Blue-chip versus high-growth high-risk locations

Lachlan Walker 70x60When investing in property which location is a better long term decision? Should you go with somewhere which is more expensive but has consistently stable rental demand and growth? Or should you take a risk and invest in a cheaper area with potential for augmented growth and subsequent high, but volatile demand for renting?


Blogger: Lachlan Walker, Place Advisory

We welcome to the ring two contenders and will see them battle it out to decide which one you will back.

The Competition
Contestant number 1: is the ‘Blue Chip’ location. This refers a reliable region that constantly delivers but takes a slow and steady wins the race approach. A ‘blue chip’ area is a one which has consistently strong rental yields, and steady, long term, capital growth.  These regions will weather downturns and operate profitably in the face of adverse economic conditions, which help to contribute to their long record of stable and reliable growth. A capital city is a prime example. Traditionally, blue chip areas were classified as areas within a 10km radius to the CBD, and while this is generally the case, there are exceptions. In saying this, a blue chip area will almost always possess the stereotypical price drivers such as abundant public transport, parks and water and a flourishing cultural, restaurant and entertainment scene, which is typical of capital cities and inner city suburbs. For this reason they are usually more expensive to buy into than other areas. The Blue Chip is our favorite to come out on top.

Then we have the ‘Risk’- still a serious contender. This is an area which has the potential for a massive rental market, but differs from a stereotypical investor suburb. These areas have earned their label for a reason- they often come onto the investor radar due to a particular occurrence e.g. increased job opportunities. The risk, there is a possibility that this could end as quickly as it begun, sometimes with very little warning. This means that investors are not able to exit this market as profitably or easily if the market changes. One of the big reasons investors elect to buy into risky areas is the price point- and the belief of capitalizing on quality growth.

To sweeten the deal, many risk areas offer buyers attractive incentives to encourage them to buy. One form of these are rental guarantees, which provide owners with the assurance that they will continue to receive rent on their property, even if it is vacant. This is a big enticement for investors to buy into an area, however, like the area they are purchasing into, rental guarantees are also a risky practice. When the guarantee period ends, the rent will be market rates and if the market has softened, the lower rental returns and extended vacancies mean that investors can find themselves paying a lot of money to hold on to a now undesirable property.

The Goal
What investors look for, and what drives investment in an area are the three following factors:

- Population Growth
- Infrastructure and Government Investment
- Employment opportunities and diversity

These markets have a synergetic relationship- with population growth comes increased infrastructure and more employment opportunities, and vice-versa. All of these elements can be found in a blue chip location. This is where ‘blue chip’ and ‘risk’ differ. A risk area may possess one of these factors e.g. a mining town will have multiple employment opportunities, but they do not have the growing resident population to give them that ultimate security as a long term investment suburb. In the situation of a mining town, very often the increased use of Fly In Fly Out workers means the resident population is located well away from the mine.

Real Life Showdown: Brisbane vs. Gladstone
In the blue corner we have the defending champion Brisbane- a blue chip capital city. In the red corner there’s the wild card- Gladstone, a Queensland mining town 550 km north of Brisbane.  We take a look at how these two cities have performed in the residential market over the years to find out who comes out on top.

As Australia’s third largest city, Brisbane is the central employment node and key business district for South East Queensland. It is the state’s hub of commerce, professional services and industry. Over recent years Brisbane’s growth has slowed considerably against its southern counterparts, creating the ideal buyers’ market today. Brisbane’s population is still expected to grow by over 9,000 people each year; meaning there is an underlying demand for new homes and rental accommodation. At this rate, according to the SEQRP there is a forecast need for at least 138,000 new infill apartments to meet Brisbane’s predicted population growth, illustrating that residential property is in hot demand.

According to RP data, last year home values in Brisbane rose by 3.6% in the 3 months leading up to December. Over the past decade, Brisbane has recorded an average annual compounding growth of 3.7%. Over the past 12 months, house values have increased by 5.3% compared to a 3.5% increase in unit prices. Based on RP Data’s figures, there were 9,639 Brisbane house sales over the three months to October 2013 and 3,671 unit sales.  Currently, the median price to buy into Brisbane is $470,000 for houses and $383,000 for units with rental returns of $426/wk and $408/wk respectively (calculated across the combined capital cities). While Brisbane has seen its fair share of struggle during the GFC, the city is home to over 2 million people. The high percentage of owner/occupiers that call Brisbane home continued to reside in the city through times of financial hardship and the rental market strengthened. Yes, the top end suffered losses from those who over extended themselves, but Brisbane’s middle market continued to transact as people took the opportunity to trade and upgrade.

Now it’s time to turn the attention to the wild card. Recent years has seen Gladstone City grow substantially as a regional centre, catering to major industrial and mining focused activities.  The resource boom has been the major contributor to Gladstone’s residential real estate growth in the past 10 years. The Port of Gladstone is the fifth largest multi-commodity port in Australia and the world’s fourth largest coal exporting terminal. The city has become a natural distribution point for the worldwide shipment of resources in the central QLD region.

However, with reliance on our industry, the Gladstone real estate market has been adversely impacted by the uncertainty surrounding the mining and infrastructure investment in the local area over the last two years.  This uncertainty resulted from a significant decline in employment opportunities and is reflected in the on-going decline in the level of sales transactions. Unlike Brisbane, Gladstone is a rare example in the Australian property market that defied the immediate wider QLD market contraction post GFC, only to suffer the effects of a mining recession years later, and arguably to a greater extent. 2008 to 2011 saw continued apartment sales across the Gladstone market peaking with figures just short of 10 year highs.  The median price in the region followed suit and the demand in the local market drove sale prices quarter on quarter to peak at a historically high median price of $465,000. However, the market performance in Gladstone has been tightly tied to the demand resultant from the mining industry in the local area. Therefore, unfortunately as quickly as the Gladstone apartment market went up, so too did it go down.

Unlike Brisbane’s recent stellar performance, the median apartment price in Gladstone at the end of the December 2013 quarter was $365,000, a softening of 18% through the past 12 months.  In total, only 53 settled sales were recorded in the half year period ending December 2013, less than half the level of transactions for the period prior and well below the 10 year average of 143 settled sales every six months. The majority of these transactions were recorded in the lower price points with over 92% of sales occurring under $299,999.

Do We Have A Winner…?
I’ll let the judges decide, but in my opinion, Blue Chip is always the clear winner.  And generally speaking, at the end of the day, while high risk and high return areas will always put up a heavy fight, blue chip will prevail. Although buying into a blue chip area may initially be more expensive, the end results are well worth it. You will be able to expect a solid investment which consistently delivers long term growth, rather than an area with high peaks and troughs. That being said, taking a punt on the underdog sometimes pays off, however timing is critical. Remember, if it looks too good to be true, it generally is.

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