Why you should be Nervous when Investing in Apartments

I always find it a really interesting topic when someone says do apartments make for a good investment or not? My dad is born in 1939 so he’s a pre-Baby Boomer, my mom is born in 1948 so she’s a Baby Boomer, I’m 1975 so Generation X and my wife is 1980 so she’s typically on the cusp of Generation Y. So over the dinner table, we actually have a really interesting conversation about apartments because if you think about my dad’s generation, his idea of the Great Australian Dream is a quarter acre block with a detached house surrounded by a garden with the hill hoist and a barbeque. But if you look at Generation Y, they’ve grown up watching How I Met Your Mother, Seinfeld, all these apartment shows typically in New York where apartments are considered really really normal. For Gen Y and affordability, they find apartments totally ok as not only a place to invest but a place to live as well.

So who’s actually right?

I guess no one is really right other than you need to understand what makes for a great apartment versus what makes for a mediocre apartment. In my view, it comes down to the argument of should I buy a new apartment or should I buy one that is existing and established and has been around for a while. When investing in apartments, I prefer to buy the established one typically something that was built in the 70s and maybe even to the 50s and they are a bit older. They look a bit more tired but they are in better position and they are located surrounded by beautiful period homes on perhaps either side of them and they are walking distance to lifestyle amenities which make them a really great lifestyle option. But not necessarily has the sizzle of buying something new. Versus the new which has all the glossy brochures and the developer puts in a lot of effort into attracting attention, maybe they put a pool in, they’ve got a caretaker, a lift perhaps a gym. These facilities all sound really great but at the end of the day, you as a property investor, you are never going to use those facilities. It’s going to be up to your tenant. And in my experience, if the size of the block is too large and it doesn’t feel very intimate, a lot of those tenants don’t use those facilities anyway. So as a property investor, you are paying for the upkeep of them through your body corporate fees but quite often, they are a bit of a ghost town in some of these areas. I guess my view is very simple, I would prefer to have a larger percentage of the purchase price going towards the land value than towards the building. I can get that when I buy established cause I might be buying one of eight or one of twelve. If I’m spending $500,000 on that, a large percentage of that $500,000 is going towards the land value that I’m buying. Now I acknowledge that I can’t point out and say that that bit of land size is mine but I do know that one eighth or one twelfth is actually mine. Versus if I buy one of 200 or one of 300 again for $500,000, a much smaller percentage of the purchase price is actually going towards the land value and a much larger percentage is going towards the building. That’s the kind of the ratio that I’m looking to avoid and one of the reason why I prefer established over new. The other reason why I like establish is because I can actually back test and see what was sold previously and get an idea of the performance of the asset. If I were buying something brand new, typically there is no history what so ever in relation to the investment so you are doing a bit of crystal ball gazing. So my view is when face with new vs established, generally speaking, I prefer buying established property.

The second thing is, quite often I prefer to be on the side street versus a main road cause I’ve actually done some analysis and look at a whole bunch of performance and it’s really interesting. Most of the time, high 90%, the side street performs better than the busy road. That kind of make sense cause people pays more emotional value on being more private and off the side street than they do on a busy road. And that’s important because new is often on the busy road where else established which is built 40 – 60 years ago, they already have a good position, in great location surrounded by beautiful houses which can help drive the price. So I would prefer the side street versus the busy road.

I guess the other thing to think about is size vs shine. By that I mean, some of the older apartments, because the developer wasn’t under so much pressure to get the financial outcome out of it, they make the internal size a bit bigger, the living room just a bit bigger, the bedroom sometimes just a bit bigger versus the newer ones because they need the economics to work to get the bank to lend them the money. Quite often, they just shrink the sizes until they find that sweet spot where they can actually make a profit. But the brand new one looks shiny. New taps, new carpets and everyone get a bit excited about that. They often sell it under depreciation as well. Now, I love depreciation as much as the next person but I rather do that through a small renovation which can help us get it back.

This kind of brings us to my next point of the ugly duckling versus the beautiful swan. Again, I prefer to buy something that is a bit older and I can bring my own improvements to so I can create the depreciation that comes from the cosmetic renovation versus buying something that the developer has done for me that I have to pay additional amount to get and not being at the side street such as an established property.

I guess the argument is are all apartments a great investments and I would say probably not. I think there are only a small percentage of apartment that actually do make for a great investment. But in terms of deciding which one you would like to choose, think through the eyes of the person who is most important to you as an investor. SO if you are a buy and hold strategy, the most important person is the valuer and if you are a buy and sell strategy, the most important person is the next buyer or hopefully the next owner occupier. If you walk through the property as you are viewing it before you buy, look through the eyes of either one of those two individuals and think about whether they would see owner occupier appeal, whether they would see it off a busy road, whether they see some privacy and intimacy that comes from being one of 12 rather than one of 200 – 300. If they would place a huge value on that, chances are that would make for a great investment property and chances are, it will help you in the filtering process as to which apartment you should actually buy.

My conclusion is simple. Not all apartments make for a great investment. I think you need to exercise a lot of caution when deciding which one is for you. But if you think about the fact that they need to have some owner occupier appeal, they need to be investment grade and have some form of scarcity, using those 3 filters alone will help you make a better decision when it comes the time to deciding whether or not an apartment makes for a great investment for you.