and the sales rep who got his commission.

But why is this? 

Why do we witness the negative equity basket cases of outer Perth suburbs like Ellenbrook, Aveley, Dayton, Baldivis, Byford, Alkimos, and Banksia Grove, which continue to weaken when the rest of the state grows in value?

I want to take you back to a fundamental economics platform: Price Growth = Demand Growth / Supply Growth.

This is the most basic equation to explain why values go up in particular suburbs (and why they go down). 

Demand growth is fairly easy to explain, but hard to pinpoint. It comes when the demand for a type of property in a certain area increases. 

On a city level, this comes and goes as our private and public projects ramp up and down, demanding skilled labour immigration (population growth) and offering higher wages (disposable income growth). 

On a suburb level, this comes when the offerings of that suburb (location, school, shops, transport, safety etc) become more desirable to our ever-evolving society. This changes over time.

We can track this by watching the ratio of number of properties under offer vs number of properties on the market, and how this contracts and expands over time. 

For explanatory purposes, let’s think about an established Perth suburb like Rossmoyne. 

Rossmoyne has no more land available in the suburb. There are about 1,400 properties in Rossmoyne.

It was first subdivided decades ago. Now, the only time supply growth increases is when people subdivide their blocks and add a trickle of new lots of land to the market. 

These are snapped up extremely quickly and you can see how this leads to a fairly constrained growth factor; let's call it 1.01 per cent, i.e. supply of properties for sale went up 1 per cent this period.

Let's also say demand growth for properties in Rossmoyne went up 1 per cent as a product of 1 per cent more people being interested in Rossmoyne, with no wage growth (or credit growth) at the moment for people to pay more for the properties. 

So in this instance, we can see Rossmoyne hasn’t gone up in value or down in value. It sits at 1.01%/1.01% = 1.

We can define it, we can track it, it is a finite number, but can you see how when we are all increasing in wages and there are more of us looking to buy, a suburb like Rossmoyne could increase in value very quickly?

It makes sense, right?

But what about if we look at Ellenbrook.

Sure, there is a fairly constant amount of people demanding property in Ellenbrook. There has been for a decade now. 

For argument's sake, let's say the demand for property in Ellenbrook is steady this period. The factor is 1. 

However, the issue with Ellenbrook and all new land estates on the fringes of the city is that the supply factor is nearly infinite. 

There is no real constraint on how much land is available in the suburb until the day the Department of Planning decides to switch the tap off and stop approving new land development applications from the big guys. 

In this example, the equation for price growth becomes undefinable.

In a new land development, supply simply increases at the curve of demand. If there is enough demand to get finance from the banks, the land developer (who doesn’t care about suburb price growth of your 3x2x2) will keep creating new supply because they keep making money doing so.

In this sense, an investor looking for capital gains from a property in an unfinished land estate is like a dog chasing its tail.

Now while this news may be extremely disheartening to some, especially those who were sold down the river by our trusted land developers, it is comforting to know at some point in the past, every suburb was once a new land estate. 

The issue is, it’s not until the suburb is totally developed and all neighbouring options are as well that we can actually have a closed market of demand vs supply. 

This means that one day, when Ellenbrook and Alkimos and Baldivis are no longer at the frontier of our metro region, they will eventually see true price growth and not just growth fuelled by looser lending (i.e. 2005-2014). 

The problem with this notion is, given the location and size of these suburbs, and the structural and socio-economic challenges now facing owners and residents, gains made above values in 2014 could be over a decade away on the fringes.

In addition, the thousands of new homes approved to be built as a result of the recent building grants only adds further fuel to an already chronic problem of oversupply.

Not only are economic fundamentals working against any relief for these suburbs, but now, due to the real-life issues facing families and investors with negative equity from high rates of 98 per cent house-and-land package loans and general mortgage stress, socio-demographic issues such as crime and mortgage delinquency put these suburbs at great risk of being labelled undesirable on the whole. 

I wish I had better news, but the only solace I can offer is that this story is not one that I see being shared by the majority of established suburbs in Perth. 

On a whole, the broader macroeconomic fundamentals of Perth’s property market coming out of COVID-19 are as strong as they were in the last boom. 

Record low vacancy rates, record high transaction numbers, and an extremely tight number of properties for sale all push the pendulum back to being a seller’s market across most of Perth’s inner-city suburbs. We are already seeing significant growth in these suburbs.

On a whole, the prospect for Perth is promising. However, I hold a heavy heart for those continuing to hold cookie-cutter property in the outer fringes.