I received a question from a reader asking what would make a superior investment.
An apartment in a blue-chip location, or a house for the same price albeit not in a blue-chip suburb.
Will houses always deliver better returns?
In general, houses often prove to be superior investments, mainly due to their higher land value component.
This higher proportion of land typically results in a higher rate of capital growth over time, assuming all other factors are equal.
Nevertheless, it’s worth noting that apartments also have an associated land value, particularly in the case of older units built 50 years ago or more.
Two factors contribute to the higher land value in these older apartments.
Firstly, the interior finishes are usually not as modern and not of the same quality as those in newer apartments, leading to a lower proportion of the property’s total value being attributed to improvements rather than land.
Secondly, older apartment blocks often contain fewer units, such as 4 to 6, on a relatively large parcel of land – often more than 800 sqm.
Today, developers would likely build more than double the number of apartments on a similar-sized plot, making these older apartments more land-heavy assets.
When considering a property investment, it’s crucial to evaluate not only the overall land value but also the quality of that land.
Questions to consider include whether the land is situated in an area with finite supply and if the location experiences high demand from a buyer demographic less sensitive to income fluctuations, as discussed in this blog.
The size of the land (i.e., sqm) is a lot less important than the value and quality.
Maintenance and control of the asset
When comparing apartments to houses, it is also important to consider other material differences.
Many investors are attracted to investing in property because it affords them a very high level of control.
Within the bounds of tenancy laws, property owners can dictate how the asset is utilised or enhanced.
However, apartment owners face a limitation in this regard, as the management of the apartment block falls under the jurisdiction of an Owners Corporation (OC) which, whilst they might be able to influence a BC, they do not have full control.
Furthermore, the ongoing maintenance costs for houses may vary based on the size and nature of the property, often resulting in higher expenses compared to apartments.
Middle ground options
Depending on the location, investing in a villa unit could be a viable alternative to both houses and apartments.
Villa units are generally single-level dwellings, often detached, situated on a large block of land that may include common property such as a shared driveway.
While a villa unit typically comes with a higher price tag than an apartment but is generally more affordable than a standalone house.
However, not all villa units make sound investments.
Careful consideration is needed, as some villa units are situated on busy main roads, which is less than ideal.
Additionally, privacy and security can be compromised in certain instances.
Therefore, it’s advisable to engage a professional buyers’ agent to thoroughly evaluate these factors before deciding on a villa-unit investment.
What is your budget?
Your investment budget can significantly influence your most suitable investment option.
For instance, with a budget of $500,000, it would be more prudent to consider investing in an apartment situated in a blue-chip suburb near the city.
Acquiring a house within this budget in a capital city would be very challenging, nigh on impossible.
Buying a house for this budget would necessitate investing in regional locations where the supply and demand dynamics are not as robust.
Typically, I believe that an investment budget of less than $700,000 to $800,000 would be better allocated towards an investment-grade apartment, particularly given the current market conditions.
This leads me to my next observation…
Where in the cycle is each option?
Property markets have historically exhibited two cycles, as depicted in the chart for houses and the chart for apartments:
These cycles typically involve a growth phase, followed by a flat phase, then another growth phase and so forth.
Whilst property is a long-term investment, so that you benefit from the power of compounding capital growth, it is advantageous if you can enter the market just before a growth cycle.
While accurately predicting cycle changes is impossible, assessing relative value and recent returns is valuable.
In my March blog series, I illustrate this concept, suggesting that investment-grade apartments are poised for a growth cycle within the next 5 years.
Therefore, when deciding whether to invest in an apartment or house, it is valuable to consider which sector is likely to enjoy a growth cycle in the near term.
Risk that there won’t be a rising tide
Investors shouldn’t necessarily assume that past capital growth rates will reoccur in the future.
As I wrote in May, I suggested that a key factor behind past capital growth was the increasing borrowing capacities of property buyers, enabling them to borrow higher multiples of their incomes.
However, with the tightening of lending policies since 2015, I anticipate a relative stagnation in borrowing capacity, which may not contribute to future increases in property prices.
As such, it becomes crucial to invest in a location that attracts potential buyers that enjoy strongly rising incomes or possess other financial resources such as inherences.
If your budget doesn’t allow for such an investment, consider acquiring a property that provides opportunities for value creation, such as through development or alternate uses.
Growing density and development
Property investment has always revolved around leveraging the dynamics of supply and demand.
When you invest in a location with a fixed supply and strong demand, there’s a likelihood that prices will appreciate into the future.
Currently, there’s mounting pressure on state governments and councils to increase the density in our capital cities.
This involves simplifying development application processes and introducing more flexible planning rules, and similar measures.
If this trend persists, land in areas with a fixed supply, like blue-chip suburbs, is expected to appreciate as owners can optimise land usage.
Conversely, investing in a location where vacant land is abundant doesn’t enjoy the same favourable supply and demand dynamics.
Therefore, it’s crucial for investors to prioritise the location of their investment, as it directly influences the supply and demand fundamentals.
Ultimately, the focus should be on the return on investment, not the quantity of property (land size and accommodation size) acquired for the money invested.
A comparison for example
With a budget ranging from $700,000 to $800,000, an investor has the option to invest in either an apartment or a house.
Let’s look at a few examples.
East Melbourne stands out as a compelling location for apartments, offering close proximity to amenities and limited development potential due to community opposition, making it an attractive choice.
Within this budget range, one could acquire a 1 to 2-bedroom apartment in an older-style block.
It is advisable to pay special attention to potential maintenance costs.
Buying into a well-maintained block minimises the risk of large future maintenance expenses.
For house investments within this budget, I reached out to a buyer's agent who presented two possibilities.
One option is purchasing a house in an outer suburb like Lalor, situated 30 km from Melbourne’s CBD.
The investment thesis is that Lalor will benefit from gentrification over the coming years.
Alternatively, investing in a property in the prime area of a regional town, such as Ballarat.
One could buy a period property in one of the best suburbs and streets in Ballarat.
Among these options, I favour investing in a high-quality property in Ballarat, as higher-quality assets tend to outperform in the long run.
Therefore, the ultimate decision comes down to whether to buy a house in Ballarat or an apartment in East Melbourne.
If you have an investment time horizon of more than 10 years, I would buy an apartment in East Melbourne, primarily due to recent performance trends in each location.
Regional markets experienced a boom during COVID-19, although prices have come back a bit over the past year.
However, Melbourne apartments have remained stagnant for 13 years. I’m not sure if apartments will enter a new growth cycle in the next 5 years but I think they almost certainly will within the next 10 years.
As such, I think they represent the best value investment opportunity.
