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Houses versus Apartments – a different view

Last month we talked about the comparison between Houses and Apartments. This time I’d like to explore the same subject but from a different angle. I mean, apartments continue to be built in record numbers all over the country so there are investors buying them and indeed, owner occupiers as well.

When do apartments make sense?

I think to understand apartments an investor should look at them from the tenant’s point of view first. After all, it’s the tenant that is going to help you pay for it so we should know what is important from their point of view. Why would someone live in an apartment in the first place?

Location is a big attraction. Because apartments are built mostly in capital cities they have the advantage of being close to the city centre, along with public transport. Large numbers of people work in the City Centre and the surrounding areas. It makes sense to live close to work if you can. Saving time travelling to work is very attractive. It’s possible to get some spectacular views and apartments can offer those living there a feeling of security, especially those complexes that engage a concierge. Most apartments have a gym, a pool and secure parking. Being high-rise, they can offer spectacular views of the surrounding areas and they generally reflect the latest styling trends which can make them more desirable. They are low maintenance from a tenant’s point of view too. There is no garden to look after, no lawn to mow.

An apartment could also be purchased for owner occupied reasons then retained as an investment property later on. This is not uncommon as many investors start off their portfolio by moving out of their first home then making it a rental. You can imagine that a one bedroom apartment can be fine for a couple but could quickly become claustrophobic when children are around.

So, is there a valid reason for buying an apartment?

Some investors naturally focus on rental returns as a driver for purchasing and there is no doubt that renting in and around the CBD is expensive. That’s the price for living in that location. With higher rent comes higher costs in the form of Body Corporate Fees, Insurances, Sinking funds which are higher because of the need for ongoing building maintenance. There are lifts to service, pools and leisure areas to maintain. It’s the balance between the expenses and the rental income that’s important. That’s why rental returns are one of the parameters for buying an investment property.

Apartments make sense when you can buy at a reduced price and the upside is verifiable. For example, I know of a 2 Br apartment purchased recently for $475k with a Rental Guarantee of $450 p/w where other sales of similar apartments within the complex reached $495,000. Even better, the apartment was rented at $495 p/w. In addition there was secure parking for one vehicle plus a Storage area located next to the Lift. That’s an impressive 5.4% rental yield.

I thought it would be worthwhile doing a comparison of 2 Br apartments around a Capital City, in this case Melbourne, with Houses in recognised growth areas. By comparing the Rental, Gross rental Yield and the Purchase price we can get an indication of where these properties sit in relation to each other.

By the way, I chose 2 Br rather than 3Br because 3Br apartments are not as numerous and they also tend to be on the expensive side. Naturally, the high price and low yield would skew the rental return downwards and make them appear uncompetitive.

As you can see, the results make interesting reading.

Property Type – 2 Bedroom Apartment

Suburb Median Rent p/w Median Price Gross Rental Yield
St Kilda $450 $600,000 3.90%
Prahran $450 $590,000 4.00%
Melbourne CBD $540 $560,000 5.00%
Southbank $550 $570,000 5.00%

Property Type – 4 Bedroom Apartment

Suburb Median Rent p/w Median Price Gross Rental Yield
Tarneit $361 $443,500 4.20%
Craigieburn $385 $450,000 4.40%
Mernda $370 $455,000 4.20%
Point Cook $400 $560,000 3.70%
Source: REIV (figures as at Jun 16)

The first point to note is that apartments are clearly more expensive than most houses. Despite the price difference the rental amounts are surprisingly high for apartments. Another aspect to note is that the rents vary considerably from St Kilda to Melbourne CBD and Southbank. The variance is much more subdued in the outer areas.

What does this all mean?

Based on the raw Rental Yield numbers though, there are some good results from apartments in the selected locations.

The only thing missing are the costs involved in holding each property type and the finance implications. We know that Lenders are wary of financing apartments because of the much publicised oversupply issue while the crackdown on foreign investors is also a factor. Most Lenders have specific credit rules dealing with High Density apartments and they determine what LVRs are applicable. Combine these rules with postcode limitations as well as guidelines around apartment minimum sizes and you can start to appreciate the obstacles you have to navigate around to secure finance.

Contrast those conditions with houses and there is a noticeable difference. High LVR’s up to 95% are available, though there are still some postcode restrictions here too. Essentially the more money that can be borrowed the less an investor has to put in which in turn has an impact on the investor’s ability to continually accumulate property. Just as important is the need to maintain a healthy reserve for unforeseen circumstances. Obviously, how much of your own money you have to use will help to decide if the purchase is possible or not. Clearly, putting in more at the start of your investment journey will have a significant impact on how quickly you can move forward.

The fees involved for a Body Corporate will also influence your decision. A large high rise apartment has unique features such as Lifts, Car Parks, Lobby, Fire Alarm services, CC TV equipment, lighting etc. The common areas require regular cleaning and all of the fittings mentioned require regular maintenance. The cost for all of this is covered by Body Corporate Fees. These fees can range from as little as $15 a week for small complexes with limited shared services, up to $200 a week for top of the range apartment blocks with well-appointed, even luxurious facilities. It should be obvious that pools, gyms, spas and landscaped gardens will be part of the attraction of the apartment in the first place but the same facilities will have maintenance costs to be borne by the owners. Those costs will impact your bottom line.

Naturally some expenses are common between houses and apartments such as the obligatory Council Rates, Water Rates and the very essential Landlord Insurance.

What remains the biggest difference to these two investments is how they are treated by the Lenders. Lower available LVR levels for apartments force you to commit more of your own capital to the purchase which obviously ties up equity. Unless the Lenders change their policy that extra money remains locked in and because you are committing a higher portion of your own funds to the purchase your ROI (Return on Investment) will naturally be lower. In the bigger picture, having less of your own money available simply means you are less prepared for the next opportunity.

In the end though, the Houses versus Apartments argument is a lot like comparing oranges and lemons. They both have their uses and the only time to ignore one is when there is a specific need to use the other. When I want orange juice I use an orange. A lemon just won’t do.

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