Which Unit is Best – High Density or Low Density?

I’ve been in conversation with a couple of buyers advocates over the past few weeks, and it’s surprising how many of their attitudes differ with regard to investment property, namely whether you should be buying apartments in high density areas (HD) such as CBD locations, or low density (LD) inner city locations. For the sake of a comparison, I will make the assumption that if you bought in the CBD, you would be buying new whereas in the inner-city, you would buy established property.

Again it all comes down to a matter of opinion, but some things you might want to consider are:

Lifestyle

Location is very important when considering purchasing either your own home or an investment property. With respect to apartments, careful consideration must be given to the surrounds and accessibility.

In many HD apartments, CBD surrounds speak for themselves, while you will also be limited to parking spots (some with only one or no car parks), so tenants will be those who fit that bill nicely such as students and the CBD workforce. These locations are well served by public transport also. Tertiary locations are therefore important to some developments.

Inner city LD apartments need to be serviced by decent road routes and public transport, so careful consideration needs to be made to certain areas that may not have the best access via roads or public transport. Beware of locations that are only served by a single bus or tram line as tenant annoyances at transport delays can find you losing tenants quickly.

Potential Capital Growth

There’s an old saying of “Land appreciates, buildings depreciate”, and by that thought you’d look at a place with the best land content (i.e. a house). For many investors, a house is not affordable, so an apartment is the better option. However, depending on the type of apartment, you might find yourself with very little land. For example, a CBD block (where the land is the most expensive) may have 200 apartments on it, meaning you only have 1/200th of that land, whereas a small block in Elwood with only 10 apartments would each get a 1/10th share. While the land isn’t as valuable in Elwood as the CBD, you have a much larger share and therefore exposed to a potential better capital return over time.

You should always check that you have a part of the land on your title and how much – it can differ wildly!

In saying that, always have a look at the previous sales history on an apartment if it is available. You can then see the type of capital growth it has experienced in the last few years. If the growth has been slow, then it may not be a bargain you are buying, you might be getting into an investment that could underperform historically.

Costs

There are two types of costs: up-front and on-going.

Up-front costs include stamp duty, transfers and registration and are generally the highest. Many HD apartments are purchased off the plan, meaning that you only pay duties on the land (remember you don’t get much land, so the duties are very low, sometimes only a couple of thousand dollars) and help investors enter the market much easier. Most LD apartments in the inner city have been established, so you would be up for much higher costs to begin with.

On-going costs are your general maintenance and owner’s corporation (OC) – that’s the new name for body corporate fees. You might find that you’ll pay higher maintenance to keep an established property going whereas new apartments very little. However OC fees are a fee many people don’t consider when purchasing. OC fees help keep everything that isn’t directly in your apartment in good working order. This includes external paint and lighting, fixing windows in common areas and even gardening and cleaning, that’s about it for LD locations. Think about what HD apartments use: elevators, window cleaning, service elevators, emergency exits, multi-level car parks, gyms, swimming pools, retail areas, huge atrium areas, concierge services and even movie theatres. These are all very expensive to maintain so don’t be surprised if your OC fees are thousands of dollars EVERY year, so you better get some capital growth because your investment is getting heavily impacted in costs, irrespective of some tax benefits.

Income

Rental yield is one of the biggest concerns for investors. Exclusive and convenient locations can command high yields (upwards of 6% of property value per year). HD apartments are very popular amongst CBD workers and students and tend to have lower vacancy rates due to the high demand of the CBD area.

LD apartments yield lower rentals (generally 3-4% of property value per year) and can tend to have slightly higher vacancy rates as the areas may be a little less desirable and can often depend on the apartments own location (e.g. schools and transport), visual appeal and desirability.

This is a tough one as you might find that LD apartments with better capital growth will eventually outstrip HD apartments in the long run.

Tax Deductions

For many investors, tax deductibility is the key. While I cannot give any tax advice, we know that whatever you receive in income less what you pay in the loan and maintaining the property is taxable. Most items in an apartment depreciate and you can gain a tax offset from the income you earn on the property: the building, fixtures, fittings to name a few and are also available for up to 40 years (for the building in this case).

For newer apartments, you can start depreciating straight away and enjoy those benefits, whereas established LD apartments have less or possibly no depreciation available so the tax offset is missed.

Tax advice should be sought if this is a key strategy you wish to employ as some investments will provide greater tax benefits than others and will also depend on your own level of assessable income. A deprecation schedule should also be undertaken on most apartments and will add to your potential tax benefits.

So to summarise, there are benefits for either type of apartment based on the critical factors:

So which do you chose?

I have also had previous experience with both owning low density and high density apartments and can say that both do offer their particular advantages. In my opinion, those of use with long term investment horizons, capital growth is the most important for increased wealth so I would personally choose low density established apartments.

Those looking at this decision based on lifestyle needs, well that call is completely personal, so if return on investment is not important, then buy in the location you will get the most liveability out of I say.

PS – In next month’s Property Investment newsletter I’m going to share my thoughts of the other great questions…..unit or house, which is a better investment, so make sure you subscribe to the separate newsletter. If you haven’t already then we show you how in this newsletter.