It takes courage to go against the grain

I spoke to one of my mentors this week who runs a large real estate investment company offshore. We shared notes about the property market, I noted the obvious observation that investors coming back into the market here in Australia, yet apartments remaining sluggish due to less migration. Most want land and that is causing single family house prices up, a lot more than apartments.

He agreed and said he is seeing the same thing in his country and across several international markets, with the exeption of Europe, where houses are actually very expensive and quiet rare for investors to buy as rentals.

Apartments in my opinion are now very attractive investment options. Not only do they usually carry higher rental yields compared to houses, but they also allow investors a lower entry point and the ability grow a portfolio with more scalability into the future.

You’ll need to be patient, but superior compound annual growth will come in the next 5-10 years.

Looking at the numbers

According to Corelogic, house prices have risen by 18% across Australian capital cities in the year to July. Apartment prices have risen by 9%. If you go back 10 years, you’ll see that Sydney houses have doubled while apartments are up by around 50%. The numbers change from month to month, but the general ratio has yet to reverse.

Readers of this newsletter know that I like to think in cycles, over long periods of time. See this note for some background context.

I’m not sure what the trigger will be, but at some point in the next couple of years, apartments will grow faster and strong than houses. Growth rates will revert back to the mean.

It might be an opening up of borders and migrants flowing back into major metropolitan cities, driving up rents and making apartment yields too attractive to resist. It could be a suply glut due to lower apartment construction during the pandemic. It could be something completely different.

I don’t really care about the reason, what I’m focused on is the outcome. The average house price to apartment ratio has grown significantly during Covid, not just in Australia, but many similar markets around the world.

Government policy aimed at affordability

We live in a world dominated by ultra high levels of debt and low interest rates. Investors will continue searching for yield in the years to come and rising house prices will limit afforability for many ordinary home owners and investors. Apartments are a sensible option, yet at the moment, they have almost zero moentum behind them as everybody opts for a block of land.

Another big factor is the social impact of rising house prices. Western Governments operate on 3-4 year election cycles. House prices rising are good for most households, yet many young voters and renters feel disenfranchised and housing becomes a major issue at elections. So governments have continue to announce home incentives for new buyers aimed at price points which usually correspond with apartments in major metro cities.

More fiscal policy is likely to see natural demand for apartments, together with a demographic shift among millennials who prefer to work in social centres where they have access to transport, ammenity, lifestyle, employment, health and education facilities.

How to invest in apartments

I recently had a great chat with the Wealthi investment team on their weekly podcast, where we discussed different apartment options and which I believe are the best when making an investment. I also spoke about earnings growth and how to pick markets which are likely to get capital appreciation from growth in rental income.

Finally, I spoke about my preference for apartments given my own personal investment strategy and desire to grow my portfolio into the future, making apartments are more agile and diversified option where the law of large numbers should mitigate one of shocks, such as a tenant moving out of structure problems etc that come with real estate.

It makes more sense to me to have 4 apartments generating 4 income streams than 1 house generatig a single income.

Land always goes up

Capital growth is driven by scarcity. It’s true that land is scarce and this means it goes up in value over the long term. Some investors completely ignore apartments because they stop here. We need to go further. Land is one type of asset, but it isn’t the only asset. Gold is the most optimal metal, but that doesn’t mean we can’t generate better returns buy buying silver, copper or nickle when they’re price has been supressed below historical mean levels.

One final point to note about scarcity. While it’s true that land is scarce, apartments in great locations are also becoming scare in some areas due to zoning constraints and the inability to add more supply.

There’s no shortage of land in outer suburbs, but there is a shortage of good quality apartments, at affordable prices, near infrastructure and city centres. I personally don’t like CBD’s where you get high density. Instead, my preference is for village locations with a hight limit of 4-6 levels and nosey neighbhours that make it difficult for each new project to get out of the ground.

Some of the world’s highest priced property transactions this year have been apartments. Take for example James Packer’s Crown Barangaroo, where some buyers have paid in excess of $60m for apartments in the new building spanning views over Sydney harbour.

In Manhattan, a Saudi retail mogul just listed his apartment at 452 Park Avenue for US$170m. He paid US$88m. Sure, this is an exception rather than the rule. But my point is that not all apartment investments are the same. If you’re looking for value in the market, apartments have low sentiment and represent good discounts relative to houses. I’ll be adding in my portfolio over the next few months.