The ultimate guide to capital growth

Many property investors and homeowners need capital growth. They rely on house prices increasing, slowly over time, to fund future plans.

Often that might be so they can live a comfortable lifestyle in retirement or build a passive income. But sometimes it’s just an investment to grow their wealth.

So, it’s no wonder while property buyers make their purchasing decisions they’re often wondering: "What’s going to rise in value faster?”

Often this comes down to just guessing. So in this article we’re going to break down the factors that tend to indicate higher levels of capital growth.

And … we’ll also include a few factors that people think are important – but which in practice don’t really matter.

What is capital growth?

Capital growth is the increase in the value of your rental property or own home over time.

It’s essential to property investment because this is where most of the money is made in real estate.

To give an example, let’s say you bought a property 20 years ago at the median house price of $176,000 (August 2001).

Today that property might be around $850,000 – since that’s what the median price is today (August 2021).

That’s potential capital growth of $674,000.

But capital growth does more than just offer a nice cash sum when selling your property 20 (or however many) years later. There are other benefits too.

Use equity to purchase another property

You can use the new-found equity in your property to purchase another investment property or a holiday home. This allows you to use one property to fund the purchase of the next.

Guard against inflation

Purchasing property also tends to protect the purchaser against inflation better than leaving the money in a bank’s term deposit.

Let’s say you purchased that $176,000 property back in 2001 with a 20% deposit. So you put down $35,200.

Well, what if you didn’t purchase a property? What if you put that money into a savings account and never touched it instead?

Well, 20 years later, assuming a 3% interest rate after tax (which is pretty generous), you’d have $63,575, if you left your money in the bank. That sounds pretty good. Your money increased by just over 80%.

But remember, over that time - assuming a 2% inflation rate - the cost of goods, in general, would have increased by just under 50%.

So the two options in this scenario were:

So because property has a mix of leverage and is a tangible asset, it’s stood up to inflation much better than the term deposit option.

But, clearly, you need the capital growth for that to happen.

Which is why investors ask themselves: how can I secure the best growth possible?

The answer to this question is not straightforward and is influenced by several factors:

• The property itself – which is where you might consider factors like the property type, the number of bedrooms and the land size
• City or region it is located within – which is where you might consider factors like the property cycle, population growth and economic strength in the region

So now let’s walk through these two factors, first starting with the property, and then moving on to the city or region.

What does a property that grows in value quickly look like?

Let’s talk about the type of properties first, because most properties tend to gain some amount of capital growth over time.

The three areas we’ll cover are: property type, number of bedrooms and land size.

House vs townhouse vs apartment

The data shows that apartments, historically, grow in value more slowly than townhouses and standalone houses. That’s been the case in each of the country’s 3 major cities.

When apartments are compared with standalone houses with the same number of bedrooms (i.e. 2-bed apartments vs 2-bed houses), the difference in capital growth has historically been between 15%-49% less growth per year.

However, it’s less straightforward to say what the trend is for houses vs townhouses.

In the instances where standalone houses achieved higher capital growth, the difference is sometimes marginal, and certainly less consistent than the trends we observed for apartments.

So what sort of property type should I buy to try and get the best capital growth?

Usually, it’s a standalone house or townhouse in a good area or neighbourhood.

But there is a trade-off. These properties are often negatively geared in the interim if borrowing all of the money to invest. That means the investor often has to contribute money towards expenses that aren’t solely covered by a tenant’s rent.

1-bed vs 2-bed vs 3-bed

​​On the subject of type of property, you’ll want to break it down even further to include the number of bedrooms.

The data is a little inconsistent, but a clear trend is that 2-bedroom properties are preferable to those with only 1 bedroom.

For instance, between January 2000 and June 2020, 2 bedroom apartments grew in value by 6.48% per year; 1 bedroom apartments grew at only 4.71% per year.

This is why we here at Opes tend not to recommend 1-bedroom townhouses and apartments for property investors – if the investor’s primary goal is capital growth.

That’s not to say that 1-bedroom apartments or townhouses can’t be good investments. It’s just that they tend to be better suited for yield investors.

From 2-bedrooms and above, there is no consistent trend across New Zealand’s 3 main cities where a particular number of bedrooms beats out the rest.

So as long as growth-hungry investors stay away from 1-bedroom properties they should be fine.

Land size

In property investment circles it’s commonly thought that land is the money maker. The more land you have means the faster your house price grows.

By this thinking, a townhouse with only a small lawn is never going to match up to the quarter-acre house and land package.

That’s not the case.

Opes’ data-crunching found no statistically significant difference to support the idea for properties with land over 50 square metres.

So small plots of land, like apartments and tiny townhouses, don’t tend to grow in value very quickly. But above that minimum there’s no statistically significant difference.

That’s not to say that land isn’t valuable, it’s just that having more of it in your section doesn’t make it grow in value any faster than would otherwise be the case.

So growth-focussed investors, stay away from plots of land of 50sq m or less and you should be fine.

What sort of city or town should I invest in for capital growth?

Moving on now from “what” type of property to “where” should I invest.

Here are three factors to consider when looking for a high capital growth area to invest in – property cycle, population growth and the economic strength within the region.

Where are house prices currently overvalued? Where are they undervalued?

Property markets operate independently from each other. They don’t all increase or decrease in value at the same time.

And the reason they don’t move together is that properties in different cities are not good substitutes for one another.

A house in Gisborne can’t be exchanged for the same house in Auckland, especially if you’re someone who wants to live in Auckland.

This means one part of New Zealand might be going gangbusters, which another region might remain stagnant.

This creates the environment where one property market might become slightly overvalued, and for another to become relatively undervalued at any one time.

The way we figure out which is which is by comparing where a region’s median house price sits compared to the median New Zealand house price.

For instance in Auckland – over the last 29 years – the median house price has been around 1.4x New Zealand’s median house price.

Well that’s the average, but sometimes that ratio (Auckland house price/NZ house price) is sometimes above that average. Sometimes the ratio is slightly below that average.

When Auckland house prices are below that average, we say the region is slightly undervalued. When Auckland is above the average, we say that it’s slightly overvalued.

Right now, Auckland house prices are about where we’d expect them to be. On average the region’s house prices have been 1.4x the NZ average. And right now they sit at 1.39.

This suggests Auckland might get roughly the same amount of capital growth in the future compared with the rest of New Zealand.

But, we're not saying investors shouldn’t buy in Auckland. Rather, we are saying there may be other regions that are more undervalued right now.

Here’s a breakdown of how over or undervalued each region is right now using this method:

What’s the population growth in each region?

It’s common to think that population growth = faster capital growth.

After all, more people means more demand for houses – and that should push house prices up, right?

Well … yes and no.

There is definitely a correlation between high population growth and higher house price growth. But the correlation isn’t as steep as you might think. See the graph below.

In this instance, for every 1% percent increase in annual population growth, annual house price growth picked up by 0.4% points.

So, while growth-focussed investors should definitely look for population growth as a factor – and we certainly do look at this here at Opes Partners – it’s not a 1-for-1.

And even areas with a shrinking population can still see house prices increase to some degree.

So why isn’t the trend stronger?

Because while more people does mean more demand for housing – that demand also translates into increased supply.

In other words, if more houses are needed, developers build more. This alleviates some of that pressure in the market.

What we’re trying to get at is to warn investors away from the popular thinking of finding the region with the highest population increase and think: “I’ll just invest there”.

So while population growth is definitely one factor to look at, it shouldn’t be the only factor.

Economic strength of the region

More people in the city has to be weighed against ensuring they have the income to support house price rises.

You might have a large population base, but if houses are unaffordable to buyers then there won’t be much room for capital growth.

So you need to ask yourself:

• Is there space for interest rates to decrease (which makes borrowing more affordable and means there is more room for property prices to increase)
• Are there signs of continued job and economic growth (which makes incomes increase over time)

Economists like to talk about GDP, or growth per person per capita. But what you should really care about is how much real income real families are earning, or household income growth.

Let’s talk about the Bay of Plenty region.

Over the 21 years between 1998 and 2019 (the years we have current data for) the average household income in Tauranga increased 4.14% per year.

Over that same time-frame household incomes in the Kawerau District (a small district also in the Bay of Plenty) grew by only 2.99%. That’s the slowest in all of New Zealand.

So, if you were considering an investment property in the Bay of Plenty region, putting all other factors aside, which would you rather invest in? Which area is going to be able to support higher rents? Which area will have the income to support higher house prices?

Which area is likely to be more prosperous in the future?

If you’re like most property investors, you’ll probably gravitate towards Tauranga in this instance.

So... Where should I look for high capital growth properties?

It’s important to note: not every city or region is going to tick every box on this list.

After looking at the data you’ll need to make a judgement call about where you believe is the best place for you to invest.

That will be different for each individual and will be decided for you based on how much money you have to invest.

But, armed with these tools, you should be able to analyse a region and then make an informed decision.