One pie too many...

One of the most basic concepts in economics is utility, the satisfaction you derive from consuming or using a good or service.

Long before quinoa and tofu took over school canteens, I taught the concept of utility by getting my students to imagine eating a hot meat pie and sauce at lunchtime. (It worked well if we were in the lesson before lunch!) “How was that?” I’d ask and they would say “Delicious!” Then I’d ask them to imagine eating the next one. The response on average, “Great” (mostly from the boys and “OK” from the girls.) Now have the next one in your mind and the next, “’not feeling so good hey?” as they got into the role, grimacing and clutching their stomachs.

Then the whole point of the exercise, “OK, now you all throw up!” Once the class clown had calmed down I would remind them that the first pie delivered great satisfaction, the next less so and so on until they actually felt ill and derived negative satisfaction; too much of a good thing. They had consumed to the point where a ‘good’ becomes a ‘bad’. Seriously.

I’m sure to this day every one of them could explain the concept of diminishing marginal utility with great clarity! The concept is an important one with implications for our own personal decisions but also for our economy as a whole. ‘Rational Expectations Theory’ assumes that we all behave in ways that will maximize our satisfaction (utility) and profit so we make decisions based on past experiences, observations and expectations about the future which tend to come true. For example, consumers expect the price of fans to fall as a sudden cold snap hits, so they hold off buying, demand falls, stocks of fans gather dust and they go ‘on sale’. But critics would argue that expectations can be less than perfect; often based more in opinion than fact, in wishful thinking than reality and in crowd mentality.

In the property market, instead of sticking to the fundamentals there’s a temptation for some to promote the next ‘hotspot’ and for some investors to seek it like the “holy grail”.

What the first lot are hoping is that enough people believe the story and make it come true (often because that’s what they have on their stock list). Unfortunately what they often create is a “building or buying hotspot” not necessarily a “growth hotspot” and even more dire, an oversupplied rental market.

Ethical, compliant, educated property professionals should not and cannot offer you certainty. Capital growth predictions can only be made on the ‘balance of evidence’. Areas need to be identified on the basis of long term growth drivers; population, demographics, infrastructure, stable employment hubs, schools, shops and lifestyle amenities and of course rental vacancy rates to name a few.

‘Hotspot chasing’ lends itself to speculative buying because often what’s fueling the fire is exogenous like international commodity demand and cannot be relied upon long term. Think some mining towns! At one point among the most expensive town by median prices, now some of the worst performing regional towns.

Chasing ‘hotspots’ can leave you burnt.