Location, location, location: why up to two-thirds of property investors may get it wrong

The housing market is moving again. In the past month, national prices have climbed 0.9%.

What matters most to buyers (and especially to property investors), along with price and value, is location.

The cliché suggests that in the long run that’s all that matters.

So it would be unfortunate if investors were getting it wrong. Our examination of proprietary data from a major bank covering 1.15 million residential mortgage applications over the six years between 2003 and 2009 suggests they might be.

Published this month in the Pacific-Basin Finance Journal under the title Home advantage: the preference for local residential real estate investment, it finds that more than two in every three Australians buying an investment property pick one close to where they live.

This means that someone who lives in Manly is far more likely to invest in Manly over anywhere else in Sydney or in Australia and so on.

Read more: Three charts on: who is the typical investor in the Australian property market?

There are several good reasons for this. First, the time, effort and travel costs are typically lower when investing in your local area than investing further away.

Second, property investors sometimes plan to self-manage without an agent, making proximity an advantage. The Real Estate Institute of Australia believes 1 in 5 investors self-manage.

And property investors might believe that they have a “home advantage” in knowing their location better than non-locals.

Home bias means eggs in one basket

Home bias is well-documented in other markets. For example, investors in the stock market are more likely to hold shares in Australian rather than international companies.

This is even the case for superannuation funds, who set aside a sizeable portion of their assets for investment in Australian stocks – far more than the Australian stock market would represent in a global stock portfolio.

It brings with it problems alongside the advantages of convenience and local knowledge.

Most investors hold only one investment property alongside their place of residence, making it one of the few chances they have to diversify away from the risk embodied in that suburb.

Instead, most double down on that investment.

Read more: The Game of Homes: how the vested interests lie about negative gearing

If you are wondering whether this is unwise, or unwise enough to outweigh the advantages of local knowledge, consider this question: How likely is it that the location you happen to live in will always outperform every other location?

Interestingly we find that “sophisticated” investors are more likely to invest outside of the suburb in which they live than less sophisticated investors.

Investing non-locally is more likely among investors who own shares, already receive rental income, and work as professionals or in management positions.

And a more fragile financial system

The risks that doubling down on locations impose on unsophisticated investors extend to the financial system itself.

Higher geographical concentration of property investments increase the risk of defaults and foreclosures in a market downturn, amplifying economic cycles.

Australians have a lot of wealth tied up in property, and the property market in turn is highly connected to the financial system through bank lending.

Our study suggests there is an opportunity to strengthen Australia’s financial system by educating potential investors about risk. It could make them, and the Australian economy, better able to withstand downturns.