Are you thinking about buying an investment property and are not sure whether to buy a house or unit?

Many investment property analysts argue that it is the underlying value of the land which drives the capital growth of property. With only 0.3% of Australia’s vast country urbanised, there’s no wonder that land is a premium and owning your own home is still considered the “Great Australian Dream”. Compared to some other countries, Australia has strict and somewhat cumbersome planning regulations that restrict outward urban sprawl. According the Dr Shlomo Angel, Professor of Urban Planning at New York University, land supply bottlenecks lead to increases in land prices and therefore increases in house prices since land is a major component of this.

Such constraints on land supply contribute to making buying an investment property in Australia one of the least affordable places in the world. The median house price in Sydney for example is 8.3 times the average annual salary (down from 8.6). For some further perspective, Sunshine Coast has a median multiple of (9.6), Gold Coast (8.7), Sydney (8.3), San Francisco (8.0), San Jose (7.2), Adelaide (7.1), Melbourne (7.1) New York (7.0) and London (6.9).

This year, the 5th Annual Demographia International Housing Affordability Survey noted that; should Australia be able to maintain its over-valued house prices it would come at a cost as future generations would pay a lot more for housing than the past causing Australia’s relative standard of living to decline.

So, considering buying an investment property - should you buy a house or unit? Looking at the Sydney suburb of Mosman, houses have shown average annual growth of 9.3% over the last ten years whereas units have recorded growth of only 5.13%. The table below also illustrates this point across a snapshot of suburbs in the Lower North Shore, Inner West and Eastern Suburbs of Sydney:

For these suburbs, houses prices have outperformed units in terms of capital growth over the past 10 years.  Recent RP Data figures shows that nationally houses have outperformed units by about 2% per annum over the past 10 years.

However, RP Data figures also show that nationally, over the past 5 years, median houses have recorded a yearly capital growth rate of 4.8% while units have increased 4.7% over the same period. So they have been line ball over 5 years. The housing market typically slumped during 2008 with the economic slowdown and increases in interest rates.

When considering buying an investment property, as well as capital growth, it is also essential to consider the rental yield from the investment. Typically, units produce a higher rental return than houses as they are located in higher density areas, near transport, retail centres and employment hubs so are highly convenient and desirable to tenants. Often the difference in rental return between houses and units is not as great as the difference in capital value between the two, so with respect to their capital value, units often produce proportionally higher rental yields than houses.

The issue of housing affordability and the strength of the first home buyers market are likely to be behind the recent capital growth levels of units with a $100,000 difference between the national median house and unit values*. Longer term, many investment property experts still consider that houses will continue to be the property investment of choice for those seeking capital growth, especially as land becomes scarce.

So when buying an investment property which is better, capital growth or rental yield? 

That really depends on several key factors:

1.    Are you investing primarily for capital growth or income?   

2.    Do you need your rent to cover your mortgage payments or are you looking for tax benefits through negative gearing? 

3.    What is the predominant type of housing for the suburb? Houses or units? In a suburb where 90% of the dwelling stock is comprised of houses, this may be an indication that there is an insufficient level of demand from those looking to purchase units and vice versa.

4.    What are the demographics for the suburb and are these changing? In inner city areas close to the CBD, there may be a higher level of demand for units than houses and accordingly, units may be the better when buying an investment property.

There are many other factors to consider when buying an investment property.

*Data sourced from Australian Property Monitors, July 2009

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