Apartments or houses?

PORTFOLIO POINT: Apartments are fulfilling the Australian dream for Generation Y, but the reasons why are complicated.

It’s the perennial question from investors: What makes the better investment – a house or an apartment? Predictably, the answer isn’t straightforward.

Much depends on the budget and ensuring the choice of property maximises investment potential within the boundaries of the budget. But, surprisingly for some investors and industry commentators, recent reports from RP Data and other agencies show apartments and units have outperformed houses in recent times.

But how could an apartment – without its own land – outperform the Australian dream of a house with a back yard? The answer is more complicated than you might expect.

First, there are the demand aspects. An increasing number of Australians of all ages, renters and home buyers, are opting for an inner-urban lifestyle. In part, this is a rejection by some of the long commute to work and the paucity of services found in many outer suburban areas.

Access for inner-urban dwellers is about more than getting to and from work because it also factors in access to hospitals, schools, parklands and recreation facilities. All of these tend to be clustered in inner-urban areas.

Members of Generation Y are marrying and raising children later than any other generation in history, so the lure of the back yard and estate living is not as high as it was with preceding generations. Conversely, the attraction of a low-maintenance, highly secure “lock up and leave” property is rising.

Younger buyers are being joined by members of their parent’s generation, a small minority to date, but an increasingly significant cohort nonetheless. The older “downsizers” are attracted to the same interesting shopping and entertainment precincts as younger buyers, but downsizers arrive with sizeable budgets.

This brings me to the final reason: the constrained buying capacity for houses, common in young buyers. After years of above-market growth, many detached inner-urban houses are now beyond the budget of first-time buyers.

Apartments have therefore come under heavier demand and this, to some extent, accounts for their high price growth; those erstwhile house buyers are now applying their financial resources to the apartment sector. High demand for apartments also means the finite supply of established apartments is pushing many towards the new apartment sector.

The completion of new apartments is lagging behind demand in most Australian cities despite the rash of inner-city high-rise apartments built in the early 2000s.

As demand increases and supply is constrained in our inner suburbs, the price for inner-urban land increasingly is being forced up. And it’s these inner suburbs where we find the highest concentration of apartments and units. Consequently, the owners of inner-urban apartments and units are benefitting most from the fastest-appreciating land, even through their holding does not include a direct land component.

Like me, RP Data research analyst Cameron Kusher has been focusing his attention on the units-versus-houses debate and found that on a month-to-month basis, annual value growth for units has been outstripping houses consistently since April 2008.

In the 12 months to June 2010, unit values increased by 11.4% compared to growth of 10.2% for houses.

“Historically, houses did experience a much more rapid appreciation in value than the growth recorded by units,” he says. “But over the past five years units have recorded average annual value growth of 7.4% compared to 7.1% for houses. These results suggest that the superior performance of units is a relatively new phenomenon.”

Kusher confirms that this recent capital growth performance of units is in part due to falling affordability, pointing out that RP Data median unit prices of $420,000 compares well to houses of $495,000. But he also acknowledges access and lifestyle factors are an equal driver in the continuing growth in value of inner urban apartments. “Gen Y is a large demographic with a limited budget that can see the value of living close to work, gyms, restaurants and friends versus the long daily commutes to places without those benefits,” he says.

Real Estate Institute data from NSW, Queensland and Victoria backs up RP Data’s research, showing growth in the value of apartments often outstrips houses in the past five years.

In Sydney, the detached house median price growth was 30.1%, ahead of other properties, mainly apartments, which grew by just 10.5%. But inner Sydney units grew by 33.6%. Brisbane apartments grew by 42.5% while houses grew by 38.2%. Melbourne saw parity between apartments and houses at 55.3% and 54.4% respectively.

In Perth, Brian Greig, communications director of the Real Estate Institute of Western Australia, nominates inner-Perth suburbs such as Maylands as epitomising the trend. “Units make up a smaller percentage of property over here than they do in east coast cities”, he says. “But the growth experienced by inner-urban units over the past five years and during the boom of 2006-07 is superior to houses. Maylands units have seen average growth of 14.8% per year over that period compared to the average house price growth in Perth of 6.7%.”

As inner-urban land value proves itself king, high-rise apartments are likely to miss out. They are as unpopular with Gen Y buyers as are McMansions on the urban fringe. And for the owners who succumbed to these cramped, so-called “investor units”, the frightening news is that the driving mechanism of growth for inner urban apartments is largely absent.

The land value attributable to each unit in these towers is typically only a minuscule portion of the purchase price, sometimes just 10% or even less. Compare this notional land value to low-rise, established complexes, where the land value per apartment is typically around 50% of the purchase price.

Well-positioned, established apartments in low-rise, inner-urban complexes of less than 25 apartments are increasingly in demand and yet their supply is highly constrained. It’s this equation that sits underneath their performance and makes them as strong an investment proposition as any other in the Australian property market.

A good rule of thumb right now is that if you have $800,000 or more to spend, a house tends to have a greater annual average capital gain than apartments at that price range. At $700,000–800,000, the investment picture is a little less obvious; either an apartment or a house can prove to be a sage investment.

However, under $700,000, apartments are often the winning investment.

Whatever your budget, picking the right property and location is key. For investors with an eye for the future, the right inner-urban apartments not only have performed well; they are likely to continue performing – as long as you choose the right property.

Property Q&A

This week:

• Should be buy another unit, or a house?
• We just can't find what we want.
• Is Melbourne heading for a correction?
• How should I invest in Brisbane?

Two units or one house?

My wife and I reside in a house in Rouse Hill in Sydney’s outer north western suburbs valued at about $800,000. We have a one-bedroom investment unit in Armadale, Victoria, bought six years ago for $306,000 and now worth $400,000, renting for $320 a week. We want to reinvest in the market. Are we better off diversifying into a second unit or selling the one we have and purchasing a house at a much higher value?

The first step is to have your borrowing and purchase capacity assessed and ascertain whether you have the right asset to begin with. Over the past five years, units in Melbourne have seen a median price growth of 54%, so you unit’s growth of 33% in six years sounds low.

You should have your property assessed by an independent, qualified property adviser who is very experienced in the inner southeastern suburbs. If your adviser’s report shows the property is not investment-grade then, yes, you should move to sell it and then perhaps invest in a house if you have a sufficient budget. If the report shows your unit is investment-grade, then it’s probably not a good idea to incur the cost of selling and then buying another investment property. Instead, you should consider using the equity you have built up in your unit to invest in another property.

As part of this process you should have your borrowing capacity assessed which will help inform your final budget for an additional purchase. In Melbourne, an apartment is usually a better investment for investors with a budget under $700,000. For investors with a budget of $700,000–800,000, either a house or unit will work as an investment, depending on the location and the property itself. With a budget of $800,000 or more, a house usually proves the better option.

Whichever option you choose, ensure that your investment property delivers the optimal capital growth relative to your purchasing capacity. The best strategy for property investors is to keep high quality assets and use their growing equity to reinvest.

Fruitless search

My partner and I have been searching for a property in the inner Melbourne for nearly two years, in the suburbs of Kensington, North Melbourne, Brunswick East, Windsor, St Kilda East, Caulfield North, Glen Iris and Hawthorn East. With $650,000, we have been looking for a two-bedroom apartment with two car spaces and storage, or a two-bedroom unit with a lock-up garage. We are constantly being out bid by down-sizing baby boomers or investors. We are concerned that we may not actually get into the market and we’re at the crossroads of buying a property that does not meet our requirements or continuing to rent. What are your thoughts?

Trying to find the perfect property can be very frustrating. But with your budget, you should be able to afford the right property as long as your requirements are realistic. A couple of issues stand out with your search, which I think are holding you back.

First, it sounds like you have a bit of a scatter-gun approach when it comes to the suburbs you have identified – they’re very spread out. You may need to narrow your search down to two or three suburbs and really get to know the area well.

The other thing I think you should consider is how much accommodation you really need in your first home. Your search for a property with two bedrooms is fine, however you should recognise that most established inner-urban apartments generally come with just one allocated car space or a single garage. Few have additional storage space. You should consider whether it is more important to find accommodation for you and your partner or to find accommodation for your two cars. This seems to be the main stumbling block in your search, which may well have set your buying power back by two years and something like $80,000.

If two car spaces are a must, you may need to look at a more modern building and increase your budget. Once you have resolved the above issues and attended some local auctions, you should have a more accurate idea of what properties will sell for in your target area and this will give you a more realistic chance of securing your home.

Melbourne correction

Some commentators are suggesting that the Melbourne property market will experience an "outright correction" later this year. Do you think this is likely? If you had a house in the outer northern suburbs of Melbourne, would you bring forward a planned sale from March 2011 to lock in the recent price rises?

Yes, there are some commentators saying that house prices are about to fall even further. I don’t think it’s very likely. The past few months have seen a significant increase in supply and a modest, if welcome, easing in prices.

When it comes to selling your house, I think the normal seasonal fluctuations are your most important consideration. My advice is to avoid putting your property on the market in mid-spring and mid-autumn, when there is a high level of supply. Often the shoulder of a peak selling season offers the best time for sales due to low supply but it depends on the market dynamics each year.

Spring is traditionally the time of year with the most activity, but if you sell during the middle of the season, you’re likely to face the greatest competition. My reading of the market is that after a slowdown for the election and another one for the football finals, a lot of property will hit the market in October and November. If you’re quick, September may be one possibility as the market supply, depleted during winter, starts to see demand from buyers increase, but you’re probably too late for that now.

The best option then is early December or late January through February as the late start to the Spring market may leave many buyers unsatisfied and the market undersupplied as 2011 dawns.

Investing in Brisbane

I want to invest about $800,000 into a Brisbane residential property. Am I better off buying two small apartments or one house?

As an investment, apartments can perform just as well as houses. If you take this option, be careful not to buy two apartments in the same location. Instead, diversify into two different areas that both have high capital performance profiles. This creates a good buffer against any localised fluctuations in the market. Two moderately priced properties can also give you a slightly higher rental return as this part of the market is within the budget constraints of the broad cross-section of the renting public. The other advantage of having two properties is the flexibility it gives you to sell one property if necessary and retain the other.

If you opt for two properties at about $400,000 each, you will need to buy into smaller one or two-bedroom apartments in low-rise, established blocks in Brisbane’s inner suburbs to deliver the growth you need to make your investment work. Be sure that each apartment is no smaller than 45–50 square metres.

On the other hand, one carefully selected house worth about $800,000 may provide access to a wider variety of stock in premium growth and high land value areas. You are more likely to be able to get the all-important scarcity factor – period-style architecture, a direct land component and a premium location – at this price level.

Specifically in Brisbane, investigate whether one property rather than two is the better option by consulting an independent property adviser. Two and three-bedroom family houses in inner to middle suburbs are worthy options. Narrow your search to older or period-style houses in quiet residential streets within 10 minutes’ walk of major transport routes. For example, select pockets in northern suburbs such as Gaythorne, Alderley and Enoggera, and southeastern suburbs like Fairfield and Yeronga are good examples of areas where investors can find the right style of house in the right location.

Monique Wakelin is co-founder of Wakelin Property Advisory, a Melbourne-based independent property acquisition and advisory company, and co-author of Streets Ahead: How to Make Money from Residential Property.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Do you have a question for Monique Wakelin? Send an email to monique@eurekareport.com.au.