Why higher Land-to-Asset Ratio means a better investment for you

Residential property is a fascinating investment asset – there are so many different types of properties and I must say, it can be very confusing to someone who is trying to learn about investing in properties!

As an example, on the type of properties front we have houses, villa, duplex, townhouses, apartments and studios…just to name a few! Now, most people would probably know that houses in general are better investment than say, studios. But do you know why?

The difference in growth fundamentally lies on the concept of “Land-to-Asset ratio” and I believe it’s an absolute crucial concept that every property investor should understand. But first, let’s have a look at the definition of this term.

What is “Land-to-Asset Ratio”?

We know what Land is, and asset in this case means the property that sits on top of the land. Therefore, the “land-to-asset ratio” is simply the value of the land divided by the value of the asset (house/townhouse/villa etc) that sits on top of it.

The higher this ratio means the closer you are purchasing towards the actual land value. In other words, if you have a land-to-asset ratio of 1, that means you’re literally paying for the land and the house that sits on top of it is free! Who wouldn’t want a free house, right?

In reality however it’s very rare that you can achieve a ratio of 1, however the closer to 1 the better because of the reason above. On contrary, if you have a low land-to-asset ratio, then this may not be a great investment.

So how do I apply “land to asset ratio” concept into different type of properties?

It’s simple. The land value you can usually obtain from council rate notice, or sometimes even from general public website (in QLD for example). Once you have that information, it’s then a simple matter of dividing the land value by the purchase price, as per our above formula to arrive at this magical figure.

As an example – a house may be valued at $500K and the land underneath is worth $300K. In this instance the land to asset ratio will be 0.6. Whereas an apartment in a high density block may be valued at $500K however the land the unit block is sitting on is only worth $150K, so the land to asset ratio here is only 0.3. (You might ask why the land value so low for apartment? Just picture the land value as a full sized pizza that are being cut into 15 pieces or more, so each slice will only get a small portion of the total value – that’s why!)

We also know that land appreciates and building depreciates over time. That’s why you would want to target properties with a high land-to-asset ratio so your money has a much better chance of growing rather than being eaten up by depreciation!

This then leads to another interesting point on why some of the brand new units in high density complex would lose more value in the first few years…

Why are some units valued at less than what they were when brand new?

We know too many people getting trapped into buying brand new Off-The-Plan (OTP) apartments. I for one also bought my first property as OTP and there are quite a few things that I’ve learnt from it. Check out my earlier blog post if interested.

If you ever walk into an OTP showroom you’ll be hit with advantages such as – AWESOME depreciation up to first 10 years to help get money from ATO when tax time comes, NO ongoing repair/maintenance cost (as its brand new), EASY to find tenant (as its brand new), sometimes they even chuck in “RENTAL GUARANTEE”…

Sounds very good, right? No wonder most uneducated investors would fall for it. I mean, who wouldn’t want a hassle-free investment that’ll look after itself and grow in value over time??

But what these selling agents did not disclose is that if depreciation outgrows land value growth then the unit will be valued less. In particular the first 5 years where depreciation of a complex is at the highest, that means the building may have depreciated (lost value) more than the growth in land value, subsequently causing the unit to be valued at less than what the original purchase price is.

That’s why any experienced investor would steer clear away from the OTP apartments because they know not only high density apartments has a low land-to-asset ratio, there is a chance that they will underperform due to depreciation outweighs land value growth.

So if you can, stick to houses that has highest land-to-asset ratio or small/boutique apartment complexes (ideally no more than 10 to 15 – due to small number of allotments each apartment will still have relatively good land-to-asset ratio!). These have performed consistently well over long period of time and will continue to do so as land values continue to rise in the future due to scarcity.

As always, if you have any questions about land-to-asset ratio or any of the above content feel free to leave a comment or contact us directly using the contact form.

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