The value is in the land
We’ve all heard the old adage that house prices always rise, however, houses themselves actually fall in value.
What I mean by that is while we see property prices rise, what we are actually seeing is land prices appreciating in value. While the actual physical structure of the house itself is actually depreciating.
On the surface this makes sense. When you buy a car, it depreciates rapidly. We see just how fast the value of a car declines when we try and sell it a few years after buying it.
With property, the value is a little more difficult to see. One reason for that is that we don’t often check the market value of our home regularly. And we certainly don’t break it down into a land component versus the value of the dwelling itself.
This is also one of the main reasons we see house prices outperform unit prices. According to CoreLogic, over the past 30 years, the median house price has increased by substantially more than units.
In 30 years, houses increased in value by 453.1% or $760,879 while units grew 306.7% or by $479,880.
When we think about what we are actually purchasing, this makes a lot of sense. If we look at a block of units, they do have a land component. But it is typically just a lot smaller. If you purchase an apartment in a block of 100 units, then you theoretically own one per cent of the land.
Compare that to a house with a large land component and we can see why the appreciating land adds to the higher level of growth. You own 100% of the land compared to 1% in a large unit block.
It’s also worth factoring in the costs that come with maintaining a property. More structure also means more costs along with more depreciation. There are also tax benefits for property investors that can be factored in. When the value of the structure declines in value over time, the ATO lets you deduct this from your income via depreciation. This has the potential to significantly help investors. But generally speaking, you would prefer to see your assets rise in value despite the benefits from a tax point of view.
The other factor that we have to include is not all locations are considered equal. More land in the outback is not going to compare to a small land component in a blue-chip location in a major city.
So armed with this knowledge, how can we use it to make better investment decisions?
Right off the bat, the first thing we need to try and do is look for properties with larger land components. We can immediately rule out large blocks of units and new off-the-plan apartments as these have the biggest structural component and are likely to depreciate the fastest.
However, as an investor, we also have to make some practical considerations. While it might be great to buy a large block of land in a well-established area, the reality of doing that is not often possible for most average investors.
We want to be able to capitalise on growth, but we have to be able to service the mortgage on the property at the same time.
For me, I look at finding good quality family homes that are located in high-quality areas outside of the larger cities. There is no shortage of quality locations like this along the East Coast including places like Newcastle, right up to Brisbane and South East Queensland.
This allows you to get the best of both worlds. Large land component and in a good area that is likely to experience capital growth.
Buying something like an off-the-plan apartment might seem like a good idea if it is located in a blue-chip area, but more often than not, you are simply buying a depreciating asset that will struggle to grow in value for many years.
Focus on land, in good areas are you will give yourself the very best opportunity to come out ahead.