Rule #1: Capital Growth = Land Content x Location Value.
We start our series of tutorials with this fundamental rule of property investment. It’s one that isn’t immediately apparent because most of us care about the homes we live in – and when I say homes, I mean the buildings.
Real estate is about more than location, location, location. It’s also about the AMOUNT of land you own in that location.
The basic principle of capital growth in real estate is that the value rises fastest when the demand (the number of people who want the property) is growing faster than the supply (the amount of properties available that meet their criteria).
Examples where this happens include harbour-side real estate in Sydney, beachside real estate in Melbourne; property backing onto a beautiful park or located in a sought-after school district. All these examples are in short supply and can’t be increased, which makes them scarce and therefore increasingly valuable.
The scarcest commodity of all is land. Yes, dirt “and they aren’t making any more of it”. Especially well located dirt. Remember, well located can mean many things. At a large scale, well located can encompass all of Melbourne when you take into account the city’s rapidly increasing population (Last year 125,000 people moved to Melbourne and last time I checked, not a single square cm of new dirt was created!). So almost everywhere land is increasing in value due to rising demand, with little new land becoming available (except in the outer corridors) – at least not within the existing footprint of greater Melbourne.
So when you think about a property investment – as a family home or a separate investment – the first question to ask yourself is “What’s the land content?”
The value of land within a particular location is usually fairly similar. For example, nice family home in Bentleigh, approx. 600 square metres in size, near the train station and in the McKinnon High School Zone would be worth about $1.5 million (or about $2,500 per square metre).
So an old unrenovated home in such a location is probably worth exactly that – $1.5m – so the house is worth zero and the land content is 100% of the value.
On the other hand, a beautifully renovated or new built 5 bedroom house on the same block might be worth $2.5m – so the land content ($1.5m) is only 60% of the value of the property.
Now as an old accountant friend of mine said, “Evan, only remember one thing – buildings depreciate, land appreciates.” So, the higher the proportion of what you are buying is land versus buildings, the stronger your capital growth is likely to be over time.
The equation is similar for apartments – divide the total amount of land by the number of apartments. There are other complexities to take into account, such as body corporate involvement, heritage or zoning overlays, but the principle is the same.
This golden rule of land content applies to both house and apartments, but it applies much more fundamentally to buying houses and it’s why, in general, houses perform better over the longer term – they have higher land content.
So here’s the takeaway; look for property with high land content in a scarce, sought-after location, buy it, and you’ll be in for a great ride!
For more information please contact Evan Thornley, Executive Chair on firstname.lastname@example.org