Nowhere is the age-old cashflow versus capital growth debate in property circles more heated than when it comes to discussions around niche real estate assets, such as purpose built apartment accommodation.
Specifically, vertical inner city towers targeting student tenants.
Considered a high-risk bricks and mortar proposition, student apartments have become an increasingly prevalent feature of CBD skylines across Melbourne, Sydney and Brisbane over the past ten years in particular.
Developers saw an opportunity to cram cheap, compact apartments into large, generic buildings that could be knocked up in no time, as the popularity of Australian Universities and Technical Colleges grew exponentially with overseas students.
A lucrative lure
By 2009, international student education was worth a cool $18 billion to the country’s economy as our third largest export industry, almost double what it was five years earlier.
Traditional tertiary precincts, such as the popular Melbourne suburb of Carlton – home to Melbourne and Latrobe University facilities, as well as the highly regarded Royal Melbourne Institute of Technology (RMIT) – were inundated with specialist student digs as demand for affordable accommodation skyrocketed.
Products were cleverly marketed to property investors as high return assets, targeting relative newcomers who were too risk averse to buy into anything that didn’t come with a cashflow guarantee.
Student apartments represented an affordable entry point into the lucrative inner city residential housing market for beginner investors, priced at $150,000 to $300,000 in most instances.
What was not so obvious in the glossy A4 brochures however, was the fact that although purchasing such a purpose-built investment did indeed mean higher than average returns, it also meant much lower than average capital growth over the long term.
And capital growth is what you ultimately need to achieve any type of real wealth with which to retire.
In fact some of the cheekier developers responsible for these student apartment projects actually used the premise of location – with many constructed in prime inner city areas – to suggest potentially strong growth prospects.
But this is where things start to unravel.
Crunching the numbers
As it stands, when it comes to analyzing long-term performance, no industry analysts have paid too much heed to the student accommodation sector specifically.
While the developers and financial advisers they pay commissions to will happily provide investors with anecdotal reports as to yields and capital growth, along with high profile recommendations from their friends in big law and accounting firms, the record books are quite devoid of useful facts and figures.
Generally speaking, it is widely accepted that yes, student accommodation will provide higher than average rental returns in comparison to other inner city apartments, delivering yields of around 6 to 8 per cent.
At first glance, this compares favourably to average rent returns for Melbourne, Sydney and Brisbane, which were at 4.07 per cent, 4.91 per cent and 5.02 per cent respectively for the September 2014 quarter.
But when you drill down into the numbers, student accommodation really runs into trouble when it comes to long-term capital growth.
Suddenly, your property investment looks about as useful as a term deposit account, particularly when you consider the tax bill you’ll have as a result of that extra rental income.
Not all about location
Investors who are new to the real estate game can be forgiven for thinking that an inner city postcode immediately translates to lucrative growth prospects.
However when you consider Melbourne’s inner city precinct of Carlton, it becomes clear that location in isolation does not necessarily mean decent capital gains.
In fact, Carlton is a prime example of how the type of accommodation that dominates a suburb can actually cause its value to go up or down.
The median value of units in Carlton fell by 0.27 per cent for the year to September 2014, whereas next door in Carlton North (where student accommodation does not dominate the market) property prices increased by an average 5.86 per cent for the same period.
Additionally, the suburbs that collectively make up Melbourne’s inner north and western precincts experienced an overall rise in values of 12.06 per cent.
This trend of poorer growth for Carlton compared to surrounding neighbourhoods (including Melbourne city overall) can actually be tracked over the preceding five years.
On the other hand, average rental returns across Carlton performed significantly better across the year ending September 2014 – at 6.18 per cent compared to 4.09 per cent for Carlton North and 4.07 per cent for Melbourne overall.
When investments turn sour
Although investors have enjoyed above average yields from the Australian student accommodation sector, the fact remains that many have been burnt when it comes to on-selling these very specialized assets, or even just trying to refinance with one in their portfolio.
For one, lenders don’t like them and will demand a greater upfront contribution to the purchase price (usually a minimum deposit of 30 to 40 per cent), meaning more of your equity is tied up in the one asset – and an underperforming asset at that.
Then of course you have the competition to think about.
Values are ultimately underpinned by supply and demand. When one type of accommodation saturates an area, chances are you will be required to sell at a very modest profit and possibly even a loss.
Further, you substantially reduce demand by narrowing both your tenant and buyer market to students or niche investors, not to mention the tenancy turnover and potential lengthy vacancies to consider.
Sure a 6 to 8 per cent per annum return sounds nice, but when you account for extended holiday periods (where students are inclined to return home) and the short-term housing habits of your rental demographic, suddenly those returns lose much of their consistency and appeal.
Finally, what happens when Australian tertiary places are no longer as attractive to the international student market, as is currently the case?
Overseas student enrolments are now on the decline, meaning those higher returns are at risk of steadily falling in the face of renewed competition for tenants.
And when the yields disappear from this niche investment vehicle, so will any semblance of a worthwhile asset for your investment portfolio.