Investing in Apartments

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It’s a common dilemma for investors as to what type of property performs best in the long term.  Houses, apartments, offices?

Alot of people believe that houses always grow better than apartments because they have a greater land value.

It is true that a house generally has a larger land component and that it is the value of the land that increases over the years, whilst the physical property itself depreciates (loses value).

However, the principles of supply and demand will determine whether a house, office or apartment grows at the fastest rate.

Supply and Demand in Action

Consider this.  A large migration of young professionals moves into an inner suburb near the CBD to help fulfil roles in a major IT company.

Some of these professionals are not yet ready to buy a property for themselves as they have not been earning money for very long and they are not too certain about where they will be working further into the future.

Therefore they need some rental accommodation to live in.  Because they are young, full of energy and without children, most of them want to live in an apartment instead of dealing with the maintenance of a house and land.

However in this suburb, which is nice and close to their workplace, there are not many apartments available to rent.

The ones that are available get snapped up quickly and because there is some fierce competition from people on decent incomes, they manage to push the rental prices up 20% in just 6 months.

Clearly, there is now an undersupply of rental apartments in this area.  The houses in the area have done ok and rents have gone up just 5% in the past year.

Property Investors Move In

Now, some savvy investors see the large rent surge in the apartment market and decide that those rental yields are quite attractive and some of them start to look for apartments to buy and rent out in this up and coming suburb.

Since there are not that many apartments in the area, investors are now competing for the limited stock on the market and this drives up the apartment prices 15% over the following year.  House prices do ok and go up just 7%.

Can you see what has happened in this example?

Even though houses in the area have more land and are more expensive than the apartments, the change in demographics of the suburb have pushed rents and prices of apartments much higher whilst the houses have seen relatively average growth.

So if you were a smart investor, would you buy one house in this area for $600,000 and rent it out at $500/week or would you potentially buy 2 apartments for $300,000 each and receive rental return of $250/week each?

The rental return is the same, but the growth prospects are much different.

12 months later, the 2 apartments are worth a combined value of $690,000 (up 15%) and returning $300/week each (up 20%).

The house is returning $525/week now (up 5%) and is worth $642,000 (up 7%).

In this example, it is clear that apartments have done much better even though they contain less land value.

This also shows why it is important to research an area before buying, in order to determine what are the market opportunities and the type of properties people will be drawn to.

This shows the forces of supply and demand at work.

More Supply to Meet Demand

But the results could have been much different if there was a larger supply of apartments already available to fill the market’s needs.  In this case, the supply would have much greater impact and possibly show no growth for the apartments.

Since it is easier to build 100 apartments in an established suburb, rather than 100 houses (since there is barely any vacant land available), oversupply issues can be more common in the apartment market.

So apartments can be a great investment, but always find out what factors are driving demand and how much supply exists to meet it.



5 Responses to Investing in Apartments

  1. You have done a good job discussing the effects of demand and supply in the real estate market. I totally agree with you. We should know who our target buyers in a specific place are and what are their needs, in order for us to determine what kind of property we must provide.

  2. Kerrie says:

    Excellent property investing tips. There is always a risk in over-generalisation…
    Kerrie recently posted..Stock Market TipsMy Profile

  3. I think I am a smart investor :) so it’s much better to buy and rent smaller apartments. In the event of a crisis it is easier to sell them, or at least sell one of them and keep the second and continue to rent.

  4. Interesting- I must admit we often make the assumption that there is more latent demand for houses than apartments, but the scenario you gave in the article proves that this is not always the case- it boils down to the simple laws of economics- market conditions, and supply and demand.
    Letting Homes recently posted..Largest new town in Scotland plans developingMy Profile

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