Why past performance is no guide to the future
When it comes to partners, horses and football teams, past performance is often used as a guide to predict future performance. Many experts assure us that it’s the same with the property market, but this leads to a huge contradiction in exactly how past performance predicts the future.
Only buy in areas that have experienced good past growth
One group of experts claim that we should only buy properties in suburbs that have “stood the test of time”.
They say that high past performance offers us not only the greatest level of security, but the best prospects of continued price growth into the future. This is based purely on the expectation that such high past performance will continue into the future.
Seems logical, except that there are many suburbs and towns where housing markets have boomed for years, only to crash without warning. In fact, every boom has ended at some time, even if prices haven’t crashed.
The expectation that growth will continue in the future in some suburbs purely because it has in the past ignores the continual changes in population, purchasing power and affordability that occur in our all housing markets. High past performance is a good result for property owners in such areas, but is no guide to their future performance.
Only buy in areas that are overdue for growth
The other group of “past performance” experts use past performance in the opposite way. They rely on the absence of high past performance to pinpoint areas that are “overdue for growth”.
They identify areas where prices have not risen for years and then claim that such markets are due for a catch up to others where growth has occurred.
This ignores the fact that demand may have dropped in such areas, or maybe there have been huge housing developments causing oversupplies. It could be either or even both situations which keep prices subdued. Just because growth hasn’t occurred is no guarantee that this is about to change.
The issue for investors is that while both experts use past performance to justify their predictions, one group looks for areas with high past performance to find potential boom markets, while the other searches for areas with little or no past performance to do exactly the same.
The solution lies between these two extremes
The reason that some suburbs consistently outperform the overall market is because they are in well-established localities where no additional stock can be added. These tend to be the leafy inner or middle-distance suburbs of major capital cities where family homes are held for long periods of time, which results in market tightness and better long term performance.
Yet, even in such above average performing locations, there will still be one or two suburbs whose recent price growth has lagged behind the others, because buyer demand has temporarily fallen below the supply of properties for sale. This means that it will be possible to find a suburb where prices are overdue for growth, and purchase a bargain priced property in an area where prices will still perform well over time.