Location Score/Demand to Supply Score

‘Buying Property Made Simple’ is the marketing claim of the website LocationScore (similar scores can be found at DSRData and BoomApp). Is this a realistic claim? Or is it just another flashy marketing tool in an industry riddled with them?

WHAT IS A DEMAND TO SUPPLY SCORE

A demand to supply score is generated for a suburb by aggregating data across 8 different property indicators,  before an algorithm is used to produce a specific score. This score determines the current level of demand within a suburb versus its current level of supply, and ranks it against other suburbs, in the context of the entire Australian property market. In my experience it is an effective tool, that generally reflects the reality on the ground and is a useful predictor of short-term capital growth (or otherwise). However, it has considerable limitations as a predictor of long-term capital growth. Like all tools, it needs to be used in the appropriate context, and is just one of the many tools available to us to make sound investment decisions.

To use a demand to supply score properly, we need to understand exactly what it tells us. The raw data it uses are the 8 following property indicators:

Stock on Market

The percentage of the overall number of properties in the suburb currently available for sale

Online Search Interest

The average number of searches for a particular suburb on online portals, divided by the total number of properties for sale in that suburb.

Vendor Discount

The difference between the original listing price of properties and their final sale price

Auction Clearance Rate

The percentage of properties taken to auction, which sell at auction

Renters/Owner Occupiers Split

The percentage of renters within the suburb versus the percentage of owner-occupiers

Days on market

The number of days on average properties take from listing through to a settled sale

Vacancy Rate

The number of rental properties in a suburb which are currently available for rent

Rental Yield

The average gross income generated by rental properties across the suburb, expressed as a percentage of the median value of property within the suburb.

I explain some of these indicators in detail elsewhere – you can click on the links to find out more.

WHAT ARE THE KEY INDICATORS OF THE DEMAND TO SUPPLY SCORE

From an asset value perspective, the key indicators are stock on market, days on market and vendor discounting. If there is limited stock on market and it is selling quickly without much discounting, this is a hot market, regardless of the other statistics, and will likely lead to price growth. Renter/Owner-Occupier split is a better long-term indicator than a short-term one, as it says more about the character of a suburb than short-term supply and demand. From a rental perspective, rental yield and vacancy rate will give you a good idea of the strength of a rental market, although rental yield can be ambiguous, as it is tied to asset values not just rental demand.

Auction clearance rate is problematic in Queensland, as auctions are an uncommon method of sale, due to historical preference and onerous government requirements around price disclosure. They are more common in high-end suburbs, and less common in lower-end markets, which means that the number of auctions in a suburb will often be too few to provide a meaningful indicator. Sometimes this can distort the results.

HOW DOES THE DEMAND TO SUPPLY SCORE PERFORM IN REAL LIFE?

So how does the DSR Score perform overall? I’ve found it to be very effective in determining immediate demand/supply in lower-end and mid-range suburbs, where there is plenty of data for each indicator, and where the rental market is aligned more closely with the owner-occupier market. Suburbs with a high demand to supply score will generally have large numbers of people at open homes, and properties, if well-priced, will frequently sell on the first weekend.

I’ve found it less effective in suburbs at the top end of the market, which will mostly achieve only an average or below average score, but still see the highest level of price growth. I believe this is because there are less buyers at the top end, which reduces the level of online search interest and increases the number of days on market, as deals take longer to reach. However, the sales prices will often be higher, because buyers have more capacity to pay and sellers can usually afford to hold out for the price they want. So don’t necessarily be deterred from a high-end suburb because of a lower DSR Score – it’s not necessarily a true guide of future price growth in the suburb.

  The biggest limitation with LocationScore/Demand to Supply Score is in accurately predicting long-term growth.

The biggest limitation with LocationScore/Demand to Supply Score is in accurately predicting long-term growth.

The greater limitation with demand to supply scores is their predictive power over the longer term. The score only takes into account immediate, not long-term supply and demand, and

An extreme but pertinent recent example is property in mining towns. You can be sure that many of the mining towns in Queensland, such as Moranbah, Dysart, Roma and Middlemount, and Western Australia, such as Karratha, Port Hedland and Newman, were achieving high demand to supply ratio scores during the peak of the mining boom. After all, buyer interest was very strong, properties were selling very quickly, stock on market was low and rental yields were exceptional. Those who bought at this time would have seen strong growth over the next two years, before experiencing a catastrophic plunge of up to 75% in value after that. The Demand to Supply Ratio score was accurate at the time. However, it couldn’t predict the changes in the housing market wrought by the collapse in resource prices and the loss of jobs which followed (demand), and the big increase in housing stock driven by the boom in prices (supply).

So to return to the original point, does the score make property buying simple? Well, it does make it simpler – it’s a tool which can save you a lot of time in aggregating data from a range of sources, and for the right suburbs, gives you a pretty accurate snapshot of the current state of the market. It’s also helpful for checking on an area being spruiked as ‘hot’ by property marketers; take the cases of Ripley, Yarrabilba and Pimpama – all ‘growth’ locations according to marketers but all rank as ‘poor’ on the demand to supply score.

But should it be your prime decision-making tool for selecting a location? I don’t think so. A high demand to supply score probably signals short-term price growth, but few of us are investing only for the short-term. Buying when the DSR score is high may mean buying at or near the peak of a market, which is a poor long-term investment strategy. On the other hand, If I can buy in a quality suburb with low future supply, but that currently has a low DSR Score, I will, because I have confidence in the location long-term, and because counter-cyclical buying can mean buying a property below its intrinsic value, rather than above its intrinsic value at the peak.