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Why past performance is no guide to the future

Why past performance is no guide to the future

A racing horse’s “form”, or past performance is often used as a guide to predict its future performance. When it comes to the property market, many experts assure us that it’s the same. But if we actually look at how they use past performance to make their forecasts, we immediately come across a huge contradiction.

Only buy in areas that have stood the test of time

One group of experts claim that we should only buy properties in suburbs that have “stood the test of time”.

They say that their high performance in the past 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 high past performance predicts future performance. 

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 past performance to pinpoint areas that are “overdue for growth”. They identify suburbs, towns and even cities where prices have not risen for years and then claim that such markets are due for a catch up to those locations where high growth has occurred.

This ignores the fact that demand may have dropped in such areas, or that there have been huge housing developments causing oversupplies and that either or both situations keep prices subdued. We have seen such experts predicting the imminent boom of Brisbane’s housing market every year from 2013 onwards, based purely on the fact that growth hasn’t occurred.   

The issue for us 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.

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How spruikers use stats that suit them

How spruikers misuse past performance stats

It’s human nature for us to exaggerate when talking up our achievements. We tend to embroider facts about our relationships, families, work and homes, placing them in the best possible light while we push any uncomfortable truths which don’t fit our picture of perfection into the background.

Sales people do exactly the same, but we often don’t realise what they are doing because we want to believe the best about something we are about to buy. This is why project marketers, sellers’ agents and property spruikers will dress up their potential property investments to look their absolute best and why they get away with it.

This suburb has enjoyed Impressive past performance

When talking up an area’s past price performance, they will look for the stats that suit and ignore those that don’t. As this table shows, a spruiker selling property in Moranbah would tell you that house prices there have boomed by nearly 20% in the last year, not that they are still nearly 40% lower than they were five years ago.

A sellers’ agent trying to push property in Springvale South, however would show you that house prices have shot up by 50% in the last five years and ignore the fact that they have fallen by over 10% in the last year.

The area’s population is about to increase dramatically

Another commonly misused stat is projected population growth, trotted out to show you that an area is about to experience a substantial rise in population and therefore in housing demand. The stats used may relate to an entire region, such as South-East Queensland, and may have no effect on demand in already established suburbs.

It is also critical that any population projection indicates what types of households will be arriving, the types of housing they will prefer and their expected length of stay.  For example, the predicted rise in population may be for retirees, which would have no effect on first home buyer locations, or construction workers whose need for housing will be short term rentals.

These stats can be twisted to tell almost any story and mislead prospective investors. Even more important is the fact that while more households create more demand for housing, this will only lead to price growth if the supply of new houses falls behind the demand for them.

This infrastructure project will cause a massive rise in housing demand

Perhaps the sneakiest claim of all is the use of “infrastructure” in the spruiker’s bag of tricks to predict a housing market boom for areas where they are selling property. The project could be a new hospital, university, shopping centre, railway line, highway, airport or mine, and is often used to support their claims that housing demand will shoot up as a result.

The facts are that most infrastructure projects do not increase housing demand at all – they create demand which is directly related to their purpose – hospitals for sick people, universities for students, shopping centres for shoppers. Even railway line expansions, highway duplications and new mines may employ fly-in-fly-out construction workers on family friendly rosters, which means that any rise in housing demand will be where the construction worker families live and nowhere near where the project is located. Even more importantly, many infrastructure projects are altered, cut back, delayed or even abandoned altogether before they even start.

Check everything that they say – and then look for what they left out

Always be wary of any stats boasting impressive past price performance results, high population growth projections or claims that a rise in housing demand will be driven by new infrastructure projects. One good method to evaluate any spruiker’s claims about a potential property investment area is to check the origins of their stats – is this information sourced from reliable, independent and recognised data providers? Then check what they have left out and why: 

  • Will new households really be moving into the area?
  • What types of housing  will they prefer?
  • Will the new housing developments in the area lead to an oversupply?

It’s only natural for project marketers to talk up the benefits of investing in their new property developments, so it’s essential that you do your due diligence in establishing the accuracy of their claims.

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The interest rate riddle

The interest rate riddle 

Some pundits are claiming that our current historically low interest rates are good for the housing market, but this could be far from the truth.

The RBA has been reducing its official cash rate in an effort to keep the economy in growth, not to generate more housing buyer demand. This is basic economics at work, with the RBA realising that our economy is sluggish and in danger of sliding into recession. By lowering interest rates, they hope to encourage consumers to spend more and stimulate the economy in the process.

The RBA does the opposite when the economy is in danger of overheating, as higher interest rates reduce our spending capacity and slow the economy down. In theory therefore, the lower interest rates fall, the better for prospective property buyers, because their repayments become more affordable. Speaking at a recent event to mortgage brokers, the federal Treasurer, Josh Frydenberg noted that the current low interest rate environment “augurs well” for the housing market.

In theory, theory and practice are the same, but in practice, they are not¹.

So much for theory – the practical issues with really low interest rates are that they also oblige the banks to offer lower returns on savings. The current standard variable rate on savings accounts now sits somewhere between 1.3 per cent and just 0.11 per cent, so any further interest rate cuts will start to push these into negative territory. This means that you will pay the bank for the privilege of looking after your money.

This is when investors start seriously looking elsewhere for better returns and it’s not hard to find them. Many shares currently offer yields over 5% and gold has increased in price by over 10% in the last few months. As investors withdraw their savings and invest in other assets, the banks are left with less money to lend.

At such times banks do the same as investors, selecting products which offer them the best returns. You will soon see banks promoting personal loans and credit cards rather than housing finance, as they cut back their funds for property loans in favour of more rewarding products.

The result is that the total amount available for housing finance falls when interest rates reach critically low levels, resulting in fewer new or refinanced housing loans. This in turn encourages existing home owners to stay put, rather than upgrade, and forces more aspiring first home buyers to continue renting until things change.

While housing prices tend to steady or fall slightly at such times, asking rents rise, because our population keeps growing and increasing numbers of new households are forced to remain renters.

This is exactly what happened the last times we experienced such low interest rates such as during the Federation Recession which occurred immediately after Federation in 1901, the Great Depression in the 1930’s and the Menzies Credit Squeeze in the 1960s.

The left side of the table reveals those three periods in our past when interest rates were at their lowest, which is also when economic growth stalled and we went into recession. Even though interest rates were low, house prices barely moved or even fell, as housing finance was difficult to obtain. Because our capital city populations have always been growing, the demand for housing by new households was turned into rental demand, so that asking rents rose substantially.

The right side of the table shows what took place when the recessions ended and interest rates started rising again. The demand from housing buyers increased, and prices went up as well, even doubling in just a few years during the postwar population boom. The table also shows you that asking rents stopped their growth and even fell.

Why did house prices rise while interest rates were increasing?

There were several reasons for this explosion in buyer demand when interest rates started rising again. Firstly, interest rates are adjusted in response to current economic conditions and rising rates are a sign that the economy is thriving, that unemployment rates are low and wages and salaries are increasing. When housing prices also rise, it means that the borrowing power of property buyers is going up more than the interest rate resets.

Secondly, higher interest rates give the banks more money to lend because saving becomes a comparatively more attractive investment option, and higher rates also make housing finance more profitable for the bank, so the total amount available for housing finance actually increases.

History shows us that really low interest rates are a sign of economic stagnation or even recession, and nothing to be aiming for. In fact, the government is making desperate attempts to keep our economy in growth with income tax return handouts and massive infrastructure projects.

A small but steady rise in interest rates is something we should look forward to because it will indicate that the economy is growing and that the banks will be able to make more finance available for housing investors, renovators, upgraders and first home buyers.

As long as any increases in future interest rates are at a lower rate and slower pace than the associated rise in the borrowing power and purchasing ability of property buyers, the housing market is certain to thrive once again.

¹ Quote attributed to Albert Einstein

Attribution: Image of The Joker by Leopoldo Aurioles

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The missing listings mystery

The missing listings mystery

We all love a good mystery, but don’t usually expect to find one lurking in our property markets. What is the mystery all about? The riddle is about the number of listings, or rather the lack of them in our largest property markets.

Listings are properties that are for sale, and when buyer demand falls, as has been the case since the end of the Sydney and Melbourne housing booms, listings tend to rise because more owners are trying to sell their properties but fewer properties are being sold.

The laws of supply and demand dictate that prices decline when demand falls and supply rises, but here we have an enigma that is befuddling property market analysts, because as the graph shows, the number of new house and unit listings has been falling in both Sydney and Melbourne since the middle of 2017.

While fewer people are buying property, the number who are trying to sell is falling as well. The only possible explanation for this conundrum is that potential sellers believe that the housing market is about to turn around.

Owners appear to be waiting for some signs that the market has passed its low point and that buyer demand is about to rise.

Are there signs that we have passed the low point

These indicators might be a rise in auction clearance rates, an increase in sales, interest rate cuts, rising yields, falling vacancy rates, growth in housing finance approvals or even an actual rise in median sale prices.

But what do you suppose will happen if some of these signs occur and they encourage more owners to try and sell? The number of properties listed for sale will start to rise, and the recovery could be short lived – which is what economists call a dead cat bounce.

This is created when potential sellers hold off because they think that prices have hit the bottom and the market is about to recover. The fall in supply causes a slight rise in prices to take place.

The bounce quickly ends when owners realise that the market is going to get worse after all, and they decide it’s time to cut their losses. Listings then rise as they try to get out before prices fall further.

Once this rise in supply starts it often escalates, because more and more owners decide to try and sell before conditions deteriorate any more. On the other hand, potential buyers will do the opposite and wait for prices to fall further before deciding to buy.

Luckily, three-quarters of houses are owned or being paid off by owner-occupiers and are more or less crash proof, because they are held for long periods of time. First home buyers typically hold their homes for at least four years, and then only sell to upgrade. Existing home owners stay put much longer while they raise their families in family homes.

Property owners are playing the long game

This is the reason that property, especially houses, offer such long-term stability to investors – most of the owners are playing the long game on our behalf. Rent demand, rental yields and rental vacancy rates mean nothing to these households, who have no incentive to sell their homes just because prices are rising or falling.

The property is their home, and when it’s time to upgrade to a bigger house or a better location, any movement that has occurred in the sale price of their current property will be reflected in the buy price of their new dwelling.

Don’t expect a property market boom anytime time soon

The missing listings mystery is warning us not to expect a boom anytime soon, in fact, I predict that median housing prices in many locations may keep falling for some time. The outcomes for property owners, sellers and buyers will, however, be very different.

Investors in off the plan units are likely to find that their investments will be worth less than they expected, and that their new properties will be harder to sell while listings keep rising.

On the other hand, aspiring first home buyers will gain the benefit of lower asking prices, and existing home owners wishing to move won’t experience any effect either way. It may take longer to sell their current home with more listings on the market, but they will also have more choices and bargaining power for their next purchase.

Source – Quarterly percentage change in new listings graph data: Published CoreLogic Macquarie Research, data to July 2019
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Beware of the modern day property prophets

Beware of the modern day property prophets

Thousands of years ago, we relied on wise men called druids or shamans to interpret the meaning of signs and predict the future. For example, when our forebears saw a solar eclipse, they thought that the sun was being devoured by some huge invisible monster as they stared upwards in horror.

They were unable to comprehend why this was happening, but the wise men knew all about eclipses and could even predict when they would occur.

Rather than impart this reassuring knowledge to the people, they told them something quite different.

‘Yes,’ they said, “a huge heavenly monster is eating the sun and only we, your protectors can save you – but this will be for a price.’ When the people had paid up, the druids assured them that they were scaring the monster away, and that the sun would soon return to its former glory, which of course, it soon did.

We still rely on modern day druids and shamans

Home owners, investors and potential buyers all want to know what’s in store; whether to buy, where to buy, what to buy, whether to hold or sell, and because most of us don’t know how to interpret the meaning of all those figures, stats, indicators and dynamics out there, you may have to rely on modern day druids or shamans to do this for you.

Whether they’re called property theorists, strategists, advocates, agents, advisors, educators or mentors these days, most of them will still only reveal the future if you pay them, just like the shamans of old.  

This is where it really gets complicated, because each of your advisors or educators may give you a different spin, depending on their own perspective and even personal interest. Who should you listen to and who should you avoid?

One expert is urging you to invest in Brisbane, another says buy in Perth, still another warns you that Brisbane’s housing market is about to crash, yet another urges you that Darwin is about to go gang busters. Who is right?

How to check their motivation, credibility and past accuracy

Well, there’s an easy way to test them. The internet makes this easy. You can check the motivation of any so-called expert by checking their website – do they claim to have “acquisition experts” on their team, or do they have access to “unlisted” or “off market” properties?

This code language means that they are probably seller’s agents or project marketers who will be getting paid a commission, finder’s fee or kick back for pushing a property on to you. In other words, the property you purchase will certainly be in their best interests, but may not be in yours. 

You can also check to see what others are saying about these experts. Google the person’s name, together with words such as “housing market” or “property expert” and see what pops up. You might be surprised!

You can also easily test their past accuracy. Using Google, go back in time and compare what they said some years ago about the property market to what actually happened.

Of course, not everyone can be right all the time, but at least by testing the accuracy of the those who claim to be experts, you’ll be better informed than our forebears were when they thought that the sun was being eaten.

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Tips and traps of buying overseas

Tips and traps of buying overseas

At some stage in our lives, many of us dream of owning a cottage in the south of France or a hacienda on the Spanish Riviera, maybe even a log cabin up in the Swiss mountains. Others may be tempted to buy an overseas investment property, particularly when our own housing market is stagnant and there’s no growth potential.

Buy a property in Spain and receive an honorary residency permit

Some countries enthusiastically welcome overseas property buyers, with Spain and Portugal even offering residency permit enticements to foreigners who buy a property worth over €500,000.

This is because housing demand in many European and Asian countries is flat as their populations decline. Not only are fewer babies being born, young people are emigrating.

While the demand for aged care accommodation is growing, the declining populations in many countries is creating a growing surplus of family homes. Hence the Spanish government offers incentives for families to move there and buy a home.

You can’t buy a property in Switzerland unless you are a resident

The opposite applies in Switzerland, where the government is charged with discouraging foreign immigration and restricts property ownership to those people who already have residency permits. But before you jump into foreign home ownership, it is also important for you to know the tax and legal systems that apply, as they could be very different from ours.

Beware of wealth, property, value added and inheritance taxes

For example, if you rent out the property during your absence, both the local country and Australia may tax your income from rent, unless Australia has an arrangement with the other country which takes the tax you have paid overseas on rental income into account. 

Most countries have a capital gains tax, plus an ongoing property tax similar to our state-based land taxes, but some also have property related taxes that do not exist in Australia.

These include value added tax, which is applied to improvements made by the owner, wealth tax applied to properties worth more than certain amounts and inheritance tax which kicks in when the property passes to beneficiaries.

In some countries, inheritance tax is low or non-existent when properties are left to spouses or children, but become onerous when estates are left to others, or if immediate family are bypassed in a will.

And on the subject of inheritance, it is worth noting that some countries oblige you to leave your property to your next of kin in accordance with the established practice of the country.

This means that your lover or mistress, if you have one in France, is entitled to a share of your French estate when you pass away. Could be quite a shock to the family back home!

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A Chinese ghost city

A Chinese ghost city

We tend to think of ghost towns as places where all the residents have long since packed up and gone, but in China some huge cities have recently been completed – built entirely on the opposite premise, that people will arrive.

One such new ghost city is Kangbashi, located on the barren steppes of Inner Mongolia, the home of summer sandstorms and freezing winters.

While it may be fairly typical of modern cities in most respects, Kangbashi stands out because of its remote location, its huge size, its impressive monumental architecture – and an almost total lack of residents.

A city built for over one million residents remains largely empty

Kangbashi was intended to house over a million residents and the city was virtually completed by 2009. Every possible need of the future residents was catered for, with sporting centres and stadiums, cultural galleries and museums, showcase architecture, monumental gardens and massive shopping centres.

The only thing missing was residents, as only a few thousand moved in when the building work was completed. The few westerners stumbling across Kangbashi at that time could not make any sense of what they saw – a huge city without people; it was a ghost city. 

Why was such a huge empty city built?

This prompted questions about the purpose of Kangbashi. Some cynics say that the city’s remote location indicate that it was designed to house people displaced from other parts of China in the event of a nuclear war, or other major catastrophe. It was designed to be a sort of refuge of last resort. However, given the scale of the city’s monumental artworks, impressive architecture and attempts to encourage tourism, this seems extremely unlikely.

Others claim that the city was built to help diversify the economy of the area, to encourage the impoverished rural communities in the region to relocate to Kangbashi, assisted by generous compensation packages. If this is true, then the city’s isolated location and harsh climate would not matter to people already used to such conditions.

Property investing is a form of life insurance to some

Another cause of the lack of residents is that many Chinese see property investment as a form of insurance, and buy new apartments not to rent out, but to keep brand new and unoccupied, as security for the future, like someone might hoard gold under the bed. Therefore, while many apartments in Kangbashi were purchased by Chinese investors, only a few have been bought for their owners to occupy.

Maybe the city just needs time. The population keeps growing steadily with nearly 200,000 residents at last count and nearly 5,000 local businesses operating successfully. Tourism is also growing steadily, and likely to rise even more as the city slowly springs to life.

If we build it, will they come?

The concept of a whole city being built on the premise that residents will follow is something we are not comfortable with in the west. The proof, if we need any, lies in the massively overdeveloped high rise, high density unit blocks in our inner urban areas whose owners are suffering from high vacancy rates and falling prices.

The issue is that these have been built by developers on the basis that past buyer demand reflects future buyer demand. Rental demand is not the concern of a developer, although it soon becomes one for the investor who buys a property.

In centrally managed and controlled countries such as China, prebuilding a whole city is quite feasible and residents can be created by encouraging or even forcing people to relocate.

It remains to be seen whether the vision will be realised and Kangbashi becomes a model for other such bold enterprises, but at this stage the ghost city is definitely slowly coming to life.

 

Acknowledgement: Image by Popolon – Own work, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=44947017

 

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Cashflow comes to the rescue

Cashflow comes to the rescue

Many commentators hope that property market prices are on the rise again, but there’s a much more likely prospect in store for property investors, because rents are about to start rising dramatically.

Property investors have two strings to our bow – cash flow and growth, and the recent media focus on prices has pushed cash flow into the background. This is understandable, because capital city rental yields are currently at lows that landlords haven’t had to deal with since the early fifties and seventies.

There is currently little incentive for investors to get excited about property, but while we don’t always experience both cash flow and growth at the same time, our major cities have always consistently delivered either high cash flow or good price growth at different times.

This is clearly demonstrated in the graph below, showing you the average annual rental yield and house price change for Australian capital cities from 1901 to now. 

Rental_Yield_and_Price_Changes

The graph shows that during the years when Australian capital city house price growth was low or even went backwards that rental yields boomed at the same time. The correlation is close because our capital city populations (apart from Darwin in 1975 after Cyclone Tracy) have always been rising. This in turn means that if new households can’t get housing finance the demand for rentals rises.

How many years does it take for rent to equal a house price

The years are grouped together in the way that they appear in the graph because they show you another statistic – the number of years that it took for the rent received by a landlord to add up to the value of a house. In other words, from 1936 to 1939, it took just four years of rent to be the same as the value of a house. But right now, it would take twenty-four years of rent to equal a current house price.

Years_Rent=House_Price

The stats are out of kilter, as the table below shows. Rental yields are way below their historic long-term average, housing prices have gone up too much, although they certainly haven’t boomed, and rents are too low to make housing a viable option for investors.

Rental yields are well below their long-term average

Table

Yet our big city populations keep growing, with most of the new households coming from overseas and interstate, generating an immediate rise in the demand for housing, especially in Sydney, Melbourne and Brisbane. The issue is that most of these new arrivals can’t buy houses or units – they have to rent for a number of years, until they are sufficiently established to be able to obtain housing finance.

While the last few years have seen a massive fall in investor owned housing stock in our major cities, rental demand from new arrivals has been shooting up. History shows us what happens next – that massive increases in rent are highly likely to occur over the next few years.

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Why our governments are building useful things

Why our governments are building useful things

In its July Statement, the RBA has stated why it has cut the official cash rate twice in just two months: “Easing of monetary policy will support employment growth and provide greater confidence that inflation will be consistent with the medium-term target.’

If you turn this “bank speak” into plain English, it means that the RBA thinks that unless we spend more, we are in for rising unemployment and may well slide into recession.

One of the main reasons for this unhappy situation is that, according to the latest HILDA survey, average Australian incomes have not risen in real terms (after being adjusted for inflation) since 2009. And so, the RBA is doing all it can to increase the amount of spending money we get each week. 

The value of safe haven assets keeps rising

We are not responding to this stimulus by buying more, so the Federal Government has chimed in with tax cut incentives, including a big once off income tax refund. But rather than planning huge spending sprees, most consumers are apprehensive.

They sense that the economic mood is changing and rather than spending more, they are spending even less, putting their spare cash into safe havens such as bank shares and gold (the graph shows the rise gold’s spot price in US$ since August 2018.)

The RBA can do little to prevent this decline in spending and in its July statement urged our governments to spend more money by building useful things to stimulate jobs and growth.

Build freeways, railways, tunnels and airports

The government knows that spending more, while foregoing revenue with its cut cuts will delay the long-awaited return to a balanced budget, but the alternative is far worse – being the first government to lead us into recession in thirty years.

That’s why the Federal Government, in concert with most State Governments are committed to an infrastructure-based approach to economic growth, building freeways, railways, tunnels and airports, all of which will help to reduce unemployment and put pressure on real wages to rise at last.

Real income growth will increase both housing affordability and buyer incentives, something which our exhausted housing markets are desperately calling for, but it’s going to be a very slow process. Investors would be wise not to seize on any slight rise in housing prices over the next few months as proof of a recovery, especially as potential sellers are likely to flood markets hoping to get higher prices, only to find their hopes dashed as buyer demand remains sluggish.

The “two-tiered housing market will soon return

This is why we are likely to see a “two-tiered” housing market dynamic occur once again over the next few years. The losers will be those capital city housing markets which experienced the highest price growth in recent years and also have large supply overhangs. The winners will be those areas which are likely to benefit from current or fully funded government infrastructure projects creating more housing demand. This is where rents and prices could rise dramatically.

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The armchair dream of set and forget property investing

The armchair dream of set and forget property investing

With housing prices continuing to slide in most major capital cities, many investors feel exposed and threatened, because they have gone heavily into debt to purchase their properties.

This is when we get reassurance from some armchair experts who insist that the property market is merely subdued, that it’s marking time and growth will return soon. To support such “set and forget” buy and hold strategies, these theorists point to the long-term performance of property and state that growth is about to return, because it always has in the past. But how has the market really performed in the past? And what does this actually tell us about the future?

The theorists show us graphs such as the one below, proving that regular and consistent price growth exponentially increases your equity over time.  

They then assure as that this is how the Australian housing market works, with prices doubling every eight to ten years. Because the market has behaved this way for so long, they argue it will continue to do

But has the market actually performed so reliably in the past? The graph below shows the rate of price growth that has taken place in every capital city other than Sydney and Melbourne over the last fifteen years, according to ABS published data.

Quite clearly, the buy and hold reality is nothing like the buy and hold dream at all.

The differences between the dream and reality are more extreme when we compare the performance of different suburbs to each other, even in the same city, and different types of property in the same suburb.

“Buy and hold” can certainly be a workable investment strategy if you purchase the right type of property in the right area, at the right time and pay the right price, but the evidence shows that jumping in and buying anything, anywhere on the assumption that all housing markets and all types of properties will perform the same over time is totally flawed. Investors who follow such an armchair investing strategy are likely to find that their dream soon becomes a nightmare.