Don’t speculate in property hotspots

After all these years in property I’m still surprised at how investors decide which property to buy, but it doesn’t surprise me why so many don’t get past their first or second property.

You see… many buy for emotional reasons and while others think they’re investing in property, for some they’re really speculating.

By definition, speculation is “the practice of engaging in risky financial transactions in an attempt to profit from short or medium term fluctuations in the market value rather than attempting to profit from the underlying financial attributes embodied in the instrument.”

But so often I hear people who think that they are investing say things like: “I know this area has had poor capital growth in the past, but it’s about to take off,” or “I’ve bought a report – I know this is the next hotspot.”

I can understand why, in an attempt to outperform the market, people wonder where the next hotspot is going to be.

But when they ask my opinion they’re usually disappointed that firstly I don’t know, and secondly that I don’t really care.

I’m not in the business of speculating.

Instead, I make my investment decisions based on proven long-term performance, rather than short-term speculation.

The fact is hot spotting – seeking out the “next big boom” location – is speculation and not true property investment.

If you look at the track record of people chasing the next trend it’s been pretty poor.

On the other hand to “invest” in property requires the intention of generating long-term capital growth that tracks above average, long-term price growth for the area.

Now, here’s what I find interesting:

Many of the hotspots predicted by some of Australia’s property analysts turned out to be correct.

Some of the regional areas and mining towns boomed, at least for a while as investors chased up prices, but unless they got the timing right, chasing the next hotspot turned out disastrous for many investors.

Some are left with properties worth considerably less than they paid and with less rental income than they expected.

They are now unable to sell their properties as buyers have abandoned these markets, which have little depth from local demand.

If you’re into investing in short-term trends, being right isn’t what’s important; it’s being right at the right time that counts.

Very few can do that, so the history of investors trying to find the next boomtown is littered with people who get the story right and the outcome wrong.

Instead, I buy in areas that have a proven long-term history of outperforming the average capital growth and that are likely to continue to outperform, because of the demographics of the people living in the area.

Hot spotting is virtually the opposite of this sensible, not-so-sexy, tried and tested system for successfully building a property portfolio.

Let’s have a closer look at a few other reasons why I steer clear of looking for hotspots:

1. Hot spotting is about short-term speculation, not long-term wealth creation.

The key to building a substantial property portfolio is to use your first property to leverage into your next property and then using those two properties to leverage into more investments and so on.

You will only have the ability to do this if you invest in locations that consistently provide long-term capital growth.

By definition, ‘hotspots’ are not these types of areas.

Just as quickly as they heat up, property values in these locations can come off the boil and cool very quickly.

Look what happened to many mining towns and sea change locations around Australia.

2. Hot spotting often means following the crowd and more often than not, the crowd gets it wrong!

Many people trying to buy in the next hotspot get their advice from online reports or “get rich quick” seminars, and in the short term some of these predictions are self-fulfilling.

If you suddenly get a diverse group of investors buying up in a small town that has little market depth, this tends to push up prices, “proving” this area really is a hotspot.

What’s really happening is that you’re seeing an over-inflated market that, more often than not, is unsustainable in the long term.

Some of our mining towns, as well as the Gold Cost and the Sunshine Coast, are great examples of this phenomenon.

On the other hand, strategic investors buy counter cyclically, when others are afraid to get into the market.

3. Hot spotting requires accurate timing, yet most investors don’t have the necessary knowledge to know when it’s the best time to buy.

Sure, certain hotspots have excellent potential to generate long-term capital growth, but these are rare.

For example, there’s the inner-city suburb that’s yet to take off because while it’s on the verge of gentrification, it still has an air of industrialisation. Some investors can pick these areas before the market takes off, but timing markets like this is difficult.

The real problem is that by the time you find out about the next hotspot, it may be too late to benefit from that substantial early growth.

Or the opposite could be true….

You might end up jumping in too early and not reaping the rewards for many years, while in the meantime, your money has been tied up and you’ve missed out on real opportunities in proven areas.

4. Hot spotting is usually based on opinions rather than facts.

When you read articles in the media or hear reports on TV that suggest an area is about to take off as the “next big thing”, in reality you’re simply just being given someone’s opinion.

Be careful and ask yourself, are they biased because they have properties to sell and it suits them to be spruiking a certain area?

You’re better off to rely on your own research and due diligence, rather than blindly accepting a so-called expert’s potentially biased advice.

5. Hot spotting can generate short-term inflation in suburbs that can’t sustain a high level of price growth over the long term. Today’s hotspot could be tomorrow’s overheated market.

For example, when the resources boom hit Western Australia and far north Queensland, thousands of investors jumped on the bandwagon and bought into the mining towns that sprung up overnight and became a buzz of activity.

But now that the resources sector has cooled off, many of these towns have gone from boom to bust, as the major industry supporting the local economy came crashing down.

I know of many investors who are still having trouble offloading their underperforming properties in these mining towns and regional centres, which were previously called hotspots.

My suggestion is to avoid the excitement of hotspots and follow an investment strategy that allows you to survive changes in the market, without taking big losses.

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property. Subscribe to his Property Update blog.