Apartments vs house: What’s the best investment in today’s market?

Investing in a house vs an apartment. Source: Getty

Is it better to invest in a house or an apartment?

That’s an age old question, but the shift-change to a new working and home life prompted by the COVID-19 pandemic, combined with a loss of confidence thanks to some shoddy high-rise apartment buildings during the last building boom has seen investors increasingly shy away from investing in apartments.

It seems that more investors are now asking if apartments are still a good investment in the current market?

Well…my response is… it depends.

It depends upon the location of the apartment, if it’s family friendly or if it’s in a high-rise Lego Land building, and it depends upon the neighbourhood, the size of the apartment plus a myriad of other factors.

So I’ll first unpack the challenges the apartment market faces, what’s driving the change in sentiment from investors and what we can expect going forward.

And then finally I’ll answer that question – “should you invest in a house or apartment"?

Houses have outperformed apartments

Over the last few years, houses have generally outperformed apartments in Australia’s major cities.

While record-low interest rates, improved household savings, low listing volumes, post-lockdown lifestyle changes, returning cashed-up expats, government incentives and soaring consumer sentiment has spurred a surge in prices in the housing market, trends in apartment prices show a different story.

I remember times when apartments outperformed houses, but for the last decade or so house values have risen at more than twice the rate of units.

And the current property boom widened what was already a sizeable difference in prices.

For example Sydney’s median apartment price of $755,000 is now about $355,000, or 32 per cent, cheaper than the $1.11 million median house price.

Of course, historically apartments have been cheaper than houses but the gap in prices has grown particularly wide in the past year.

You see…demand for apartments has dwindled with much of the traditional buyer market for apartments - investors and particularly for investors as well as migrants - having disappeared.

At the same time migrants and international students who made a large part of the tenant pool in the many new apartment towers scattered around our capital cities have also disappeared, increasing vacancy rates, decreasing rents (up to 30 per cent in some cases) and discouraging investors from making new purchases.

But it's important to remember that these are big picture ‘overall’ statistics and there’s not a one-size-fits all for all apartment types.

Some apartments, especially family-friendly low-rise apartments in lifestyle neighbourhoods have still performed well and are likely remain in continuous strong demand.

Apartment living: The numbers

According to the ABS, prior to the pandemic in 2016, more Australians than ever were taking up apartment living, whether out of preference, convenience, or for other reasons.

The 2016 Census of Population and Housing found that 10 per cent (2,348,434) of all people in Australia spent Census night in an apartment.

This meant that there was around one occupied apartment for every five occupied houses in Australia - compared with one to every seven, back in 1991.

This growth in apartment living was primarily an urban phenomenon, concentrated within Australia's major capital cities.

But Australia’s reorientation to apartment living was fueled by a number of factors.

Among them there are the young couples delaying having a family, the lifestyle-oriented boomers downsizing and an increasing number of single-person households across the country.

That was then.

Fast forward to the COVID-19 pandemic and the data would look very different today.

Last year apartment renters fled from the cities to urban areas, threatening to turn the property market on its head.

This, combined with the biggest collapse in overseas visitors and foreign student arrivals in the nation's history drove up the number of empty apartments, particularly in the inner cities.

However, the latest Domain data shows that the number of empty properties has now plummeted across the country during the beginning of 2021.

While the number of vacant rental listings has fallen significantly in Brisbane, Darwin, Perth, Adelaide and Hobart over the past year, Sydney and Melbourne continue to bear the brunt of closed international borders that has left many inner-city apartments without tenants.

Data from Domain showed Melbourne’s vacancy rate sat at 4.7 per cent as of February 2021 — a massive spike from the same time last year when the vacancy rate was 1.6 per cent.

“In Sydney and Melbourne, the general rule of thumb is that the closer you get to the city, the higher the vacancy rate,” Domain senior research analyst Nicola Powell said.

The importance of neighbourhood

A key driver for the divergence between Australia’s housing and apartment markets was the importance of neighbourhood the global pandemic.

Sure last year offices were shut and lockdowns were in place but moving forward more of us are likely to continue working flexible rosters and working at home more than ever.

This means gone are the days where our ‘home’ was simply the place we rest our heads and enjoy some down time between work and our social lives – the coronavirus crisis has put an end to life as we once knew it.

If social distancing and the Covid-19 environment has taught us anything, it has taught us the importance of the neighbourhood we live in.

If you can leave your home and be in a short 20-minute proximity – whether that is on public transport, bike ride or walk - to a great shopping strip, your favourite coffee shop, amenities, the beach, a great park, that’s the new gold standard of where people want to live.

While in the past many people choose apartments because of the convenience of living near work, now the new remote-working flexible lifestyle born from the pandemic means that workers can now work from anywhere and are no longer tied to being within a short distance to their office.

These days, the “place” people want to live in a ‘lifestyle neighbourhood’ where all amenities are in easy walk or drive rather than living in congested CBD locations.

At the same time, COVID-19 has changed what we want from our homes

And it’s not just the importance of neighbourhood which has shifted Australians’ views.

The legacy of the lockdowns and the work-from-home-movement have made many Australians reevaluate what exactly they want in a home itself.

All of a sudden people were trying to find space to be able to work, study and also relax all under the one roof - and in many cases this hasn’t gone well.

Prior to COVID-19 more Australians were trading space for place and were embracing apartment living, trading their backyards for balconies and courtyards in inner city locations.

But now everything is different.

Now we want more space – a zoom room, a bigger yard, and a garage that can be converted to a gym.

In fact, recent research by major bank Westpac found that with more Australians working from home and juggling school and family commitments under one roof, spacious living is now the top priority.

The COVID-19 pandemic environment has significantly changed home ownership goals and what Australians want most in their next home.

The research also revealed that Australians have significantly changed home ownership goals.

Homeowners are less likely to prefer high-density living in a post-pandemic world, with 77 per cent saying they would now prefer to live in a house because of COVID-19.

This is compared with 22 per cent who sought a home in an inner-city or urban area back in 2019, pre Covid

If so many Australians are going to be working flexibly or remotely for the foreseeable future, it makes sense that in many cases, an inner-city apartment wouldn’t tick all the boxes.

High density building slumps

At the same time as a lack of confidence, a shift away from inner city living and a shake up in the type of property Australians want to call home, the apartment market has also faced a slump in approvals for the construction new high-density projects.

In fact there’s been a 30 per cent slump in approvals for new apartment construction in 2021.

While we are building more detached houses and townhouses, there are very few new apartment complexes in the pipeline.

Our government has a business plan of growing Australia’s population to help drive our economy, and had previously thought our population would grow to 30million people by 2030.

It’s now suggested our population will only grow to 29 million at the end of the decade, but this still means that 3 and a half million people will need to be accommodated somewhere over the next eight years.

This means that when overseas borders are reopened and immigration returns, we will have a shortage of apartments as the lead time to build new high-rise complexes is much, much longer than that for building new houses.

Many, who will be coming from countries where they used to living in high-density apartment complexes will prefer to live in apartments, at the same time we will need to build many more apartment buildings to accommodate such large numbers so quickly.

But I’m concerned about the mini high-rise apartment complex is built over the last two decades.

High rise apartments: The slums of the future

It’s worth pointing out that while large well-located suburban medium density apartments will make great investments increasing substantially in value over the long term, many of the high-rise towers built in the last fifteen years will continue to underperform with poor, if any, capital growth in the foreseeable future.

Of course, these cookie cutter style apartment blocks never made good investments.

They offered little scarcity and had no owner occupier appeal having been built with investors in mind, and often overseas investors who didn’t fully understand the needs of the local market.

Worse still, because of the high developer margins and marketing costs, many investors paid too much to start with and have since found that on completion their properties were worth considerably less than their contract price.

Not only that but they’re faced with major structural defects, fire issues and water issues.

The sad reality is that today, in light of the many media reports of structural problems in some of these high rise towers, there is a crisis of confidence.

This sector of the property market has lost the trust of the buying public and confidence will take quite some time to restore as various stakeholders including state and local governments as well as the construction industry including building surveyors and certifiers scramble to shore up the building sector.

Investors are shying away

Historically, a significant volume of apartments were bought by local and overseas investors.

But as I explained, now many of these investors are shying away from apartments, due to increasing concerns about vacancy rates, capital growth and also because of COVID-19 related concerns.

Highly-publicised failures and defects in high-rise apartments, such as the Opal Tower in Sydney is also playing its part and dampening demand.

But it’s important for investors to remember that not all apartments can be lumped into the same category.

As I’ve already mentioned, inner city CBD apartments are the ones that are particularly suffering with high vacancies and falling values, while family friendly larger apartments or low rise apartments in aspirational and lifestyle suburbs are still in strong demand from owner occupiers and tenants.

But the latest data now suggests that apartment prices are stabilising, and it’s likely that as house prices keep rising and the gap between homes and apartments widen, investors and home buyers will return, particularly for low rise “family friendly” apartments.

While many new homes are being constructed, the pipeline for new apartment complexes is very thin meaning when our borders eventually reopen and demand for apartments increases from the many new migrants and students returning to Australia, apartment prices will start increasing again as the cost of constructing new projects will be considerably higher than previous building costs.

This will of course push up the price of new apartments and with it drag up the price of established apartments.

Remember, property markets are cyclical

When analysing the inferior performance of apartments over the last decade, it’s important to remember that all markets and asset classes move in cycles which include periods of growth, contraction/correction and sideways drift (where there is no change in value).

This means that while, in the short run, returns can be inconsistent, it’s well documented that investment returns eventually revert to their long-term averages.

That is, periods of below-average growth tend to be followed by periods of above-average growth and vice versa

While houses outperformed apartments with regard to capital growth over the last decade, for the 10 years prior to that many well located apartments grew in value as much as houses did.

The fact the houses have displayed strong capital growth rates over the past 10 years due to appreciating land values, interestingly implies that apartments are currently intrinsically undervalued.

Remember, apartments have an implied land value underneath them.

Of course, the high-rise apartments with 200 in a block have very little land value attached to each apartment – it’s the developers aim to squeeze as many apartments on the land as possible.

On the other hand, low density established blocks of 8 to 10 apartments in great suburban locations have a significant land component attached to each apartment.

Logically, therefore, despite limited price growth recorded over the last decade, if land in a particular suburb and street has increased in value significantly over the last decade (as can be seen from increasing house values) then apartments (which tend to have a 45-55 per cent land value component) must also be worth more.

In fact, intrinsic land values implied by house price growth during the last decade suggests that many apartments may be fundamentally undervalued by as much as a huge 30-40 per cent.

That’s why I believe there is a strong likelihood of significant price growth for well located apartments in the coming ten years to rectify the current misalignment, making the right type of apartments (family friendly medium and low density apartments in lifestyle suburbs – not inner-city high rises) an asset worth holding onto or considering investing in.

But comparing apartments to houses is unfair

Of course if your budget allows you to buy a house or townhouse in an A grade location that’s first prize when considering an investment purchase, but our booming property markets mean that more and more investors are unable to afford a house in an investment grade location.

I’d certainly rather own an apartment in a top street in a blue-chip suburb in the house in the middle or outer ring location further away from the CBD.

There’s a strong amount of research data confirming that average capital growth rates are higher closer to the CBD and decline the further away from the CBD a property is located.

Fact is, the rich are getting richer and they don’t want to travel further out and I believe the gap between values in our established inner suburban locations and the outer suburbs will only widen.

And in general apartments deliver better yields than houses meaning they are cheaper for investors to hold on to.

Australia’s apartment market: The outlook

In the short term….

Over the next year or two, it is likely that there will be less demand for apartments while first home buyers continue to prioritise houses and investors remain wary.

In the long term….

Over the next 10 years, I think we’re going to see a shift in Australia’s apartment market, and a much more substantial increase in capital growth.

Why?

A number of factors are at play.

Firstly, it’s clear that as our population grows (once borders reopen) we’re going to need many more large apartment complexes to accommodate millions more Australians.

While currently around 10 per cent of our population living apartments, this is significantly lower than the percentage of people living in apartments in similar size western cities to Sydney and Melbourne, where it’s not unusual to find 20 to 30 per cent of the population living in apartments.

Then, in light of structural and building problems in recent years, the next round of apartments will cost significantly more to build as builders and surveyors will be forced to avoid cutting corners and risking further scrutiny.

This will, in turn, push up new apartment prices and therefore values of good established apartments.

Also, there is no longer an oversupply of new cheap apartments or a surge of foreign buyers incentivised by cheap stock.

Therefore, it is very likely the capital growth rate for apartments over the next ten years will substantially exceed the growth rate over the past ten years.

Particularly in Melbourne and Sydney where the locals are used to living in apartments.

As always location will do 80 per cent of the heavy lifting in a property investment’s performance with regard to capital growth.

So if your budget allows you to buy a house or townhouse in an A grade location that’s first prize when considering an investment purchase, but I’d certainly rather own an apartment in an investment-grade suburb location than a house in a poor location.

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia's leading experts in wealth creation through property and writes the Property Update blog.

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