James Bond and a pair of twos | Crazy, Sexy Luck | The most valuable commodity I know of is information / by Adam Howard

Welcome to another instalment in the series on the property market, information and rational decision making.

Last week I finished with another opaque reference to poker, and the rational player now knowing that a low number pocket pair is much better and stands a much better chance of winning the hand than a hand including an Ace and a picture card.

That is just based on probability; the slim probability of being dealt the pair in the first place compared to the greater probability of getting an Ace and any other card; the slim probability of being dealt another card that turns your pair into three of a kind compared to the even slimmer probability of 3 of the 5 flop cards turning your Ace and nothin’ into something truly remarkable.

The problem with probability is, it isn’t that sexy.  Winning a hand, knocking maybe three of your opponents out, with a pair of 5s isn’t as hot as knocking them out with a straight where your hand is completed with the final card dealt.  It is, however, a lot more likely.

You are never going to see James Bond, while staring across the table at his nemesis and not showing a flicker of emotion, calmly lay down his pair of 2s.  Doesn’t sell copy.

BUT, if you are waiting for the final card of the hand to clinch the win, you might be waiting a long time.

That’s what the reference to knowledge was about at the end of the Update.   Rational decision making is about obtaining as much information as you can about a key decision, and then how to use that to make as good a decision as possible.

Not a perfect decision, there is no such thing.  

If you put the above analogy into the context of the property market, then it really depends on what you are trying to achieve.

There still appears to be a belief out there that property is a good investment; blanket statement.  Well, it depends…

It appears we weave a story of skill and foresight around the actions of older people who purchased properties 40 years ago in suburbs which at the time where regarded as marginal.

The purchase prices were ridiculously small in today’s dollars; less than $10,000 for a full block in Subiaco or North Perth.

These suburbs are now desirable, and as we have shown, land values could be over $1,000 per square metre and as a result the investments have proven to be very successful.

At the time however, I doubt those purchasing the property were thinking about how much capital appreciation would occur over the ensuing 40 years.  Come on…that’s just stretching it too far.

It may have been a first house, and in those days home loans were Principal and Interest from the outset with a maximum term of 10 years, so the debt was extinguished quickly.

Maybe the owner decided to move to another suburb and for one reason or another decided to keep the first property.  Maybe a friend or family member needed somewhere to stay, or the sharp rise in property prices between 1975 and 1978 convinced the owner it would be a good idea to hold onto it, just in case.

The mid to late 1970s saw another sharp increase in the number of immigrants to WA, and with this the renting culture was born.  Now the owner could hold onto that first property and rent it out, and given the debt was almost gone it was another form of income, so why would you now sell it?

Then our owner gets married, has children and enters two decades of schooling, so nothing happens to the property.  In fact, given the madness of putting kids through school our owner probably forgot they owned it at all.

Now, in the 2000s we find our owner in their 50s or 60s, with children of their own and wondering what to do.  Sell?  Use the property as equity to help their children buy property?  Subdivide and sell?  Subdivide and rent?

Well, which option the owner chooses really depends on what they need, but the fact remains they have options because they held for the long term, and I guess in the property market this is called playing the percentages.

At the time, in the 1970s, knowing that you should hold property for the long term is like knowing being dealt a pair is better than being dealt an Ace and something.  Just a really basic, first step level of awareness that most people don’t or certainly didn’t have. 

This is where I will clarify what I meant above about today’s investors telling themselves a story around skill and foresight when looking at the actions of those that paid 4/5ths of not much for properties 40 years ago, and then sold them a few years ago, walking away with a million bucks.

Property was cheap in the early 1970s, even by that day’s standards, and you could buy large slabs of it for small amounts.  That’s lucky, isn’t it?

Then Perth changed from being a sleepy backwater with almost no external population growth, to being a rapidly growing city.  That’s lucky again.

This growth in population has continued unabated for over 40 years.  That’s lucky again.

Then R codes, or residential zoning codes, were introduced in 1991, under the control of local town and city councils.  These councils saw that if they relaxed zoning laws allowing the subdivision of titles this would create more rate payers and increase local government revenue, so large scale subdivision followed resulting in a sharp increase in land prices per square metre.  Hello, more luck.

THEN, Western Australia experienced a once in a generation mining boom, with property prices doubling between 2003 and 2006.  Cannot believe how much luck our owner is having???

So, using our poker analogy, our owner got dealt a pair, and then the other two cards for 4 of a kind got dealt on the flop.  You couldn’t lose.

This type of long term investment is also really what Warren Buffett’s much touted concept of “value investing” is all about.  Identifying an asset which is cheaper than your maths shows it should be, deciding if the investment is short, medium or long term on the basis of the asset type and your anticipated return, and then making the purchase.

It’s a simple strategy based on doing your homework about an asset, knowing what it should be worth, compared with what you can buy it for, buying and waiting.   Attention to detail, some maths and then patience.

The issue with the WA property market is, it has become more competitive as more and more owners, and investors have entered the market.  

Back to cards and my political forecaster and author, Nate Silver.  Between being an analyst for accounting firm KPMG and a political forecaster Silver spent time as a professional poker player.  This was in the days when online poker was relatively new and unregulated. Silver explains that poker is a zero sum game, where there is a defined amount of money in the game and the goal is to move that money from the unskilled and unlucky to the skilled and lucky.  A large part of the game is identifying who is the wood duck; the dumb money; and taking their money.

Silver said that as poker became more popular and more regulated the mean level of players improved, and he felt he was at risk of becoming the dumb money in some games, so he left the market.

My point is the WA property market is similar.  It is now a mature market where it pays to make sure you have as much information as possible in order to tip the odds in your favour. There are lots of assets for sale that might not be worth the asking price, and equally there are a lot of assets for sale that may potentially be purchased for lower than fair market value.

So, what information?

Well:

·      Median property price in a suburb;

·      Suburb size;

·      Number of properties sold in that suburb and the metro market;

·      Average time on market for properties;

·      Number of properties on the market at any one time (what constitutes equilibrium / oversupply / excess demand);

·      Approximate price per square metre for land in a suburb;

·      Approximate price per square metre for land based on different lot sizes;

·      Rental yields;

·      R codes in an area;

·      Any potential changes to R codes;

·      Any planned infrastructure projects that may impact an area;

And the most important piece of information:

·      Are you desperate or unwilling?

And that’s just off the top of my head.

I have provided the sites online where this information can be found.  As a refresher they are:

·      REIWA

·      UDIA WA

·      Dept of Planning

·      Local Council websites

On top of that, builders are so competitive these days that if you Google any of the above items a number of builders’ websites pop up that will teach you what you need to know, in the hope you use that builder for your project.

In order to whet everyone’s appetite I will, as always, provide anecdotal evidence.  Two pieces in fact.

A character from a previous Update, The Trader, has been looking for a new family home for a while in the Mount Lawley/Inglewood area and he and I have been discussing this.

We went over the available statistical data and came to the opinion that land prices in Mount Lawley were around $1,400 - $1,500 per square metre for blocks greater than 800 square metres.

We also shared the opinion that a larger block was better value, if you had the capacity to make that purchase, and that it was best to be an unwilling buyer, and to find a desperate seller.

How to identify a desperate seller?  A house that had been on the market for a long time and had just had the listing price reduced.  Well, the sellers aren’t testing the market here, are they?  They obviously need to sell, otherwise why stay on the market?  And dropping the price is a clear signal that it needs to be sold.

Long story short, The Trader has managed to buy a 1,000 square metre block in a very nice part of Mount Lawley for about $1,100 to $1,150 per square metre, and also get a very nice 4 x 2 house in the deal.

A great deal.  Nice for me as The Rookie to play a small part in it.

What about an instance where a buyer has some extra information about a property that might make it more valuable than the current price per square metre?

I was talking to another friend whom we will call The Family Man.  The Family Man had been searching for a good opportunity for a while and was patient.  I think this put him in the unwilling category.

His strategy was to find a property in an area that had the potential to appreciate in value rapidly, but then isn’t that what every property investor is looking for?

His target market was Melville and once again, he and I had discussed potential land prices around that area.  It looked like the lots greater in size than 550 square metres were selling for about $900 per square metre, and lots below 550 square metres for about $1,100 to $1,200.

But remember, as parcels of land decrease in size, the price per square metre rises, even though the absolute price drops.

He found a property, bought it at auction for about $950 per square metre.  Wait, that’s above market, right?

The Family Man knew that the zoning in the area was highly likely to change in the 12 to 24 months after settlement, with the new zoning potentially allowing him to divide that block into 4 new titles of about 200 square metre each.

Even without any premium applied based on the smaller size, that turns a property he paid $870k for into something worth almost $1m.

That is like holding a pair, but somehow knowing there’s a face down card waiting to be flopped that turns your pair into three of a kind.

Worth betting big on that one.

Now, before I finish it’s worth noting that this conversation about property is only something that can occur in a metropolis where the population is growing.  People create demand, so if there are less people, prices go backward…fast.

Think about Detroit.  It’s shrinking at a rate so fast that people are literally giving properties away.  Another friend, whom we will call The Auteur, told me of an apartment designed by the great minimalist architect Ludwig Mis Van Der Rohe he found in Detroit while filming a TV show for sale for $35,000.  In any other vibrant city this property would be worth millions, but in Detroit its worth less than a second hand Toyota Kluger.

Summary; we are lucky to be in a town that’s growing…fast.

My final point.  R codes may be news to people, so here ’s the skinny in 30 words or less.  Introduced in 1991, R codes dictate how many times a 10,000 square metre piece of land can be divided. 

Eg R40 = 10,000 / 40 = 250.  Each lot within an R40 area can be divided into new lots of 250 square metres each.

Until next week, food for thought…