Evidence is mounting that investment-grade apartments are positioned to appreciate

Investopoly

I wrote this blog in February suggesting that I thought investment-grade apartments were intrinsically under-valued. Well, according to Jarrod McCabe, director of Wakelin Property Advisory, "the investment-grade apartment market in Melbourne is showing signs of growth this year". My view that apartments are intrinsically under-valued has become even stronger over the last 6 months and I would like to share a few reasons why. House prices have appreciated significantly over the past 5-10 years and maybe that's changing As this chart suggests, house price growth has become significantly stronger than apartment growth over the last nine years. The median house price appreciated by 6.8% p.a. on average over that period compared to 4.1% p.a. for apartments. Since citing this chart in February, anecdotally, it would appear that demand for investment-grade houses in Melbourne's blue-chip suburbs peaked towards the end of 2017. Buyer demand in this sector of the market has been less buoyant in 2018. This suggests that perhaps this growth cycle (all markets move in cycles) has ended. Maybe the trend will turn around and apartments will generate stronger growth than houses? Tightening credit means people can borrow less The credit environment is very tight (as I have noted many times previously) and that has put downward pressure on people's borrowing capacities. I estimate that most people's borrowing capacities has reduced by between 20% and 40% (sometimes more) over the past few years. This means more people will be priced out of the housing market (in prime locations) and be forced to consider invest in a one or two-bedroom apartment instead. Supply of new-build apartments The supply of new-build apartments will have an impact on overall median data and supply-demand fundamentals. However, the geographical concentration of new developments is what you must consider. Capital city data is less meaningful. For example, in Melbourne, there has been a lot of new apartment development in Prahran and South Yarra but that seems to be slowing down now. However, suburbs such as Richmond and East Melbourne currently have a lot of large construction projects in progress and this will likely have a negative price impact on established, investment-grade apartment prices in those locations in the shorter-term. Property price growth is rarely linear This week, I was reviewing the performance of a property that a client has invested in recently. The property is located in Richardson Street, Carlton North. The chart below tracks its sales transactions from 1975 through to 2018, some 43 years of data. You will notice that over this time there have been three growth cycles. The first cycle lasted 18 years and generated 12.9% p.a. of growth. After that period the property didn't do very much for 11 years. And then the most recent growth cycle has been for 14 years generating 12.7% p.a. This property may continue to appreciate for a few more years to come - maybe this cycle hasn't ended - no one knows. Importantly, the overall appreciation of this property over the last 43 years averages out to be 9.6% p.a. - which is what you would expect from a quality investment-grade property. In the long run, I think it is reasonable to assume that this property will continue to generate similar returns over the next 43 years. However, my point is that property prices very rarely...