When it comes to getting to the heart of an issue you need to “follow the money” – that will tell you all you need to know about how something really works, and investing is no different.
If you want to make good investment choices, take your lead from those who clearly have a clue – the truly wealthy, and not those who would like to give the impression of wealth.
You would think that the best places to buy when investing in property, the places that would guarantee you the best returns, would be the exclusive areas – Kensington and Westminster in London, Manhattan in New York City and Bondi Beach in Sydney. You can smell the wealth and privilege on the streets of these suburbs, so it seems like the obvious choice. It is certainly true that the prices in these areas are sky-high, but much of what keeps them high is sentiment, the incomes yields are not forthcoming and smart investors will soon wonder just how sustainable it is.
On the periphery of primary markets are the secondary markets, where middle-income employees like to set up home because they are the perfect place to raise families due to their close proximity to work, school, shopping and recreational facilities. They offer convenience in terms of transport, too, by abiding by the rule of 10 minutes – being within 10 minutes of established and reliable bus or train routes.
These secondary markets tend to have highly resilient properties as there is steady demand for them from the middle-income sector of the economy. What’s more, with prices that are generally one-third of the primary markets, the rental incomes produce a sustainable income. In the US and Australia, these areas are called “bedroom communities” because they are the suburbs where the average family wants to live.
Properties in these secondary markets have the most long-term, sustainable capital growth, and provide the lowest risk because you can rent them out at decent yields no matter what is happening in the broader economy. As an investor you can depend on a steady demand from renters for these areas. In New York, these suburbs are found in New Jersey, where prices are about one-third of Manhattan’s, but yields can be up to three times higher than Manhattan. This is why the wealthy invest in these secondary markets – it makes sense in so many ways.
Tertiary markets can be deceiving, they are located on the edges of secondary markets and can look attractive when the market is booming. At these times the secondary markets can become too expensive, so it is tempting to start looking for properties in these markets. All will be fine as long as everything keeps going well in the broader economy. But these markets are highly susceptible to economic shocks. Their location means they are the areas people leave as soon as they can afford to – examples in London would be Croydon and Barking, both of which are far out of the City of London, making commuting to work expensive and time-consuming.
The lessons many investors have learnt when dabbling in these tertiary areas is that there is a big, and painful, difference between the yield you saw on paper and actual money in bank.
Essentially, the middle class tend to focus on the shiny, bright primary markets, hoping to make big returns, while others try to make a quick buck on the tertiary markets. The money to follow comes from the secondary markets. This is why the wealthy put their time and effort into getting their returns from investing in these areas.