Land versus building - land goes up, building goes down

Information provided by Open Wealth Creation

 

The aesthetic appeal of the dwelling on your property often receives a lot of attention despite the fact a building will depreciate in value while the land it's located on won't.

It's now time to stop looking at all the pretty buildings. It's time to have a good look down and notice the ground that you're standing on. Let's talk about what you're really investing in. A smart investor invests in land. The house sitting on top will go down in value. The land is the only thing that will increase in value.

The golden rule when investing

Land appreciates or goes up in value. This means it's an appreciating asset, while buildings depreciate or go down in value, meaning buildings are depreciating assets.

The taxation ruling on this is that the building itself has a deemed lifespan of 40 years and theoretically at that point needs to be replaced. Let that sink in and never forget it. Wealth comes from land only. The building's only purpose is to gather rental income and assist to cover the land holding costs. 

Ask yourself, what's long-term growth?

People's definition of long term is often different to mine. The reason for this is because my portfolio is not really for me. My portfolios are for my kids and their kids and so on. My definition of a long-term investment is an investment that will continue to grow in value for 100 years plus.

This is why apartments are bad investments. Yeah, that's right, bad. Apartments are a flashy investment option. There is something cool about the thought of owning an apartment. But the fact is they don't meet my long-term criteria. Even if apartments were to grow in value at a faster rate than medium-density housing, I still wouldn't buy apartments to add to my portfolios. The fact is if I purchased an apartment I know that in 60 or 70 years' time it's going to start to look rundown, it will end up a slum.

An apartment will age and then need replacing. I can't imagine at that point in time all the apartment owners banding together to chip in to build a new building on the land. Instead the apartment will have to be sold for below value, at a price that's cheap enough for a developer to make a profit by knocking it down and building again.

Smart investors don't try to pick winners - they avoid picking losers

When we think of land content, why are apartments in most cases far from worthy investments? Ask yourself this question, if you buy an apartment, how much land do you get with your purchase? You do get some land, but to really understand how much land you've purchased, you have to divide the size of the block the building is sitting on between all the apartments. Yeah, that's right; essentially you don't end up owning much land at all, which means there's not much to appreciate in value.

Therefore, my choice is to purchase medium-density housing that will continue to grow in value, even if in 60 years I have to replace the house that sits on top of the appreciating asset, being the land, I will still have a very solid portfolio.

Remember the golden rule: land goes up in value and the building goes down in value.

People talk about land value content as a rule. Don't worry yourself too much about this calculation. If you're buying houses or even units or town houses with reasonable size land for that particular suburb, they can be worthy investments. I do, however, strongly advise staying away from small units; you can classify one or even very small two-bedroom units, with low land content, as an apartment.

Here's a basic rule I use when considering an investment. The total floor area of all buildings needs to be less than the total area of the site. It's fairly simple when you think about it.

Meaning the land content ratio (LCR) must be > 1:1 or 100%

Example 1: LCR of the standard home.

House = 200 sqm

Land = 400 sqm

LCR = 2:1 or a LCR of 200% (this is good as the land is double the size of the building).

Example 2: LCR of the standard apartment.

Apartment building = 10,000 sqm

Land = 1,000 sqm

LCR = 1:10 or a LCR of 10% (very bad as the land content is only a fraction of the building size)

An old rundown house that needs knocking over may sell with 80 per cent, 90 per cent or even 100 per cent of the sale price being land content (like the block our home is now built on, when we first purchased it).

Let's think for a moment about supply and demand. When demand becomes greater than supply, it means there are more buyers than suitable property at that point in time. Pressure on supply means prices go up.

When supply becomes greater than demand, it means there's more property than buyers in the market, meaning prices stagnate or drop until they reach a price point that encourages more buyers to enter the market.

When it comes to apartments, developers can just keep stacking more and more apartments on top of each other, so it's hard in some places to get real pressure on supply. This is why I also recommend that you don't invest in or around CBDs. Over the long term, the land component is what will increase in value. As a general rule, medium-density housing with good land content will continually outperform apartments. Stick to a safe, proven strategy. Stay away from apartments and you'll do okay. If you like apartments, rent one.

Tips

  • Never forget the golden rule: land appreciates, buildings depreciate.
  • Remember, the total floor area of all buildings needs to be less than the total area of the site.
  • Wealth comes from land only. The building's only purpose is to gather rental income.
  • Don't buy apartments or small units with minimal land content.
  • Say it again: land goes up in value, buildings go down in value.

Cam McLellan is a property author, blogger and the chief executive officer of Open Wealth Creation, www.openwealthcreation.com.au

The above information is supplied by Open Wealth Creation.
Disclaimer: while due care is taken, the viewpoints expressed by sponsors
do not necessarily reflect the opinions of Your Investment Property.

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