How important is land when buying apartments?
It is one of the so-called “golden rules of property”; the driver behind the price increase of any property is land value.
Mark Twain famously summed this up when he wrote that land is the best investment because “they are not making any more of it”.
That seems straightforward enough, but does this golden rule work when it comes to investing in apartments?
What is land content value?
According to this theory, the capital growth driver of an apartment is driven by the value of the land embedded in its price.
The mechanics of this approach are simple: if a complex of 20 units sits on land worth $4 million, each apartment has $200,000 worth of land value and if a unit sells for $450,000, its “land content value” is 44%.
Many property advisers will tell you to aim for an apartment with content value of at least 40%.
If you are an owner of a unit in areas like Brisbane’s Southbank or Docklands in Melbourne, this theory may come as a bit of a shock.
It is quite common for these owners to be told via council or bank valuations that their land content value is as low as 5%-15%.
Does that mean these properties will only experience low growth? Well no, not necessarily.
It’s about market demand …
If high land content theory was an iron law of real estate, then many apartments in New York, Paris or even Sydney’s Potts Point for that matter would have proven to be a terrible investment.
Yet in many of the world’s most expensive cities, high-density units with low notional and values are the norm.
The reason units in some of these areas have had above average growth comes back to that other real estate rule: the mechanics of supply and demand.
If a market in a high-density location, like Monaco or central Sydney, has 4,000 apartments for sale and 6,000 interested buyers, the price of units will rise even if the notional land content value of these units is low.
In these markets, it’s the competition between buyers for “available space” which better explains what is really going on.
… and market supply
What happens when we reverse the equation: more units for sale than interested buyers – will values will stagnate or fall?
The short answer is that they can. We’ve seen some instances of this play out over the past 20 years in cities where there has been a big increase in high rise living. When the numbers of apartments for sale outpaces the numbers of buyers, prices
have stalled or fallen.
The problem here is not the low notional land value of units; it’s usually a case of development running ahead of demand. When you look at some of these precincts years after that over-development phase has ended, in many cases the sale prices of units is growing again.
Where it holds true
In suburbs surrounding most of our capital cities, detached houses are the dominant property type with just with a sprinkling of apartment complexes. In these markets, land content theory is a good guideline.
But in areas increasingly dominated by high and medium-density living, land content theory is not that helpful.
In these areas it is the “competition for available space” which is a much better guide.
- Paul Thornhill (realestate.com.au)
