Land component

[Dis]

This is the first time I've seen a study comparing land prices with house prices:

http://money.ninemsn.com.au/article.aspx?id=299850

Based on this, a hypothetical example:

Property 1
House and land in melbourne. The house is newish and appealing to renters. The land lord can charge a good rent (by current standards).

Gross yield 5%. Net yield 4%. Interest rate = 7.5%.

Over 5 years the owner has a negative yield of 3.5% X 5 = 17.5%
Over the same 5 years the owner has a CG of 25%.

Overall he is 7.5% better off. For the sake of arguement, less assume rising rents during this time. Given the high quality of the property lets be really generous and increase his net gain 15% over 5 yrs.


Property 2
House and land in melbourne. The house is old and not appealing to renters. The land lord can only charge a very poor rent (by current standards). The value of the builing makes up a negligible part of the purchase price

Gross yield 3%. Net yield 2%. Interest rate 7.5%

Over 5 years the owner has a negative yield of 5.5% X 5 = 27.5%
Over the same 5 years the owner has a CG of 70%.

Overall he is 42.5% better off. For the sake of arguement, less assume rent didn't rise at all during this time due to the poor quality of the property. The invester in IP2 is still better off by 27% over the 5 yrs.


Some other impications from the above example:
- Investor of IP1 is only making about 3% a year even with generous rental increases
- Investor of IP1 will need to hold 3 high yielding IPs to make the net gain of IP2. How much hime will be lost and how much money (your funds) will be needed before the 3rd Ip is obtained.....?

For your comments

 

[steveadl]

Dis, good article, and great example!

Whilst the specific figure may vary and it would depend on locations, I agree with the principle. This is one of the main reasons I switched from buying new properties (building comprising about 60% of value) to older ones (land comprising 80-90% of value).

Offers better potential growth over the medium to long term. Even for those who have no intention of developing themselves.

 

[BayView]

Whilst both properties have a terrible rental yield, the main factor that come into play because of this is CASHFLOW.

The first property hasn't included DEPRECIATION, and because it is newer, it has more on-paper deductions, therefore improving the cashflow/yield. If the investor re-invests the tax returns (and he/she should) then the returns are compounded and the investor could move onto the next property earlier.

The second property, while returning a better cap growth, would be harder to service the neg cashflow due to the lower rents. The owner may not be able to hold it long enough to realise the gain.
It could be better long term because it has "add value' potential, therefore enabling the rent to be increased and return;
a) better rental yield
b) better on paper deductions
c) better cap growth.
But, you would need to have the funds/cashflow required to adopt the strategy.

IP 1 could infact be a better long term investment from the point of view of servicing the loan, which would allow the investor to get into more property with similar characteristics sooner, and have more exposure through multiple properties to the rising cap growth.

The lack of cashflow on IP 2 may hold the investor back from entering the market again sooner.

If both properties were the same price, and the investor was on a lower income, then IP 1 would probably be the better investment for that person in the short-medium term.

 

[tubs]

I personally like houses between 5-15 years old. Still new enough to get good rents and depreciation, but not so new that the split between house/land values is too weighted in favour of the house.

 

[lev_lafayette]

The Housing Industry Association have been putting out publications on the comparative increases between land and housing prices for some time now (go to the Economics Group section of their website)

As I rather notoriously pointed out in another thread ;-), land supply is relatively fixed and thus tends towards monopolistic prices. Buildings are something that people can make and be employed and be housed in, that is, supply is relatively variable.

Buying up more of the former is individually good if you already have a huge chunk of the market (but collectively bad), whereas if you're starting in IP you should want to increase the incentives - as you've pointed out by your stats - in the second group.

It's just bug crazy to create a disincentive for actual housing, but so many seem happy to let it slide.