House or apartment: which to buy?

Are you after rental income or capital gains? It all depends on your goals.

The question comes up all the time: are houses better investments than apartments? There isn’t a simple answer, as each investor will have their own criteria. One way to look at the performance of the different housing types is to compare capital gains over time. Across Empire’s combined capital city index, houses have recorded price growth of 7.8% pa over the past 15 years while unit shave recorded 6% pa capital gain(see chart). Houses have shown a higher rate of capital gain than apartments consistently over the past 10 and five years and over the past 12 months.

Cranbourne, VIC North Albury, NSW Morayfield, QLD Liverpool. NSW Epping, VIC Wollongong, NSW Caloundra, QLD Logan Central, QLD Newtown, VIC Mandurah, WA
Cranbourne, VIC North Albury, NSW Morayfield, QLD Liverpool. NSW Epping, VIC
Wollongong, NSW Caloundra, QLD Logan Central, QLD Newtown, VIC Mandurah, WA

In fact, since the index started in 1996, there have only been a few short periods where unit value growth outperformed that of houses. The higher capital gains for houses can probably be attributed to the underlying land value. Land prices have risen substantially over the past decade, particularly in those cities where the release of vacant land has been slow, such as in Sydney. Another way to measure performance is to examine the yield profile of the two housing types. Since 2001, houses have shown lower gross rental yields than units.

Best streets Frauenfelder St, Fallon St, Mate St, North St, Pauls Lane, Buckingham St, Stephen St, Bellevue St, Smith St, Plover St, Union Rd, Wingara St, Nowra St, Koonwarra St, Boronia St $211,000
Best streets Frauenfelder St, Fallon St, Mate St, North St, Pauls Lane, Buckingham St, Stephen St, Bellevue St, Smith St, Plover St, Union Rd, Wingara St, Nowra St,
Koonwarra St, Boronia St $211,000

At the end of July this year, a capital city house was returning a gross yield of 3.4% on average, compared with the unit market, where the average gross yield was 4.3%. Most capital cities show the same trend. However in Adelaide and Hobart, whose apartment markets are relatively immature, the 10-year growth rate for unit prices is slightly higher than that for houses.

The net yield may show a closer relationship, considering units are likely to show higher expense profiles because of the cost of body corporate fees. As the population grows and detached housing becomes less affordable for many prospective buyers looking to purchase within an easy commute of the city, it’s reasonable to assume apartments will become more popular investment choices.

An off-the-plan choice is a high-risk strategy

Many factors can push up the price and leave you owing more than the property is worth

Buying off the plan to make a profit should be regarded as a speculative investment. What you’re hoping for, if you buy a property off a developer’s blueprint, is that the property will be worth more a year or two down the track when the building has been completed. Unfortunately this process is not as simple as
it sounds as there are many risks with such investments that are not well known.

One of the big risks is whether or not the market rises during the building period, which is dependent on many economic factors. If it falls instead, then be prepared to fork out more cash to your lender, as you may have negative equity in the property, particularly if you overpaid when you purchased. Another area to watch is the contract. Off the-plan contracts heavily favour the developer and include shrinkage clauses, sunset clauses, like-with like furnishing clauses and others that can detrimentally affect your investment.

Best streets Bathurst St, Campbell St, Macquarie St, Elizabeth Dr, Castlereagh St, Memorial Ave $405,000
Best streets Bathurst St, Campbell St, Macquarie St, Elizabeth Dr, Castlereagh St, Memorial Ave
$405,000

For example a shrinkage clause allows the property to be reduced in size by up to a specified percentage which is often between 3% and 5%, which may turn a double bedroom into a single or reduce the size and functionality of a balcony, thereby reducing the value of the property. If the market price has increased significantly, the builder may enforce the sunset clause. Here the completion of the building is deliberately delayed until after the date of the sunset clause. That will allow the developer to return your deposit and sell at a higher price when finished.

Building defects are also tricky for new buildings. Developers tend to fight fixing anything and look to blame the builder – the developer and builder are usually separate companies. They are in a pricing conflict of interest and, unfortunately, once the contracts are signed they switch their focus to building to a price, not a standard. The result is a bunch of defect issues down the track which, according to many strata managers, is very common in new buildings.

You also need to be aware that you are generally competing with foreign buyers who are not worried so much about the price they pay as, first and foremost, they are looking to get their money into Australia. This can inflate the price you pay and make it very unlikely you’ll be able to sell at a profit when the development is complete. That could result in you being in negative equity. Patrick Bright is an EPS Property Search buyer’s agent and author of bestselling book series, The Insider’s Guide to Buying Real Estate.