A very narrow gap between gross rental yields and mortgage interest rates is a buy signal for investors.
Invest in a house or an apartment?
‘Unteaching’ clients is often part of an investment property advisor’s role – the challenging of preconceived ideas about what represents a good investment, stripping away biases and switching off emotion-driven decision making.
That is, as you would expect, a delicate process. Few of us let go of our preconceptions, biases or emotions easily!
A classic illustration of the ‘baggage’ some new clients bring to the table is when they declare that ‘we are in your hands’ and then in the next breath add, ‘but I only want to invest in an apartment’ or ‘it’s got to be a house.’
These stipulations generally reveal a belief that one type of property is inherently a better investment prospect than another. Or that the investor is basing their investment decisions on where they would prefer to live.
The truth is, on a fundamental basis, there is no pre-determined pecking order between apartments and houses. There are top performing houses and poor performing houses; and likewise with apartments. It is all about choosing the right type of property in the right location within a tolerable budget.
In most cases, it is that budget that determines whether the investor should consider an apartment rather than a house or vice versa. Let’s take an investor with $400,000. The choice is simple in my eyes. It has to be an apartment. That’s because it’s not possible to buy an investment-grade house – that is, a period-style 2 bedroom house situated on a quiet blue-chip inner suburban street that is close to the amenities of life – in any of our major cities for that price.
Unfortunately, too many house-aligned investors with $400,000 make the fatal mistake of heading away from our inner and middle suburbs until they find and buy something they can afford on the fringe of our cities. Eventually they discover that the ‘cheap’ house 30-40 kilometres out of the city doesn’t deliver decent capital growth. And that’s because there’s always a new wave of housing development on our fringes to ensure there is no scarcity of supply whilst demand is hampered by the lack of good public and private infrastructure and access to employment opportunities so far out from the city.
Similarly, if an investor has $800,000, a 2 bedroom house within 2-15 kilometres will be the go in most capital cities (although occasionally one might consider a 2 bedroom apartment in our more expensive cities, Sydney and Melbourne).
For every city, there is a sweet spot in budgets where the investor can choose between houses and apartments. In Melbourne an investor with a budget of $600 to $700 thousand might go for a house in the inner northwest or a quality apartment in the inner east. In Sydney the sweet spot would generally be higher – around $700-800,000 – and lower in other capital cities. I call it a sweet spot, because the investor has a greater choice.
The only other variable for choosing one building-type over another is diversity. An investor with an existing portfolio of houses is likely to be well served by diversifying into apartments when they next add to the collection, and it is always a good idea to invest in a different side of town once you have a few properties. This will smooth out the impact of the short-term spikes or troughs in localised demand for a particular property type that can occur from time to time.
In investment, it pays to be discerning, but do leave your building-type preferences at the front door.