Harnessing the ripple effect

By MoneyQuest
In Home Loans, Investment

Savvy property investors are taking advantage of the ripple effect in order to get out in front of the next boom. Are you prepared to ride the wave?

What does learning to surf have to do with property investing? Well, lesson number one for anyone dipping their toes in the water for the first time is if you want to ride a wave, you have to get out in front of it.

Riding a wave in property works pretty much the same way, and a concept known as the ‘ripple effect’ is helping some of the pros stay out in front.

Booms typically have their start in the prime areas, and send ripples out to neighbouring suburbs as priced out buyers look for the next best thing. Savvy investors can get a lift from these waves if they can identify how to hitch a ride before they pass on by.

“It’s definitely one of the most simple, and predictable, principles that an investor can follow to ensure better than average growth,” says Real Estate Investar’s David Hows.

From ‘best suburbs’ to ‘next suburbs’

Hows says investors might want to rethink what they take away from the many ‘Best Performing Suburbs’ reports that come out each year. “So many people read in the paper and they see the top suburbs for growth over the past year and they think, ‘Fantastic, I’ll go and invest there’,” he says. “But the danger is that they have had their growth or they’re at the end of their growth and worse still maybe you will pay too much at the top of the market.”

“Look at what’s next, and not what has been.”

Because of the ripple effect, Hows says, next up are very likely those nearby suburbs that haven’t had the same level of growth, but share many of the lead suburb’s characteristics.

“It’s a real thing,” says Terry Ryder of hotspotting.com.au, “and if people are willing to do a bit of research and then look next door, or down the way, and say this area has similar qualities but hasn’t shown the same growth in the last 12 months, I think it’s next.”

Counting on uneven growth

Jeremy Sheppard, research director at property firm Redwerks, says the ripple effect occurs because price growth in an area does not happen evenly. You will often see growth start in the CBD, or perhaps, he says, in an area benefitting from a new train station or emerging café culture.

“So whatever happened in that suburb to make it more attractive so that there was this sudden spike in growth, people at some point are going to be willing to be just close enough,” he says. “Maybe they can’t afford the suburb anymore or maybe the market’s just so tight that they can’t get in so they choose the option that is near enough.

“But as you get further away then there is less and less of that ‘near enough’ quality in the outlying suburbs,” he says.

“I kind of compare it to buying a ticket at a concert,” says Investar’s David Hows. “You say, ‘I really love this band and I am happy to pay $350 to sit in the front row’. If the seats a few rows back are $200, you’re likely to say, ‘well for an extra $150 I’m willing to go blue chip because I get that extra benefit’.”

But once the difference in price between the front row and the b-grade seats gets significantly larger, concert goers are more likely to give up that vaunted chance to be close enough to their idols.

“Then, the additional value that I’m getting for the additional cost isn’t as good as I’d like, and so I’m willing to go with a seat a few rows back,” says Hows. Furthermore, as those previous front row buyers move into the cheaper seats, there is more competition for those seats and in an open market their price would get a boost.

Ride the ripple

Investors have managed to get good rides out of the ripple effect over the past decade in suburbs across Australia as homebuyers fled the epicentres of the country’s small and large-scale property booms, deciding that the suburb down the way was good enough.

Sheppard keeps an eye on the ripple effect through several indices he puts together for clients, but he does caution against making a buying decision solely based on the perception that a suburb appears to be in the path of a ripple. For starters, he says, the most viable suburbs may not be the ones right next door.

Either the ripple may have already passed by, or that particular suburb may not have what buyers were looking for in the leading suburb. So investors, he says, should look more deeply at the specific growth drivers behind the ‘hub’ suburb’s surge.

“The problem that most investors are going to face is they are going to look at a map and go to the next suburb and see that it is pretty much the same growth chart,” he says. “They might need to go out for another two or three layers of neighbour suburbs in order to see an emerging trend,” he says.

He says it is especially important to identify the drivers of growth, paying particular attention to whether the neighbour has features like good access to quality schools, leisure facilities, health care, transport and infrastructure. “The neighbours with the most similarities to the source of growth are the ones most likely to get a higher share of that ripple.”

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