Property is often viewed as one asset class, however different types of properties provide different benefits. Here’s a quick guide to the pros and cons of the common property types and what’s better suited to you.
The overall goal of many property investors is to generate significant personal wealth that allows them to retire earlier and in a much stronger financial position.
To do this requires strategic purchases which can help maximise returns throughout one’s property investment journey.
However, different types of property offer investors varying benefits and drawbacks.
While each investor’s property strategy should be unique and tailored to their individual risk profile, financial capacity and life circumstances, as a general rule of thumb the different property types do fit into specific life stages of an investor.
So what are the benefits and drawbacks of the various property types and when’s typically the best time to purchase these?
In part 1 of this 2-part article we look at houses, apartments and villas. In part 2 we’ll discuss direct commercial property investment, commercial trusts and residential development syndicates.
The major advantage of investing in a house is the capital growth prospects, as opposed to income through rental returns. In theory, land appreciates in value while buildings (i.e. the improvements) depreciate, so a house with a higher proportion of land value is better placed for growth prospects, typically. Investors can also, relatively easily, add-value to houses through renovations as well as redevelopment, subject to zoning and council approval. Unlike strata titles, a house has no reliance on neighbouring properties including no common property, which provides investors with greater control over the property.
Often a house will have a large proportion of its value in the land, which is not reflected in the rental income. This creates a smaller yield than that of a unit/commercial property and often provides negative cash flow, depending on interest rates and the amount of debt. A house often requires greater maintenance, which often means higher expenses associated with replacing aging or broken items, such as leaking roofs or rusted gutters. These costs can be a drain on cash flow and need to be considered in an investor’s budget.
When to purchase
Being a growth-related asset the time to buy a house is in the early and middle stages of an investor’s lifespan. The goal is to capture as many upcycles as possible to maximise the growth potential. As average rents increase (which has been the case historically), a house will eventually provide an income that covers loan repayments and provides positive cash flow. Until such time, a house can benefit from negative gearing tax benefits. Ideally, a house provides positive cash flow by retirement as it provides a substitute income. Purchasing a house later in life can limit the amount of growth that can be achieved due to the shorter hold period and will more than likely have a negative cash flow (i.e. it will cost an investor money to hold the asset), which isn’t ideal as a retiree with no salary.
The main advantage of an apartment is the higher yields that these assets can achieve over that of houses. In many cases, apartments can be neutrally or even positively geared from immediate purchase and, as such, are good for positive cash flow, meaning it doesn’t cost investors to hold these assets and they can deliver surplus income. Apartments are also easy to hold as there is less maintenance and the building as a whole is managed by a strata manager.
The major downside with apartments can be the lack of intrinsic land value. The value of the improvements (i.e. the value of the dwelling) and the shared ownership of the land with others in the strata can mean that much of the purchase price of an apartment is in the value of the improvements (i.e. the dwelling), rather than the land value. While this typically provides better rental income, it’s usually at the expense of capital growth. Other disadvantages with apartments include the associated costs with strata fees, which are used to maintain common areas such as pools and lifts, as well as the fact that investors have less control over the property with limitations for renovations due to strata bylaws. Capital growth can also be limited due to additional supply of similar stock. Inner-city apartments, for example, will always have to compete with new stock as similar projects are likely to be built nearby.
When to purchase
Because apartments can be a good source of income, these assets are typically better suited to investors who are later in their investment journey and nearing retirement. The positive cash flow that apartments can provide can help to replace an annual salary and supplement their retirement. It’s better to buy an apartment in an area where supply will be limited (i.e. local council zonings are relatively restrictive of new similar stock).
The main advantage of these property types is that they can feature a high intrinsic land value as well as a relatively high rental yield. Capital growth prospects that are nearly as good as a house, as well as rental yields that are nearly as good as an apartment. Other typical benefits of villas and townhouses include the potential ability to renovate the property (unless it’s restricted in the by-laws), which can help increase the capital value and rental income, as well as the lower entry costs associated with these assets compared to a house. Furthermore, the easy care nature of a villa or townhouse with its lower land content allows for less maintenance costs.
The disadvantages of a villa or townhouse revolve around the strata restrictions imposed. Purchasing a villa or townhouse for a long-term hold can cause problems if there are restrictions on improvements as the property ages. The property can become outdated with very little way of remedy in terms of demolition or revitalisation. A group of villas/townhouses will also often be located amongst other groups of villas/townhouses due to zonings within the local area. Villas can also be fairly homogenous, similar to apartments, meaning there may be increased competition when selling or leasing a grouped dwelling.
When to purchase
Villas or townhouses can suit many investment strategies due to the balanced nature of such assets types. However, they are typically better suited to early-stage investors who are more risk-averse, because they can have a lower price point but higher yields than houses but still offer reasonable capital growth prospects. Typically, the risk-reward factor with villas and townhouses is lower than that of houses. Alternatively, villas and townhouses can suit investors later in life nearing retirement as the properties are typically income producing and won’t require expensive maintenance.
Finding what’s best for you
When considering purchasing an investment property it’s important for investors to understand the pros and cons of different property types and how these work in conjunction with their investment goals and life and financial circumstances. Choosing the wrong property type can lead to a significantly lower return on investment, which means it will take longer to reach your investment goals.
This is an extract from Momentum Wealth’s Residential Property Market Update