Do high earners push up prices?

Hands up if you've ever heard an industry expert recommend buying in suburbs where there are high income earners? Would you like to be smarter than an industry expert?

Ordinary advice

I've heard quite a few commentators in property investment circles suggest that buying in a suburb with high income earners will produce better capital growth. Some commentators get a little tricky with it and suggest locations where the income compared to the mortgage is high. This is often labelled "affordability".

Over the years I've analysed very carefully what really works to drive prices up because when I invest my own funds I can't afford for it to fail. However, some commentators are only interested in sounding smart to sell their business. So a lot of advice I hear is pretty ordinary.

Some industry experts aren't much smarter than a novice investor when it comes to understanding the drivers of capital growth. Many ideas like the high income earner suburb sound good in theory but fail in practise. A little extra thought is all that's needed to see why.

High income assumes high stupidity

The promise of the "high income earner suburb" is a higher ceiling on prices. With greater financial power, there is less stopping a buyer from paying more.

The problem with this theory is it assumes buyers with more money are more stupid when it comes to paying fair value. Just because they have more money, doesn't mean they must spend more.

Prices will rise when demand exceeds supply. Low income earners who can't afford to buy don't affect demand. If there is demand to buy in a suburb, then those "demanders" already have the financial capacity to buy, so the point of income becomes relatively benign.

They already live there

The most obvious flaw in the concept to me is that high income earners of a suburb already live in that suburb. So why are they buying?

Not every buyer in a suburb already lives in the suburb. Only those about to buy in the suburb will drive up prices. We want to know what their income is. Yet they may not be residents of the suburb in question.

Rough figures

Every 5 years the Australian Bureau of Statistics (ABS) conducts a nationwide census. Questions in the census ask details about the house-holders' income.

Some respondents may exaggerate the figure; others may reduce it; some may not know and guess. Some even think they can trick the Australian Tax Office with their answer. And many people don't even fill in the census. The point is these figures are only rough.

They may move out

Consider a suburb in which high income earners can easily afford properties. Why do they still live there? Why not upgrade to somewhere nicer - somewhere more in line with the income they earn?

If the suburb is on the top of the food chain like Peppermint Grove in WA or Toorak in Melbourne, then there is nowhere else to go. But for the vast majority of high income earners, there is a step up.

So identifying a suburb with a large number of high income earners may actually be an indicator of a future vacancy issue rather than future price growth.

It's not all bad

A suburb with high income earners will have some influence on values. But not in the way most people think.

If affordability is not an issue, then updating the kitchen; putting a pool in the backyard; building a deck out the back or repainting comes down to lifestyle choice. Since the decision is not purely an economic consideration, the state of properties in high income earning suburbs is usually more impressive. Investors would consider this a case of over-capitalisation.

But even this doesn't directly affect prices. Renovating a property will improve its value, true. However, for the increased value to influence prices for the suburb, the renovated property needs to sell or at least go on the market.

Now ask yourself why someone would make all these lifestyle renovation choices and then move out.

Admittedly, someone will eventually want to move out of their nicely renovated home. At the time their property goes on the market, it will affect prices. So there is some influence, but it's not a game-changer.

Conclusion

High income earning suburbs do have some influence on prices. However, if you're truly looking for capital growth potential, don't be lured into such a relatively insignificant statistic. And certainly don't look at one statistic in isolation.

The Demand to Supply Ratio that is freely available at DSRdata.com.au considers 8 statistics - each one is a better indicator of future capital growth than "income to mortgage cost". The DSR has beaten many experts in the property investment industry. And now you're better informed, you can too.

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