It is becoming increasingly difficult to buy an investment-grade house for under $1 million in Brisbane, Melbourne, and Sydney.
This begs the question; if your investment property budget is less than $1 million, where and how do you invest it?
Brisbane is becoming more difficult
In early August 2021, I presented an investment case for buying an investment-grade home in Brisbane.
My wife and I subsequently followed this advice (I put my money where my mouth is) and we purchased an investment-grade house in the Brisbane suburb of Indooroopilly, which settled last month.
Whilst I am still very bullish about the Brisbane market, it is becoming more challenging to buy an investment-grade house for less than $1 million.
Whilst it is still possible, it may not remain that way for long.
House budgets must be substantially more than $1 million in Melbourne and Sydney
It will not come as a surprise that you need a budget of substantially more than $1 million to buy an investment-grade house in Melbourne and Sydney.
In Melbourne, you need more than $1.3 million and approaching $2 million and above in Sydney.
Of course, it is possible to find houses in these capital cities for less than $1 million, but these tend to be in non-investment-grade locations and/or have unacceptable compromises.
That is, they are not deemed investment-grade assets.
Remember, there’s never a good reason to invest in a sub-standard quality asset.
Your long-term investment returns will be directly related to the quality of your investment assets.
You cannot expect good investment returns from an average (or below) quality asset.
A villa unit could be a good option
Villa units are typically small houses that share the same block of land e.g. there might be 3 to 4 on the same block.
They are often single-level homes that were constructed in the 1960s or later.
Typically, owners share some amenities, such as driveways, but mostly the owner has a direct interest in, and control of, their parcel of land.
Villa units are often prevalent in impaired locations such as busy main roads or secondary suburbs.
However, it is possible to find some investment-grade villa units in blue-chip suburbs, but you must select them judiciously.
Villa units are scarce assets, particularly in blue-chip suburbs – property developers don’t build anymore as they are not economical (higher-density apartments are more economical).
It may be possible to buy an investment-grade villa unit in Melbourne for close to $1 million, but it is becoming more challenging.
Villa units are not that common in Brisbane in established suburbs.
Investment-grade apartments in Melbourne
Arguably, the sub-$1-million property investment option that represents the best value is investment-grade apartments in Melbourne.
In October 2020, I wrote this report investigating the performance of investment-grade apartments, particularly in Melbourne.
I have taken the opportunity to update this report.
There are three predominant reasons I believe investment-grade apartments in Melbourne represent excellent future growth prospects which I summarise below:
1. Apartments have never been cheaper compared to houses
The chart below compares median house prices relative to median apartment prices in Melbourne since 1980.
Between 1980 and 2005, the median house price was on average 1.3 times higher than the median apartment price.
The relative value of houses dropped to an average of 1.2 times between 2005 and 2013, mainly driven by the relative strength in apartment prices.
The median house price is now 1.45 times the median apartment price in Melbourne, the highest point on record since 1980.
This has been mainly driven by the relative strength of house prices and at the same time, weakness in apartment prices over the past decade.
Is relative value a good predictor of future returns?
In early 1989, the median house price was almost 1.38 times the median apartment price, which was the highest point until this year.
Median apartment prices only grew by 3% p.a. over the subsequent 5 years (1989-1994), which is well below average growth (houses grew by 2.3% p.a. over the same period).
But this period included the “recession we had to have” in the early 1990s, so is not a useful indicator.
In early 1998, the ratio peaked again at 1.35 times.
In the subsequent 5 years (1998-2003), the median apartment price appreciated by 14.9% p.a.
This suggests that relative value could be a useful indicator of future returns.
It stands to reason that relative value is a reliable indicator that as the prices of houses rise, fewer people can afford them.
As such, potential buyers will be forced to either (1) purchase an apartment or (2) move to a suburb further away from the CBD to be able to afford a house.
Higher house prices will force a great proportion of buyers towards apartments.
2. Mean reversion will do all the heavy lifting
Over the past 10 years, the median apartment price in Brisbane has hardly changed.
In Melbourne, apartments have generated a growth rate of 3.7% p.a. for the 10 years ended June 2021 and in Sydney 5.8% p.a.
In Melbourne and Brisbane, the last 10 years could be described as “the missing decade” in that returns have been well below their long-term average (of 9.0% p.a. and 7.7% p.a., respectively).
It is an irrefutable fact that all established investment markets experience the reoccurring trend of mean reversion.
That is, returns will eventually revert to their mean (average) over long periods of time.
That means a period of below-average growth is typically followed by a period of above-average growth.
A typical property cycle lasts 7 to 10 years.
We have already experienced 10 years of very low growth.
Therefore, as each year passes, the probability that the Melbourne apartment market will begin its next growth cycle becomes substantially higher.
The best time to invest in an asset class is after an extended period of below-average returns.
But, of course, this isn’t necessarily easy to do because it's contrary to general market sentiment.
3. Demand will exceed supply
The chart below sets out the number of apartments approved in each state since 2000.
You will note that there was a significant increase in the volume of new apartments in Melbourne between 2014 and 2018.
Approvals for new apartments in Melbourne have fallen significantly since mid-2020.
In fact, apartment approvals in 2021 so far have averaged 8,700 p.a. (annualised) which is a level not seen since 2010.
It is noteworthy that Melbourne’s population has increased by over 1,000,000 people since 2010.
Therefore, on a per capita basis, apartment approvals are almost at record lows.
This will no doubt create a supply shortage over the coming years and as such lead to price appreciation.
Indicative budgets
If your investment budget is in the range of $500,000 and $700,000 then I would typically recommend buying an investment-grade one-bedroom apartment.
If your budget is in the range of $700,000 and $900,000, then you can target a two-bedroom apartment.
And if you can stretch to the $900,000 to $1 million range, consider a villa unit.
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