The hottest question in property: Apartment or House?

In this article Property Professor Peter Koulizos compares apartments and houses as possible investment options, so far as capital growth is concerned. He explains that they differ in performance for a number of reasons.

Demand v Supply

For those of you that have studied Economics you might remember that price is a function of demand and supply. In other words, the price of something is based on how many people want it (demand) and how much there is of it (supply).

It is very easy for the apartment market to be oversupplied as developers bring on hundreds of apartments at one time and they can’t stop building halfway through the project. In the case of houses, it is possible to build just one house and it is relatively easy to halt supply.

A project home builder generally builds one or two display homes and once contracts are signed, they start building other homes. If they don’t have signed contracts, they won’t build, thus halting supply.

It is very different for the apartment developer. If they wanted to build an apartment block that contained say 300 apartments, the bank would require them to sell at least 70% off the plan. That’s 210 apartments taken care of. What about the other 90 apartments? The developer is hoping that during construction or as soon as they are completed, they will be able to sell the remaining 90 apartments. With so many apartments available for sale at the one time, it is very easy to flood the market and cause prices to drop.

In my research, I have found that it is not uncommon for apartments to be re-sold at a lower price than they were originally bought for. One reason for this is the amount of apartments for sale at the one time (supply). The other reason is the land to asset ratio which is explained below.

Land to Asset Ratio

To better explain the land to asset ratio, I have made some assumptions:

• Value of land appreciates at 10% per annum

• Value of buildings depreciates at 1.5% per annum

If you accept that properties double every seven to ten years, this means that properties increase in value at around 7% to 10% per year. If you also accept that buildings depreciate in value and land appreciates in value over time, then these two forces are working against each other to give an overall increase in value of between 7% to 10% per year. What I am assuming is that buildings depreciate by 1.5% per annum and the land component increases in value by 10%. These figures vary depending on many factors but in the main, this seems to make sense.

Scenario

Let’s assume that you have the option to spend $500,000 on an investment property. You are unsure whether you will buy a brand new two bedroom apartment or an old (let’s say 50 year old) house on a large block.

The suburb I have picked is Christies Beach, a beach side suburb in Adelaide which is also one of the hottest suburbs in Australia. Many houses with water views and close to the water sell for approximately $500,000 and there have been some newly built apartments that have recently sold around for $500,000.

I have broken down the values in the following way:

Apartment

Land: $100,000

Building: $320,000

Developer’s Profit: $80,000

Total $500,000

House

Land: $450,000

Building: $50,000

Total $500,000

The table below outlines the performance of both properties over a five year period.

The main reason for the big difference in performance between the two properties is the money spent on the appreciating v depreciating components.

In the house example, there was $450,000 (of the $500,000) spent on the appreciating component; land.

In the apartment example, there was only $100,000 (of the $500,000) spent on the appreciating component. The vast majority of the money went towards the depreciating component; building. In addition, $80,000 of the money went straight into the developer’s pocket!

Notice also that after five years, the apartment is worth less than the original purchase price which confirms much of my research.

In summary, if you wish to purchase an apartment to live in, this may be the right lifestyle choice for you. So far as capital growth is concerned, purchasing a new apartment is not necessarily a good investment choice.

Happy House Hunting!

Source: Koulizos, P. (2011) http://discover.realestate.com.au/news/the-hottest-question-in-property-apartment-or-house

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