5 features that turn units into risky investments

1. Ageing apartments 

Martin Schoeddert, director of Iris Property, says that older apartments are possibly the best option for entry-level investors looking to avoid risk, though he cautions investors to be wary of what’s out there.

 “You have to be really careful with a lot of the [unit blocks] that were built in the late 1960s and early 1970s as a very, very high percentage of them have got concrete cancer,” he warns. “Make sure you get a really good look at the building inspection, get a good look at the Section 70 certificate, and make sure – and this is crucial to any unit investment – to have a really, really good look at how much is in the administration and sinking fund, so that you’re not getting hit with special levies.” If you do get nailed with a special levy, you could be up for thousands, which means your rental income will be headed straight to the levy, completely bypassing your wallet.

2. Small apartments 

Some experts warn against investors buying into studios or one-bedroom apartments, suggesting that a smaller dwelling may have less potential to add value and subsequently have limited capital growth.

They say the buyer market is also limited, which places significant pressure on the apartment to achieve strong rental returns. These rental returns are a cause for concern, says Empire Property Portfolio CEO Chris Gray, who believes that inflated per-person rental payments in smaller dwellings might be too high to attract a sufficient pool of tenants.

“While one-bedroom and studio apartments cost less money to buy, they can be typically more expensive per person to rent and that can limit the number of people who want to rent or buy them,” he explains.

“While your decision will ultimately depend on the suburb and its demographic, a two-bedroom apartment is usually a good choice,” Gray adds. “It’s much cheaper for two people to rent a more expensive two-bedder as they can split the weekly rent two ways. Three-bedders are cheaper to rent again, however, fewer people want to share between three.”

You should consider the demographics of the tenant market in the area before deciding whether a smaller or larger apartment is the way to go. Students based around university nodes and short-term workers in major city areas are more likely to opt for studio and one-bedroom apartments than tenants wanting to live in the family-dominated suburbs.

Michelle Galletti, managing director of Just Rent Sydney, suggests that a smaller, furnished apartment in inner-city and city fringe areas will always experience strong demand. “It’s almost like a hotel kind of scenario, but it’s more long term,” she says. “It’s cheaper, obviously, for people from overseas to rent a fully-furnished apartment for a short period of time than it is for them to pay for hotel accommodation. So a lot of companies go for fully-furnished apartments in the city.”

3. High-rise blocks 

When an asset’s value relies on its scarcity factor, the idea of a sky-scratching high-rise seems to scream ‘risk’ from all angles. Indeed, many experts suggest steering clear of huge cookie-cutter unit blocks and instead opting for smaller blocks with a smaller number of investors.

High-rise apartment blocks can limit opportunities for investors, as increased competition restricts resale potential and rental demand. Your investment won’t be unique if there are a few hundred identical products in the exact same block, all competing for the same tenants and/or buyers.

Schoeddert agrees that bulky blocks can be hazardous, particularly when it comes to weighing in on block decisions. “To me, from the investment point of view, as a single unit-holder in a big apartment block you can’t exercise anything, you haven’t got enough grunt in the owners corporation to have any effect at all. You can get out-voted in no time flat; they could say ‘we want to redecorate the lobby’ and if it’s in a block of 80, you’ve got no choice.”

Schoeddert suggests investors opt for blocks that are “small and containable”, ideally housing around six to eight units over two or three floors.

4. Premium price 

Prestige apartments are inherently risky investments. Value-adding opportunities are dampened, the chances of overcapitalising are high and the top end is often the first to go when the going gets tough.

An astronomical buy-in price means that rental amounts need to fly to achieve even a moderate rental yield, and positive cash flow is a distant dream for investors.

The higher strata levies associated with prestige properties can also cut significantly into any gains. “By definition, prestige apartments are only affordable for the top 10–20% of the population rather than the 80% majority,” says Gray. “As prices get higher, demand gets lower, and the rental return starts dropping to as low as 1–2%, which makes it hard to get cash flow if you have a large mortgage.

“Some investors choose to furnish their top-end investment apartment and rent it out as an executive rental; this can increase cash flow but can be very volatile as it is largely dependent on the economy.”

Increased insurance premiums can also be of concern. General manager – insurance services of Terri Scheer Insurance, Carolyn Majda, says the cost of the company’s Landlord Preferred Policy may increase for owners of top-end apartments renting at more than $1,000 a week. “If an apartment was rented for more than $1,000 per week and another apartment in the same building was rented for less than $1,000 per week, then their Landlord Preferred Policy insurance premiums would differ,” she says.

“Landlords who own rental apartments can access the Terri Scheer Landlord Preferred Policy. This provides cover for malicious damage by tenants, accidental damage, deliberate damage, legal liability for occurrences on the property that cause death or bodily injury, and loss of rental income as a result of damage to a property or a tenant absconding.”

Schoeddert suggests that investors should diversify their investments rather than pooling all their funds into one $2m–$4m apartment. “Personally, I think it’s too risky; I think there are better ways of property investing,” he says.

5. Bottom floor units

Is any one level of an apartment block a riskier investment option than another? Is top floor better than ground floor – or is a middle-level apartment a safer bet?

Those in favour of ground-floor units argue that their position places no constraint on the tenant market, whereas top-floor apartments may cut out certain groups such as those with prams, wheelchairs and the elderly.

Those who barrack for the top floor, however, say that they offer a more open feel as there is less chance of being built in and overshadowed by surrounding buildings. Top-floor tenants will also enjoy more privacy as their balconies are less likely to stare straight into another building. Apartment blocks with views will obviously favour the higher floors, which can be a huge boost to the property’s value.

Security, noise and insulation all weigh in on the debate, with experts expressing concerns about easier access to ground-floor units and potential noise issues for units on the lower levels. Depending on the building, top-level apartments may also benefit from a better aspect and more natural light.

Purchase price may also enter the equation when assessing which level is a better option for you. The higher a unit is located in a block, the more expensive it may be.

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  • Chandra says on 21/06/2013 10:47:24 AM

    what does it mean specifically about (high rise blocks) "small and containable"?

  • Graham Ko says on 22/10/2013 11:45:44 PM

    Buy houses and not units would eliminate all risk stated in this report!!

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