The right apartment

Anyone who has booked an economy-class seat on an aircraft could be forgiven for looking enviously at the passengers settling in at the front. There’s the luxury of the extra space in first class, the superior service, real food and exclusivity, as opposed to squashed knees, noise and plastic cutlery. It’s a classic case of getting what you pay for: the price differential between the front, middle and rear of the plane is considerable. Of the 300 or so seats, comparatively few are set aside for travellers prepared to buy the best space.

So, what does this have to do with residential property investment? Plenty, when we start looking at what an investment dwelling is sitting on: the land component, or lack of it, and the key role it plays in determining capital growth and overall value.

There is a common assumption that in the residential property market, the only way to achieve solid growth and rental returns is to ensure there is a direct land component attached to an investment. This leads many investors to favour houses over apartments.

This approach makes sense, after all the land attached to a house is tangible and irreplaceable so automatically guarantees growth in value. For the land component to effectively drive the capital growth, the property must be in a high land-value location where demand is high and supply is finite and limited. It is there that the land accounts for a significant proportion of the capital value of the property.

But land is not the only factor driving capital growth. A well chosen apartment, which has no land component, can also be a successful investment; it is not the presence or absence of land per se that determines capital growth. As long as key criteria are satisfied, investors can look forward to solid growth in small, inner-urban apartment buildings that compare very favourably with the performance of houses.

Investors assume that the scarcity and value of the “footprints” of land taken up by multi-unit developments in and close to CBDs must put them in “first class”. But sometimes the closer we get to the clouds, the dimmer the view becomes! Many investors who bought into apartment developments without understanding the importance of low density in addition to land value and scarcity in an apartment complex, are now, understandably, scratching their heads and wondering why so many high-rise apartments are reselling well below the original purchase price and the ride, even with a first-class ticket price, is still hitting turbulence.

No doubt the poor performance is partly explained by the greater the number of apartments in a complex, diluting the land component of the apartment’s capital value however valuable the ground under the building.

In comparison, if we look at older-style established apartments in prime inner urban locations and with smaller block sizes '” from 2–3 and up to 20 units '” the land component should account for somewhere between 40% and 60% of the capital value. With houses, it should be upwards of 60–70%. If we look at new apartment complexes containing hundreds of dwellings, the land component would sit around 10% of the capital value. In less sought-after high-rises the land component can be far lower. Most of the value of these apartments is, therefore, tied up in the structure, which depreciates in value and air space. This can be a highly speculative sector of the marketplace because at this point in time, there is abundant supply and too many similar dwellings in nearby towers.

The lesson for investors is that if they are to preserve and enhance capital value in larger complexes they need to take some very specific factors into account. And, not even these factors are as formulaic as we might hope.

The position of an apartment within an individual complex of hundreds of dwellings is critical. The optimal position and floors will depend on the location of the complex and the aspect and floor plan. Aspect and views form another important component of value, but not all views are created equal either. Some vistas are more sought-after than others and this varies between buildings. Check which side of a particular building provides the best and most sought-after outlook.

Be wary, too, that in multi-unit situations, units higher up in the tower are not necessarily better. In some locations, prevailing winds can cause noise problems and balconies and terraces can be unusable for much of the year. The quality of the fit-out of the apartment also becomes important when there is less of a land component. Investors should select blocks that are more geared to owner-occupiers than investors. This is because owner-occupiers represent the largest buying pool in the market and they have a long-standing emotional and financial stake in their properties that will continue to drive the longer-term demand.

The best move a prospective investor can make is to remember that because of the variability, there is no specific formula that can be applied to selecting the best high-rise tower or the best position in the complex and they should, therefore, seek independent advice and an appraisal of each individual location and building. It can mean the difference between flying high and comfortably or bracing for a forced landing!

This week I have selected the following questions from subscribers.

Near the shops

How much extra value would close proximity to a busy shopping strip add to or detract from the value of an investment property?

As long as the shopping strip is a popular and sought-after one and as long as it’s not too close, the sheer convenience can add considerably to the value of properties within walking distance. Many people covet living in a property that is close to the commercial buzz. If the strip is noted for its cafes, shops and food, then the ideal would be to look for properties 300 metres to three kilometres away. Anything closer than that could also have noise and traffic problems, particularly at weekends or evenings if there are popular restaurants in the vicinity. Popular shopping strips also offer a variety of services and are easily accessed by public transport. Look for one or two-bedroom apartments, single-fronted Victorian and Edwardian houses or 1930s/1940s brick pairs rather than larger family homes as investments. The best locations will attract a premium price, but there is enduring appeal in these areas, which means good future capital growth.

Warehouse living

What do you think about warehouses or factories in older inner suburbs that have been converted into apartments? They seemed to go through a very trendy phase. Many of them seem to be in high land value areas. Are they still a good buy and if so what should I look for?

These developments came about when our economy became more service oriented and less driven by manufacturing. This change created a surplus of warehouses and factories, often in inner urban, high land value areas. The performance of these properties will depend on the quality of the conversion, relative affordability to both tenants and future buyers, location, scarcity value and market trends, but please check its structural soundness with a qualified architect or building inspector.

Done well, the conversions into apartments or homes can be quite unusual and a good alternative to traditional houses. Converted warehouses are usually fine as homes if that is what appeals, but they often don’t compare as favourably with more traditional urban properties as investments. For a start, a good quality, well located, converted warehouse dwelling will cost $700,000 or more. For this sort of money you could buy two investment apartments or a good quality period house in a high capital growth area. Warehouse dwellings may not offer the same level of capital growth or rental demand to be found in scarcer period homes or good quality conventional apartments that are less expensive and more affordable for the vast majority of the population the vast majority of the time.

Some are sold as “shells” and it is up to the buyer to decorate and fit-out, which can add considerably to the cost. Important considerations are noise, heating and lighting. Check the acoustic rating before you buy as many have metal structures that can conduct noise. They often have high ceilings, so heating or cooling can be an expensive proposition. Natural light can also be a problem with older commercial buildings. Look for dedicated off-street car parking, preferably on the title, as this will add thousands of dollars to the value.

Commercial or residential?

We are keen on the idea of buying an investment property. My partner is favouring something commercial, such as a shop or small office building as he feels there would be less maintenance and hassle. I’m just ending up more and more confused when we try to compare a house with a commercial option. Is there a way of getting some sensible advice on the pros and cons of both?

Deciding between investing in commercial or residential property is a common dilemma among investors. The key considerations for either include your risk profile, what you can afford to borrow and repay, location, potential for capital growth, rental income and lease terms. Generally, you will have to outlay more for top-performing commercial property because it should be located in very select precincts that have scarcity value and sufficient compatible local activity. Entry prices are usually well in excess of what is needed for prime residential investments. It is subject to greater volatility as it reacts more immediately to wider economic conditions and business confidence.

The value of a commercial property often hinges on the success of the tenant’s business, the rental income and how the lease is structured. In difficult economic times, you could face extended periods of vacancy. On the plus side, commercial tenants often pay most of the outgoings such as fitouts, refurbishments and rates. Residential investors can enter the market at $250,000–300,000. Properly selected property in this sector will carry less risk for the outlay because residential property is a basic commodity '” everyone needs somewhere to live!

Demand will always be relatively high and stable, especially for inner urban properties with scarcity value. The owner of residential property will have to pay the outgoings as well as for repairs and maintenance. It is not unusual for first-time investors to start out in the residential sector and then move into the commercial area when they feel confident and experienced enough and their equity levels are higher. If you are in the earlier phase of your investment strategy, then it may be better to stick with residential, especially if your funds are limited to under $500,000. Seek independent specialist advice because both sectors offer rewarding opportunities when done correctly.

Mis-managing agent

I have two investment properties and they are both handled by the same managing agent. I have been working overseas and when I returned I asked the agent to organise for me to inspect both properties. I was not happy with their condition and the fact that necessary repairs had not been done. I had left money in the agent’s account to ensure repairs could be carried out when necessary. I am about to take another overseas posting and want to know how I can ensure the proper action is taken in my absence.

As an absentee landlord, you are particularly reliant on a good managing agent. If a property manager fails to recommend minor repairs or general maintenance they may be neglecting their duty as the custodian of your assets. In this age of emails, there is no excuse for not communicating with you regularly. The agent should be carrying out regular inspections and reporting back to you. Set a specific timeframe by which you expect to receive those written reports.

Before you leave the country again, insist on another inspection and this time ensure the managing agent comes with you so that they clearly understand what condition the property is in and what might be needed in your absence. Don’t become a victim of the out-of-sight-out-of-mind attitude. If you are going to be overseas for an extended period of time, you could look at appointing an independent party to inspect the properties along with the managing agent, say every six months. This could save a lot of expense down the track as the further the properties deteriorate the less attractive they will be to good tenants. If the problem persists, change agents. It may be worth interviewing a couple of alternative agents before you leave, as a fallback position, just in case the current agent fails to lift their game.

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

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