By Cam McLellan
Pretty buildings are all well and good, but it’s even better to notice the ground you’re standing on. That’s what you’re really investing in, because a smart investor always invests in land.
If there’s one thing you need to understand about property investment, it’s that the land is the only thing that will increase in value; the house that sits on it is only going to depreciate.
The Golden Rule When Investing
Land is an appreciating asset, meaning it goes up in value. Buildings are depreciating assets, meaning they go down in value.
It really is that simple.
The taxation ruling on this is that the building itself has a deemed lifespan of 40 years. Theoretically, at that point it needs to be replaced.
Let that sink in and never forget it. Wealth comes from land only. The building’s only purpose is to gather rental income and help cover the land holding costs.
Land vs Building Value: Think About Your Long-Term Strategy
Here at OpenCorp, we’re always about long-term growth. Ask yourself, what exactly is that?
My definition of long-term is often different to other people’s. The reason for this is that my portfolio is not really for me. It’s for my kids and their kids and so on. My definition of a long-term investment is an investment that will continue to grow in value for 100 years or more.
So with that in mind, I always ask myself how a property can fit into my long-term investment strategy – and that’s where land content value comes into the picture.
Land Content Value
People talk about land content value as a rule. Don’t worry yourself too much about this calculation. If you’re buying houses, or even units or townhouses with reasonably sized land for that particular suburb, they can be worthy investments.
I do, however, strongly advise staying away from small units; you can classify one or even very small two-bed units with low land content as an apartment.
Here’s a basic rule I use when considering an investment:
The total floor area of all buildings needs to be less than the total area of the site.
It’s fairly simple when you think about it.
Here’s how it looks as a sum: The land content ratio (LCR) must be > 1:1 or 100%
Example 1: The LCR of a standard home.
House = 200 m2
Land = 400m2
LCR = 2:1 or a LCR of 200% (this is good as the land is double the size of the building).
Example 2: LCR of the standard apartment.
Apartment building = 10,000m2
Land = 1,000m2
LCR = 1:10 or a LCR of 10% (very bad as the land content is only a fraction of the building size).
Apartments Make Bad Investments
This is why apartments are bad investments. Yeah, that’s right, bad.
Like the wicked-witch-type bad.
Apartments are a flashy investment option. There is something cool about the thought of owning an apartment. But the fact is they don’t meet your long-term criteria.
Even if apartments were to grow in value at a faster rate than medium density housing, I still wouldn’t buy apartments to add to my portfolios.
The fact is that if I purchased an apartment, I know that in 60 or 70 years’ time, it’s going to start to look run down. An apartment will age and then need replacing.
It’s hardly likely that when that happens, all the apartment owners will band together to build a new building on the land. Instead, the apartment will have to be sold for below value, at a price that’s cheap enough for a developer to make a profit by knocking it down and building again.
Smart investors don’t try to pick winners; they instead avoid picking losers.
When we think of land content, why are apartments almost always far from worthy investments?
Ask yourself this question: If you buy an apartment, how much land do you get with your purchase? Well you do get some land, but to really understand how much land you’ve purchased, you have to divide the size of the block the building is sitting on between all the apartments.
Yeah, that’s right; essentially you don’t end up owning much land at all, which means there’s not much to appreciate in value.
Therefore, my choice is to purchase medium-density housing that will continue to grow in value, even if in 60 years I have to replace the house that sits on top of the appreciating asset (the land), I will still have a very solid portfolio.
Remember the golden rule: land goes up in value and the building goes down in value.
How Supply & Demand Factors in
Let’s think for a moment about supply and demand.
When demand becomes greater than supply, it means there are more buyers than suitable property at that point in time. Pressure on supply means prices go up.
When supply becomes greater than demand, it means there is more property than buyers in the market, meaning prices stagnate or drop until they reach a price point that encourages more buyers to enter the market.
When it comes to apartments, developers can just keep stacking more and more apartments on top of each other, so it’s hard in some places to get real pressure on supply. This is why I also recommend that you do not invest in or around CBDs.
Over the long term, the land component is what will increase in value. As a general rule, medium-density housing with good land content will continually outperform apartments. Stick to a safe, proven strategy.
Stay away from apartments and you’ll do OK.
Never forget the golden rule: Land appreciates. Buildings depreciate.
And if you really like apartments, rent one.
For more advice or insight into property investing, be sure to follow the OpenCorp blog. Or if you’re looking at cracking into property investment to start building your long-term wealth, contact one of our expert consultants to help build your property portfolio.