Units or Houses – Which Make Better Investments?
Have you ever wondered whether units or houses make better investments? In this article, I’ll explore the pros and cons for both and provide you with a definitive conclusion.
Units
Compared to houses, units tend to be smaller abodes, with smaller rooms and less private open space. They may be stand alone (i.e. detached), or they may have common walls with abutting dwellings (i.e. semi-detached), and may also have shared space for driveways and parking.
Once the domain of the pensioner or downsizer, units (aka apartments, condos, and plexes) are now popular to the point of becoming mainstream for these three reasons:
1. Affordability
In general, in any given suburb, a unit will be cheaper than a house. This will be because it is a smaller sized building with more compact bedrooms and living areas, but more importantly, because it has less land.
As mentioned, having to put up with small used to be seen as a compromise. Not so much anymore. Smaller now means less cost (i.e. rates, utilities, etc.) and less effort to maintain (i.e. cleaning, garden, repairs, etc.).
2. Convenience
While apartment living has always been a necessity in population dense cities like London and New York, and in places like Europe, Australia was urbanised on the back of a “house in the suburbs on a quarter acre”, and a commute (usually via public transport) to the city for work.
Yet, as travel times increased, and as the amenities in city areas improved, the CBD area has morphed from a place to work and be entertained, to a place to live and work and be entertained. For some, the convenience of walking to the office and access to superior amenities such as restaurants, entertainment, transport, etc. have outstripped the benefits of a traditional house in the ‘burbs and a long commute on a congested freeway to work.
Furthermore, as mentioned, while seen as odd by past generations of Australians, unit living is the norm in many Asian and European countries where space is in short supply. Without any prejudice, immigrants see nothing unusual about living in the same type of (compact) accommodation as is the norm in their country of origin.
3. Yield
For investors, compared to houses, units generally provide a better income return. That is, despite needing to accept a lower rent compared to what could be achieved owning a house, investors are more than compensated with a cheaper purchase price so that when the numbers are crunched, it is usual for a unit to have a higher percentage gross return (i.e. annual rent divided by purchase price) than a nearby house.
Houses
To qualify as a house, the dwelling normally has to be on its own title and have no shared or common area, including walls, driveways, etc. Houses are usually larger than units – both in respect to room size and the amount of private open space.
As mentioned, for many generations past and present, the Great Aussie Dream was to own your own house, which was typically on a substantial parcel of land (such as the classic quarter acre which is a little over 1,000 square metres). While land sizes have diminished (most new houses today come on land parcels of 500 square metres, or less), houses remain the pinnacle of home ownership for those who like their space, are raising a family, and/or who prefer not to be living a wall away (i.e. a few metres) from their neighbours.
Which Is The Better Investment?
Consider this conundrum: you can either buy an older 2-bedroom house for $500,000 in suburb Y, or a new 3-bedroom unit in the same suburb. Which should you choose?
As we flesh out an answer, here’s a general investing principle to remember:
You are better off purchasing the worst house
in the best suburb you can afford,
than the best house in the worst suburb
you can bear living in.
Have you heard the saying “Land appreciates while houses depreciate”? It’s true. What makes a dwelling more valuable is not the bricks and sticks it is made from, which will deteriorate over time and require maintenance, but rather its land size and proximity to appealing amenities. This is sometimes paraphrased as “location, location, location”, but that is only partly true. For land to be valuable it must be usable and it must be scarce; land that is not usable or scarce is unlikely to be a good investment.
The principle mentioned above captures the reality that a bad house on good land will be a better investment than a good house on bad land.
Another general principle to remember is:
Buy the best-worst house you can afford
rather than the worst-best unit.
In other words, dollar-for-dollar you are better off buying a run down house in your chosen location than a spruced up unit. Why? Because over time the land will become more valuable (as it comes more scarce) whereas the unit will depreciate in appeal as it suffers wear and tear from use.
It is true that your rental yield will probably be lower for the house, but whatever you miss out on in income should be well and truly made up for in extra capital appreciation over time.
These two points made, you may be faced with limited deposit capital and/or borrowing ability. If so, then a unit can still be a smart investment if it helps you get in the property market, rather than having to watch on the sidelines as property prices increase faster than your ability to save.
If you are considering purchasing a unit, then here are four recommendations to remember:
- Buy old, not new. Older units are usually bigger, and you won’t pay a premium for shiny and new which is only temporary anyway.
- Don’t get attached. The less attached a unit is, the better. If possible, avoid common walls abutting living areas.
- Less is better. The fewer units on (or in) the block, the better. The more dwellings there are, the less scarcity there is, and the more cramped the living conditions, and the less land that would be “yours”.
- Aim high, or low, not middle. You are better off with a ground floor unit (for convenience), or a high floor unit (for the view), rather than being in the middle with the masses.
To conclude, data that tracks rental yields and movements in median dwelling prices over time indicates that while units deliver a better rental yield than houses, houses outperform in terms of capital appreciation. Given Australia is largely a growth (rather than income) property market, you’re better off with a house than a unit, and better off with a unit than nothing at all.
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Aim high, or low, not middle.
Actually, that’s not necessarily the case for a lot of Asian cultures. For example in China, a 6 stories building, people would prefer to live on level 3 or 4.
The reason is because:
1. Level 1 is considered to be the “ground”, which people tends to avoid especially in cities where humidity is very high, as they’d get wet floor all the time.
2. Level 5 and above sometimes are considered to be “too high from the ground”, and in traditional Chinese culture, it is considered to be bad practice for human feet to be above a certain distance from ground all the time, as people are considered to be “earthlings”, so as such are not suppose to “not touch the earth” for extended period of time.
3. So the logical choice becomes level 3 and 4 in this scenario. In Chinese, they call it “golden 3, silver 4” or something like that….
Thanks for these insights Steven.
They are very useful to know when profiling your potential buyer.
Cheers,
– Steve
Thats awesome knowledge there!!!
A major thing that you don’t mention is the high ongoing cost of Body Corporate fees for an apartment
You make a good point Charles.
Not only should investors compare the gross rent, they should also compare the net rent.
Investors owning houses may have some higher costs (such as land tax, insurance, utilities etc.), whereas investors owning units (if there is common property) may have body corporate costs to absorb.
Regards,
– Steve
I know a lot of owners of units tend to “fire” the body corporate, because they believe the body corp just charges them money while doing nothing. (and a lot of time they increase body corp fee without any justification or with justification but without evidence).
The block of units I used to live in (before I sold it), is had their body corp “fired” by more than half of the unit owners. So in essence, the owners stopped paying body corp fees, and body corp stops servicing them.
Which is not a problem until sometime decides to sell one of those units….
So when I tried to sell that unit, I had to buy a “common area liability insurance” using my own money just for the purpose of selling my unit, as none of the other unit owners were willing to pay for it. But since I was keen to sell it off, I figured it is not worth holding up the sell for $600 of insurance fee… and the unit was sold once that insurance was in place.
One important item missed in unit ownership is the good old body corporate fees and your lack of control over these. Some can be quite nasty and erode what might look like a nice gross yield.
Hi Fergus,
Thanks for joining the conversation.
You beat me by a few seconds publishing my reply to Charles. See my response above.
– Steve
Great article, yes it is a lack of control versus yield.
Bcorp meetings and committees can potentially get nasty.
Another question. Is there a golden rule for unit price for new versus old. Over the years i have attempted to stick to no more than 125% for new versus old, and less than 50% (ultimately 33%) of a house in the same location. I see some “trendy” 2 bed units in Bulimba Brisbane for $700k when there are 3 bed houses with land for $880k. A bit over priced!! Thoughts
Hi Andrew,
No, I haven’t heard of rules for value similar to what you listed above.
It’s an interesting concept though.
Cheers,
– Steve
Great article. Thanks Steve.
I have been pondering this point with prices so high – wondering if all I can afford is a unit but I’ve been hesitant as there is no usable land and associated value. This reaffirms my decision to stay away.
Cheers
You’re welcome Mark.
– Steve
Yes, I also thought “what about the horrible strata fees” for a unit.
Another point is that a new property will give you great depreciation for years to come which is a good tax deduction to those in the higher tax brackets as well as less maintenance and repair costs.
And the worst house in the street may be a lot harder to rent out than a renovated property when demand is not high.
Thanks for contributing.
Just remember that depreciation is not a free hit. It is an accounting allowance against the periodic cost of wear and tear, and to create a cash reserve for eventual replacement.
– Steve
Great article Steve. Has anyone ever considered whether now might actually be a great time to buy well located low density units in Melbourne due to the general negative sentiment around them like this article and many others have created. I have analysed a old rennovated unit in a lowrise block in a great school zone close to Melbourne city with a NET yield of 4% that is growing and avg cap growth at 6-7% a year over the past 10 years. That net yield includes all maintenance costs funded by the body corp’s sinking fund – could rent for 430pw+ (more if Airbnb), body Corp is only 1.8k a good chunk goes into the sinking fund. Sure houses can have greater upside due to development potential but appear much more speculative and harder to hold at this point due to it being a crowded trade with developers, emotional owner occupiers, investors competing to buy in with very poor net yields closer to 2% and thats without provisioning for maintenance. This requires houses to outperform units in a cap growth sense by around 3% just to breakeven. Am I missing something here for the average buy and hold investor?
Hi Bob,
I’m with you. There certainly does tend to be a tendency for “bad news” from the media to be thrown like mud – “Units are in a bubble – blah, blah, blah” and, although the article might have mentioned that these are typically CBD hi-rise units, the whole lot seem to get a caning from “Joe Public” at a BBQ.
As such, I think your point is an awesome one. As Steve mentioned in the article, older units (think “6-packs” and “8packs”) tend to be larger, with more land content so better growth; and often easier to rent because of their larger size. They are also often in well-settled neighbourhoods, thus helping with the “Location” aspect which also leads to better growth.
And if you can find one that is “needing care” and you can provide that, better yet !! Buy a problem, reno it, and sell a solution (or rent out the solution for now !!)
Benny
Hi all,
I agree with a lot of the comments. If one has to invest into units…we rent one after owning one previously…so i have some experience. I agree with everything Steve said about the older…typically Red Brick Units. They are better built, less noise ( especially the internal double brick ones), less maintenance. One does not pay for Gyms, Swimming Pools etc! I would hate to be an owner in some of these new developments. The build quality is very questionable. There are insufficient builders guarantees as well. Therefore future Strata Fees will sky rocket because of the extensive repairs that will be required. With regards to the Middle Unit issue…do not forget the extreme heat and cold! We have found that the middle unit is usually quieter in terms of traffic noise and certainly stays cooler in Summer and warmer in Winter!
Cheers
Juerg
Great !! Keep writing..
Builders in sydney
http://www.reddyhomes.com.au/
As everyone knows Land appreciates Buildings depreciate so why not just buy Land (leased of course)
Land doesn’t give you an income, unless you are running cattle on it or have some other niche use.
– Steve
Great post Steve. You have cleared the confusion between units and houses. However, how do we find the bext suburb as per the quote “You are better off purchasing the worst house in the best suburb you can afford… “? What are the criteria’s for the best suburb? Lets say i can afford to buy a 700K property in Melbourne. There are 100+ suburbs that fall into that bracket. How do I narrow down my search and identify the bext suburb not only to live but for capital appreciation or rental income?
Any pointers will be greatly appreciated.
Hi Steve,
Great article, but how about the same budget in terms of unit in Caulfield compared to say house in Mulgrave or Springvale? Cause you only talking about house and unit in same suburb, but the key is more about same price for diff suburbs? Would love to hear your thoughts on this one…
Thanks