Older apartments will defy pricing trends as developers change land use habits: Mark Armstrong

They don’t use land like they used to.  

Last Saturday a large crowd turned out for the auction of a two-bedroom unit at 5/52-54 Grove Road, Hawthorn (pictured below).

After spirited bidding the property sold for $741,000 illustrating strength in this sector. However, when we compare this price with the wider market it soon becomes clear this was an extraordinary result.

The property was held for less than four years after being purchased in October 2009 for $585,000. Based on this purchase price it has been growing by almost 7% compounding each year.

I think this level of growth means the property has performed well as an investment but considering we experienced a slump in 2011 and 2012 the result seems to defy the market.

To put this into context the median value of apartments in Melbourne over the same time frame has grown from $410,000 to $451,000, a compound growth rate of less than 3%. The Grove Road property has more than doubled the growth rate of the wider market for apartments.

In addition it has also proved to be a better investment than houses with the median value growing by only 4.12% from $470,000 to 545,000.

The Grove Road property was built more than 50 years ago at a time when skilled labour was relatively cheap and developer did not have to cram as many apartments onto the block. The property sits on 1500sqm of land yet there are only seven apartments in the development.

If a vacant block of land this size was to come onto the market in this location it would sell for around $3 million. This means each apartment has a notional land value of around $450,000. The vast majority of what the buyer is paying for is the land and this will underpin the capital growth potential because land is an appreciating asset.

There is just no way a developer would do this today.  The aim of a developer is to build as many apartments as town planning will allow.

Take for example this development on Riversdale Road, Hawthorn.

The block of land is a similar size at 1400sqm yet the developer has crammed on 31 apartments that are selling for a similar price to the Grove Road apartment. The notional land value attributed to each apartment in this example is around $100,000. This means the cost of land to the developer for each unit is only $100,000.

When an investor purchasers this property the vast majority of what they are paying for is the construction of the building and the developer's profit.

The notional land value attributed to each unit is a great guide to assist us with the prediction of likely future capital growth. While it does not give an ironclad guarantee of investment potential it should not be ignored.

Properties like Grove Road will continue to defy and out perform the wider market because they are such a unique product. It is just not feasible to produce this product anymore and as a result the supply will never ever grow. Demand on the other hand is only getting stronger and stronger.  

Mark Armstrong is a director of iProperty Plan, which provides independent analysis and tailored advice to investors and home buyers.