Busted: why investing in units isn’t always as smart as you think

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The capital growth and rental returns for units currently trump houses in a number of markets, but brimming under the surface of lower maintenance costs and higher density living are risks that many investors don’t even realise.

Risk 1: Some unit markets are oversupplied

As for any property investment, an oversupplied market is one that should be avoided. Apartments, in particular, tend to reach saturation point in certain locations periodically. 

Consider the relationship between supply and demand in the local market and predict which route it will take in the future. If you see masses of unit developments sprouting from the ground and under construction, it might be a signal to stay away. 

Look for locations where the supply of units on the rental market isn’t meeting demand and you’ll be well-aligned to rake in the profits. Talk to sales agents on the ground and assess ABS demographic data. Suburbs like Ultimo and Haymarket in Sydney, for example, are ones which are dominated by a high number of unit blocks, yet still in demand. The high percentage of lone-person households and student residents in the area continue to sap supply. 

Risk 2: Some units are too small for tenants

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 limited capital growth.

The buyer market, they say, is also limited, which places significant pressure on the apartment to achieve strong rental returns.

These rental returns are a cause of concern for Chris Gray, CEO of Empire, who says 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.

“It’s very expensive for one person to rent a studio or one-bedroom apartment, whereas 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,” explains Gray.

“While your decision will ultimately depend on the suburb and its demographic, a two-bedroom apartment is usually a good choice.”
 
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 around university nodes and short-term workers in major city areas are more likely to opt for studio and one-bedroom apartments than tenants in the family-dominated suburbs.

Risk 3: Units and depreciation

Some say that an apartment, like a fine wine, only gets better with age. The opposition argues that older apartments are fraught with danger when it comes to investing. And still others, like Chris Gray, say it’s all simply a matter of opinion.

“There’s no right or wrong,” Gray explains. “It all depends on that particular property and price. I typically buy 95% second-hand properties and 5% new.”

Similarly, Martin Schoeddert, director of Iris Property, says there’s no black and white answer. “The bottom line is that there’s absolutely no perfect solution to anything.”

The advantages of opting for a new property are many: investors can expect fewer ongoing maintenance issues, a contemporary and attractive street appeal and potentially greater tenant demand.

The biggest lure of a new apartment, however, is the tax depreciation on offer. Investors can write depreciation off as a tax-deductible expense and subsequently increase their cash flow – and the rewards get progressively better the newer a property is. Depreciation rates depend on a property’s age, with apartments less than 10-years-old collecting the greatest benefits.

However, Gray warns that while depreciation tax benefits are beneficial for cash flow, investors should always focus on assessing the potential of the underlying investment. “Calculate what the investment is worth now and by how much it's likely to grow in the future,” he says. “There is little opportunity to add value to brand-new apartments as they’ve been designed to be on-sold at a premium. Developers that sell brand new apartments are professional vendors and so often the property is very highly priced.”

For this reason, older apartments may be the way to go for entry-level investors after an affordable price tag. “Older-style properties are typically sold by mum and dad owners,” explains Gray. “Not being professional sellers, they don’t go to the extremes of de-cluttering and styling the property ready for sale, so second-hand properties typically sell for a more realistic price. Buyers can then add value through renovations.”

Investors should also be wary of exceptionally high strata levies in newer apartment blocks. As contemporary buildings offer more and more facilities – such as concierge and valet services, gyms and swimming pools – the associated levies are rising to new heights, which can seriously harm your cash flow.

Risk 4: Units in 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.

Look for blocks with fewer units and a higher proportion of owner-occupiers – experts suggest at least a 70:30 ratio of owner-occupiers to investors.

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 say ‘oh we want to redecorate the lobby’ and if it’s in a block of 80, you’ve got no choice.”

Risk 5: Off-the-plan purchases

Purchasing property off-the-plan always carries an element of risk, but this is also an area of investment where you stand to make significant gains. As Schoeddert says, it’s high risk but worthwhile. It all comes down to the individual property and the direction of the market.

Gray says there are clear pros and cons when it comes to off-the-plan investment. It can be a great way to get into the property market with little outlay, as buyers can use deposit bonds and bank guarantees to stake their claim. However, should you fail to settle, you stand to lose a fortune. “If the market moves against you, you could be putting down a 20% deposit on the current cost, plus the amount the unit has dropped,” explains Gray.

He suggests engaging the services of an independent valuer to gain a valid, impartial assessment of the property’s current value, as well as sourcing reputable research to predict which way the market will go. You should ensure you have sufficient equity and a plan in case the market blows the wrong way.

But if your stars align and the investment is a wise one, you could make significant gains by the time the project reaches settlement.

Risk 6: Units rely heavily on position within the apartment block

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 is no constraint on the tenant market, whereas top-floor apartments may cut out certain sectors 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.

 

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