June 29, 2023
Elephant Advisory

Which Is The Better Investment: Houses or Units?

In this article, we delve into the historical performances of both houses and units to help you make an informed decision when the time comes to purchase an investment property.

Which Is The Better Investment: Houses or Units?

The growing unaffordability of the property market has significantly impacted investors, especially in Australia's capital cities. 

Prices have surged to the point where entering the market is increasingly challenging for investors. Buying a house in close proximity to city centres now routinely requires a budget exceeding $1 million, thereby pushing first home buyers and younger investors towards the outer suburbs.

Units have been an increasingly viable alternative to houses in the property market, presenting a lower-cost entry point and a greater stream of supply. But does this come at the cost of the long-term financial success of your asset?

In this article, we delve into the historical performances of both houses and units to help you make an informed decision when the time comes to purchase an investment property.

How do houses and units stack up historically?

Capital gains is the name of the game when it comes to property investing. 

Whilst factors such as rental income and tax incentives will play a role, the ultimate success of an investment property hinges on its appreciation in value over time. 

Historically, houses have outperformed all other types of property.

Recent data from a 2022 CoreLogic report highlights the remarkable growth in housing values over the past three decades, showcasing a consistently widening gap between house and unit prices.

Back in 1992, the median house value in Australia's capital cities was recorded at $167,933, closely followed by the median unit value at $156,472. Over the span of the next 30 years, median house values witnessed a staggering surge of 453.1%, soaring to $928,812 during the peak of the property market in 2022. In contrast, median unit values experienced relatively modest growth, with an appreciation of 306.7% over the same period, reaching $636,352 by the middle of last year.

In terms of annual growth over the last three decades, median house values have risen by 5.87% per annum, whereas median unit values have experienced a slightly lower annual increase of 4.79%.

This is clearly a significant gap, as the power of compound interest magnifies the disparity the longer the asset is held for.

The gap in performance between houses and units can be put down to a number of factors. 

A primary reason is that houses typically have a higher land-to-value ratio than units. Whilst the structure of a property will usually depreciate in value over time, it is the land the property sits on which (usually) appreciates. Therefore, a higher land-to-value ratio will typically mean higher rates of capital growth.

Another key factor contributing to the situation is the interplay between supply and demand. As Australia's capital cities experience continuous population growth, there is a corresponding increase in the demand for higher-density housing. This surge in demand prompts developers and city planners to invest more in the construction of new multi-unit buildings to cater to the evolving needs of the population. In urban areas, this trend gradually leads to a scarcity of houses over time, further driving demand and accelerating price growth.

The COVID pandemic has also played a huge part in fuelling demand for houses, particularly here in Melbourne. Nearly two years of lockdowns and covid restrictions have left many Melbournians feeling understandably claustrophobic living in higher-density areas. As a result, there has been a noticeable increase in demand for larger properties in outer suburban and regional areas, while the growth of the inner-suburbs has remained relatively subdued.

Ultimately, with houses outperforming units by 1.08% per annum in terms of capital growth, it may seem silly to consider any other investment. However, determining whether a property is a good buy involves considering many other factors, and one of the most crucial among them is rental yield.

Are houses or units better for rental yield?

Rental yield, calculated by dividing the property's annual rental income by its purchase price, serves as a key metric in assessing the property's potential return on investment.

The rent you receive from an investment property will be a critical source of cash flow throughout the mortgage, giving you the flexibility to pay for expenses such as repairs, maintenance, loan repayments and more.

Historically, units experience better rental yields than houses do.

According to recent data from SQM Research, the mean rental yield from a unit in Melbourne is 4.6%. This is significantly higher than for houses, where the mean rental yield is only 2.9%.

Units typically perform better than houses on the rental market for a number of reasons. Units sell at a lower price point than houses, meaning investors can receive higher rental yield percentages when compared to the rental income generated. Units are also commonly found in urban, high-density areas where there is strong demand due to the proximity to employment, amenities and services.

The importance of rental yield in your property investment strategy will depend on whether you favour short-term cash flow or long-term capital growth. 

Retirees, who no longer receive a regular paycheck, place great importance on the rental income a property generates as it becomes vital for financing their lifestyle. Consequently, many older investors tend to adjust their investment strategy towards units and higher-yielding assets, recognising the growing necessity for accessible cash.

However, bear in mind that the appreciation in a property's value will quickly outpace any gains in rental income. Don’t get seduced by a high rental yield if it comes at the cost of capital growth. 

If your intention is to hold onto a property for an extended period, the most effective approach for wealth accumulation is to seek out an asset with a strong potential for robust capital gains.

What are the other factors to consider?

When weighing up your investment property options, there are many more factors that will help determine the success of your venture.

The location of your property is crucial, as it will impact demand from buyers when it’s time to sell.

When affordability is a major consideration, deciding between purchasing a unit in an attractive area or a house in a less appealing location becomes a challenging decision. While houses in desirable areas may offer the potential for significant capital gains, their higher price points make them unattainable for some investors. A unit in a highly sought-after area may well outperform a house in an area where demand is lower.

Securing high-quality tenants is of utmost importance, and units often prove to be appealing options for renters. Units in desirable areas open up a wider range of choices when it comes to selecting reliable and responsible tenants, ultimately saving you from headaches in the future.

Another aspect to consider is ongoing maintenance. As properties age, they typically require more frequent maintenance and repairs, which can result in substantial expenses in the short term. This responsibility falls on the owner in the case of houses, while units in buildings often contribute fees to collectively share the burden of maintenance responsibilities.

So are houses or units a better investment?

Historically, houses perform better than units due to their consistent demand and superior rates of capital growth. But that doesn’t mean they will necessarily be the best option for you.

Factors such as rental yield, location, quality of tenants and ongoing repairs will all affect how successful an investment property is in the long run.

If the affordability of a unit helps you better meet these other criteria, then it might present a better investment choice for your situation. 

If you're facing difficulties in finding the right property, consider seeking the assistance of a buyer's agent. They can help you locate a property that aligns perfectly with your financial needs and goals.

Also, be sure to get home loan pre-approval before making a purchase. This step will ensure that you remain within budget and don’t get caught out on settlement day.

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