Is it better to invest in a house or an apartment?
That’s an age-old question, but not one easy to answer.
You see, a few things have happened recently which have caused investors increasingly shy away from investing in apartments.
We’ve had a shift-change to a new working and home life prompted by the COVID-19 pandemic, which has come around the same time as a loss of confidence following an influx of shoddy high-rise apartment buildings (built during the last building boom).
It does seem that more investors are now asking: “Are apartments a good investment in the current market?”
My view?
It depends.
It depends on the location of the apartment.
It depends if the apartment is family-friendly or in a high-rise LegoLand-style building.
It depends upon the neighbourhood.
It depends on the size of the apartment.
It also depends on a myriad of other factors.
To explain my view further, let's first unpack the challenges that Australia’s apartment market faces, what is driving the change in investor sentiment and what we can expect going forward.
Then we can look at the most important question of all: “Should you invest in a house or an apartment?”
Challenges facing Australia’s apartment market
Here are three headwinds facing Australia’s apartment market:
1. COVID-19 has changed what we want from a home
The legacy of the lockdowns and the work-from-home movement have made many Australians reevaluate what exactly they want in the home itself.
All of a sudden people were trying to find space to be able to work, study and also relax all under one roof - and in many cases, this hasn’t gone well.
Prior to COVID-19 more Australians were trading space for place and were embracing apartment living, trading their backyards for balconies and courtyards in inner-city locations.
But now everything is different.
Now we want more space – a zoom room, a bigger yard, and a garage that can be converted into a gym.
The COVID-19 pandemic environment has significantly changed homeownership goals and what Australians want most in their next home.
And even though the worst of the COVID-pandemic and lockdowns has subsided, flexible or remote working is here to stay.
So it makes sense then that, in many cases, an inner-city apartment in a high-rise tower wouldn’t tick all the boxes.
However, family-friendly apartments in medium-density blocks in great neighbourhoods are back in vogue as the high cost of houses is creating affordability issues.
In fact, apartments have outperformed houses over the last year in the downturn phase of our property cycle.
2. Investors have lost confidence
While large well-located suburban medium-density apartments will make great investments and increase in value over the long term, many of the high-rise towers built in the last fifteen years will continue to underperform with poor, if any capital growth in the foreseeable future.
Of course, these cookie-cutter-style apartment blocks never made good investments.
They offered little scarcity and had no owner-occupier appeal having been built with investors in mind, and often overseas investors who didn’t fully understand the needs of the local market.
Worse still, because of the high developer margins and marketing costs, many investors paid too much to start with and have since found that on completion their properties were worth considerably less than their contract price.
Not only that but they’re faced with highly-publicised major structural defects, fire issues and water issues.
We’ve all seen the reports on the Mascot and Opal towers in Sydney’s Olympic Park… and this building is just one of many with structural issues.
The sad reality is that today, in light of the many media reports of structural problems in some of these high-rise towers, there is a crisis of confidence.
This sector of the property market has lost the trust of the buying public and confidence will take quite some time to restore as various stakeholders including state and local governments as well as the construction industry including building surveyors and certifiers scramble to shore up the building sector.
As a result of increasing concerns, a history of relatively high vacancy rates and questionable capital growth in many of these high-rise buildings, investors have lost confidence in these types of apartments (or even in apartments altogether) and are shying away.
But it’s important for investors to remember that not all apartments can be lumped into the same category.
As I’ve already mentioned, inner-city CBD apartments are the ones that are particularly suffering from high vacancies and falling values, while family-friendly larger apartments or low-rise apartments in aspirational and lifestyle suburbs are still in strong demand from owner-occupiers and tenants.
3. The pipeline of new apartments is thin
While many new homes are being constructed, the pipeline for new apartment complexes is thin thanks to increasing materials costs, a flurry of builder bankruptcies and a low supply of available land.
The total number of apartments in low-rise, mid-rise and high-rise projects averaged 26,040 a year, across Australia's major cities since 2015.
This average is expected to fall by 39% over the next three years when considering those projects currently under construction, being marketed and possibly to be built within this timeframe - this contraction is led by Australia's largest three cities-Sydney, Melbourne and Brisbane.
Bucking this trend is Perth and the Gold Coast.
The pros and cons of investing in an apartment
While there might be several headwinds facing Australia’s apartment market, and a few reasons why you shouldn’t invest in an apartment but it’s not all bad news… there are still some pros for apartments.
Apartment investing pros
- Apartments are cheaper to buy
The cost of apartments is generally significantly lower than houses so it makes a more affordable option when it comes to an investment or even first home buying.
The latest CoreLogic data for February shows that the median house price in Sydney, Melbourne and Brisbane sits at $1.22 million, $905,894 and $786,198 respectively.
In comparison, the median unit price sits much lower in each city - at $772,807, $589,752 and $492,059, respectively.
- Apartments cost less to run
Less space means less electricity and gas usage, which means cheaper bills.
- Apartments require less maintenance
Apartments have no garden to take care of, and any common areas are maintained by strata management.
- Apartments offer more security
Being built in blocks, apartments offer the security of their neighbours.
Often, apartment blocks also have an added level of security in the front building door ahead of your front door.
- Apartment buildings are often in good locations
By their very nature, apartments are generally in good central locations where land is expensive and living is in demand - think city centres, areas close to amenities or the beach.
- Apartments can give a higher rental yield
Again, by their nature, the lower cost of buying an apartment versus the price you can rent it out for means apartments can have a higher rental yield versus some houses, particularly older and unrenovated houses.
This is especially the case if the apartment comes with extra facilities such as a swimming pool or a gym.
Apartment investing cons
- Owners have to abide by strata or body corporate rules
Owning an apartment means abiding by the rules imposed by the strata or body corporate which manages the building and its common ground.
This could be as strict as imposing rules about pets and limiting or prohibiting renovations.
- Apartments have more fees
Although the cost of owning an apartment might be smaller, the number of fees (thanks to extra costs such as strata fees) is higher, which can be overwhelming for some investors.
- Apartments are smaller
Less space means lower bills but it also means… well… less space.
- Apartments aren’t as private as houses
Shared common areas and front doors might be a great security feature but it also means you sacrifice some privacy.
The pros and cons of investing in a house
Much like the apartment market, there are many pros and cons to investing in a house.
House investing pros
- Houses offer more space
The majority of houses offer a bigger footprint and more space on a bigger parcel of land.
This includes outdoor space in things like a garden, courtyard or entertainment area.
- Houses increase in value more
Over the last decade or so, houses have generally increased in value faster than apartments.
REIA data shows that given house prices increased strongly during 2020 and 2021, the median house price is now almost 1.6 times the median apartment price in Sydney and Brisbane, and over 1.9 times in Melbourne.
This is because the price of houses rose strongly over this time whereas the price of apartments barely changed.
A higher return on value means larger profit and larger savings.
- Houses give more flexibility
Unlike an apartment which is managed by strata, owning a house means you have the freedom and flexibility to do what you want.
This applies to anything from owning pets to renovations or even extensions, subject to council approval.
- Houses offer privacy
Without the close proximity of neighbours, house investors and owners have more privacy.
House investing cons
- Houses cost more
Houses are almost always more expensive than comparable apartments.
This means you need a bigger deposit and a larger home loan to buy a house.
- Houses require more maintenance
Owning a house means you’re responsible for all the maintenance, which can be particularly tasking if the house sits on lots of lands.
There isn’t a stratum to organise and maintain the gardens, bins or even repairs, the owner has to do this themselves.
- Houses cost more to run
More space and land obviously mean higher utility bills and higher costs in terms of buying extra furnishings and appliances.
Houses have outperformed
The chart below compares the median price of apartments to the median price of houses from March 1980 to March 2022.
On average, the median house price has ranged between 1.2 and 1.4 times higher than the median apartment price in Melbourne and Sydney.
However, since house prices increased strongly during 2020 and 2021, the median house price is now almost 1.6 times the median apartment price in Sydney and Brisbane, and over 1.9 times in Melbourne.
This is because the price of houses rose strongly over this time whereas the price of apartments barely changed.
But comparing apartments to houses is unfair
Of course, if your budget allows you to buy a house or townhouse in an A-grade location that’s the first prize when considering an investment purchase, but our booming property markets mean that more and more investors will be unable to afford a house in an investment-grade location.
I’d certainly rather own an apartment on a top street in a blue-chip suburb than a house in an outer ring location much further away from the CBD.
There’s a strong amount of research data confirming that average capital growth rates are higher closer to the CBD and decline the further away from the CBD the property is located.
The fact is, the rich are getting richer and they don’t want to travel further out and I believe the gap between values in our established inner suburban locations and the outer suburbs will only widen.
And in general, apartments deliver better yields than houses meaning they are cheaper for investors to hold on to.
The outlook of Australia’s apartment market
A lot of cheaply constructed apartments were built between 2010 and 2018 and sold to investors and overseas buyers.
However, since then, the Australian government cracked down on selling to overseas buyers, which means developers must build apartments for domestic buyers.
Domestic buyers demand higher levels of finish and quality.
It has been estimated that the cost of construction of apartments in high-rise towers has increased by close to 50% over the last couple of years due to supply chain issues, lack of materials and a shortage of labour.
This makes the construction of new apartments financially unviable at present, but there is a significant shortage of dwellings for both buyer and rental demand and knew any new construction will need to be at significantly higher sale prices.
This will make existing apartments more attractive (cheaper) by comparison.
In addition to rising costs and prices, there are lower levels of new apartment approvals on the drawing board.
This will also contribute to upward price pressure.
So, what’s the answer?
Should you invest in a house or an apartment?
Let’s look at the basics
Ask yourself, which part of the property will go up in value?
The answer of course is the land because the actual property itself will slowly depreciate or lose value.
So it makes sense that whatever your budget, you need to ensure the bulk of the purchase price is made up of as much land as possible.
This may be much easier to work out with a house as opposed to an apartment, but it is still very much applicable because an apartment has an attributable portion of the land attached to it.
Of course, for a house, you can easily quantify the land value by using a nearby comparable land sale, or the council rateable land value.
- Also read:The latest Corelogic Rental Market Report
- Also read:The Boom and Bust of our Property Cycles: A Journey Through the Investor’s Mind
- Also read:Perth housing market update | April 2024
- Also read:Latest property price forecasts for 2024 revealed. What’s ahead in our housing markets in the next year or two?
- Also read:Sydney housing market update | April 2024
The same applies to apartments in most cases.
We will take the total land or site value and divide it by the number of apartments in the complex.
Yes, it may be an apartment, but the land/site still has a value that will increase in the right locations.
But remember, not all land is equal.
1. Location, location, location
I always recommend the inner and middle ring suburbs of our major capital cities where demand is more consistent from owner-occupiers (who push up the values) and from tenants.
However if you agree that investing in the inner and middle-ring suburbs is where all the action is, you’ll soon realise that houses are not very affordable when we talk about investing in your first, or even second investment.
Compare this to the median for a two-bedroom apartment and this becomes a much more attainable proposition.
And with affordability lucky to remain an issue for some time, it’s likely that well-located large apartments will perform strongly over the next couple of years driven by demand from first-home buyers and investors.
Of course, there will always be more affordable houses around, however, to find them you need to travel further out where price growth is likely to be more subdued over the next few years as those living in blue-collar and first-home buyer suburbs I would like you to be feeling the effects of inflation and rising interest rates more in their hip pockets then the more affluent inner and middle ring suburbs.
2. The type of land is important
When looking at the land component of any given property it is important to consider the overall scarcity of available land in the location.
Think about it – in those expansive green-fill estates on the outskirts of town there is a surplus of developable land freely available and buyer demand is consistently average, meaning shortages are highly unlikely any time soon and therefore capital growth is likely to be unremarkable.
Compare this to land – even a small slice divvied up between ten to twelve apartments in a block – in the inner suburbs.
In these neighbourhoods, there are often very tight restrictions on development due to natural constraints, such as the bay and harbour-side suburbs of Melbourne Sydney and Brisbane, as well as the fact that all available land has already been built on.
It is this scarcity – this inability to make more land – coupled with ongoing demand from homebuyers and tenants wanting to live close to desirable and fashionable amenities, as well as employment opportunities afforded by inner-city locations, which underpins and places upward pressure on prices.
Here’s a case study
A client came to us many years ago with a budget of only $350,000; they wanted to buy a house as it had more land.
The proposal they were looking at was a new house and land package about 25-30km from Brisbane.
The Rateable land value was $75,000; this represented a Land to Asset Ratio of around 21.4%.
The other portion would have been represented by build costs, other commissions and fees that developers usually charge.
Alternatively, we were able to show them an apartment only 5km from Brisbane in a small boutique complex of only four.
The Rateable land value for the site here was $1 million, so each apartment had an intrinsic land value of $250,000.
The Land to Asset ratio here is 73.5% and the land value has kept rising.
There is a clear difference in the land value of these two assets, even though the price is the same.
Tips: Regardless, the investment-grade property should be the focus!
In my view, less than 4% of properties currently on the market are “investment grade.”
Of course, there is plenty of investment stock out there, but don’t confuse the two.
There are many properties marketed as investor opportunities, but they aren’t ‘investment grade’ because they don’t have owner-occupier appeal, they lack scarcity and there isn’t any opportunity to add value.
And when you look at all the fingers in the pie, including marketers, developers, advertising, referrers etc., you’ll find the price of most new properties is highly inflated.
There are so many investors sitting on these types of properties who will never see a return on their investment.
On the other hand, what I consider ‘investment grade’ properties appeal to a wide range of affluent owner-occupiers, are in the right location, have street appeal, offer security, have the potential to add value through renovations, and also have a high land-to-asset ratio.
However, not all inner-urban apartments make an ideal, high-growth property investment.
Given that land appreciates in value over time, you need to seek out a block of units that offers a decent portion of the ‘good green stuff’ to make your investment worthwhile.
High-rise developments with hundreds of flats might give the investor a very low land-to-asset ratio.
Additionally, many of these developments are built en masse by companies looking to profit from those intermittent stages in the property cycle that see buyers flood the market.
Hence, a glut of stock appears all at once and unsuspecting, off-the-plan investors end up competing with hundreds of others in the same boat, desperately trying to find tenants and having to potentially drop rents.
Whereas well-positioned, established apartments in low-rise – often referred to as boutique - complexes offer property investors an affordable opportunity to add a good all-rounder to their portfolio.
When it comes to the right combination of desirability and scarcity to provide that consistent long-term, above-average capital growth and tenant demand, I believe you can’t go past an inner-city apartment with character and potential.
Is it better to buy brand new?
The fresh smell, the clean slate, the low maintenance, and the primal need to be the first to mark your territory: are just some of the reasons why buying a brand-new house or unit is enticing.
However, that doesn’t mean it is a smart decision.
The truth is, there are no ifs or buts about it – established properties make the best investments.
When it comes to property investing, you can’t be distracted by the lure of superficial appeal.
It has to primarily be a financial decision – which means leaving your own desires and prejudices at the door when looking at established properties.
Here are a few common misconceptions about new properties, and the truth:
Misconception 1: New properties are easier to rent
If you are thinking new properties are easier to rent, you probably aren’t alone.
But with historically low vacancy rates at present, any well-located property leases easily.
Yet, chances are if you buy a unit in a brand new apartment complex, it will be filled with investors just like you.
I prefer to buy in predominantly owner-occupied areas because the buildings are generally better cared for and there is less competition (and as a result, higher demand) for rentals.
Buying an established property does not mean that it has to stay as it is – in fact, I recommend looking for established properties and then adding value through quality refurbishments.
Misconception 2: There are more tax benefits for new properties
While you initially get greater tax depreciation allowances for brand new properties - which you pay for by paying a premium for new properties - there is usually slower capital growth in the first few years because you pay this premium for newer dwellings.
It is also a misconception that only new properties are eligible for tax depreciation.
Investors can claim depreciation on improvements to established properties and by working with a reputable quantity surveyor, you can ensure you receive maximum depreciation benefits in older homes and units.
This is particularly true of renovated properties, which can deliver substantial depreciation benefits.
Misconception 3: New properties have less maintenance
New properties can and do have maintenance and structural issues, from peeling paint to cracks in the walls and ceiling, and building insurance policies only cover so much (and for so long).
In fact, I don't think I've come across a major apartment complex that hasn't had water leak problems.
As we spoke about above, over the last few years the many structural problems, fire issues, and water problems in a large number of new high-rise apartment buildings have had them dubbed the slums of the future.
It also pays to look at the bigger picture, because if you buy an established property with the intention of adding value through renovations, you can always address minor maintenance issues then.
Misconception 4: New properties don’t cost much more than established ones
When you buy directly from a developer you are inadvertently paying for the developer’s margin, the agent’s commission, and the cost of marketing – combined, these figures amount to tens of thousands of dollars.
In real terms, this means you’re actually squandering your first few years of capital growth and even instantly losing value.
If you’re not holding for the long term, you can say goodbye to a favourable resale value – especially in a slow market.
Most of the numbers that you see floating around for new (and particularly off-the-plan) properties are projections – educated guesses, in what is usually an overcrowded market.
Also, how can you actually determine fair market value?
When you buy an established property you can access historical data and market research, which paints a much clearer and more insightful picture of what you’re actually buying.
When you buy a brand new property, your room to negotiate prices is strictly regulated by a set-price list.
In the current market, it is still possible to buy established properties below "intrinsic" value and in fact, we are often finding apartments for up to 20 per cent below replacement cost.
Here’s my answer
This is why, in my view, buying an established apartment, townhouse or villa unit is the way to go.
I believe most investors will find the best success buying an existing property with ‘character’ and renovating it to add value, resulting in a higher-yielding, tax-efficient investment.
Remember, property markets are cyclical
When analysing the inferior performance of apartments over the last decade, it’s important to remember that all markets and asset classes move in cycles which include periods of growth, contraction/correction and sideways drift (where there is no change in value).
This means that while, in the short run, returns can be inconsistent, it’s well documented that investment returns eventually revert to their long-term averages.
That is, periods of below-average growth tend to be followed by periods of above-average growth and vice versa
While houses outperformed apartments with regard to capital growth over the last decade, for the 10 years prior to that many well-located apartments grew in value as much as houses did.
The fact the houses have displayed strong capital growth rates over the past 10 years due to appreciating land values, interestingly implies that apartments are currently intrinsically undervalued.
Remember, apartments have an implied land value underneath them.
Of course, the high-rise apartments with 200 in a block have very little land value attached to each apartment – it’s the developer's aim to squeeze as many apartments on the land as possible.
On the other hand, low-density established blocks of 8 to 10 apartments in great suburban locations have a significant land component attached to each apartment.
Logically, therefore, despite limited price growth recorded over the last decade, if land in a particular suburb and street has increased in value significantly over the last decade (as can be seen from increasing house values) then apartments (which tend to have a 45-55% land value component) must also be worth more.
In fact, intrinsic land values implied by house price growth during the last decade suggest that many apartments may be fundamentally undervalued by as much as a huge 30-40%.
That’s why I believe there is a strong likelihood of significant price growth for well-located apartments in the coming ten years to rectify the current misalignment, making the right type of apartments (family-friendly medium and low-density apartments in lifestyle suburbs – not inner-city high rises) an asset worth holding onto or considering investing in.
4 things to consider when making property investment decisions
Regardless of whether you’re looking to buy a house or apartment, the property investment methodology remains the same in order to make the best investment decision.
1. Property price appreciation
It’s important to consider how much the property you plan to buy is likely to appreciate over time.
Ideally, you want a property to appreciate at a higher rate than the rate of inflation.
2. The age of the property
Generally, established properties appreciate in value faster than new properties.
In the current market, it is still possible to buy established properties below "intrinsic" value and in fact, we are often finding apartments for up to 20 per cent below replacement cost.
Whereas new properties come at a premium price.
3. The state of the market
The state of the market should be a consideration when it comes to choosing your investment property, but it’s important to remember that there is no right time to buy.
Time in the market is much more important than timing the market.
4. Property value & expenses
The cost of the property plus the cost of maintaining and even renovating the property needs to be taken into account.
You might be able to snag a bargain with an existing property, but if you need to pump a lot of money into it to make it livable then you need to consider the costs involved and whether it’s worth it in the long term in terms of your capital gain.
A final note
Many people get confused when choosing between a house and an apartment.
The best piece of advice I would give is to get an understanding of what the Land to Asset Ratio is.
On most occasions, the house will come out on top.
However, remember, it is not the size of the land you should consider but the value.
Family-friendly apartments in small boutique complexes offer great alternatives to houses located a long way from things like employment hubs, public transport, schools and entertainment precincts.
Many smaller boutique complexes are on underutilised pieces of land and that will get rarer and more scarce as time goes on.
It may represent an ideal opportunity for a developer who will be looking at the land and thinking about what may be possible.
Otherwise, it will continue to be in higher demand and grow significantly faster in value to boost your wealth.
When doing your research in the future, dig a little deeper and remember the Land to Asset formula.
