Expert Bust #21 - Lots of land misses the point

Everyone knows that land appreciates while buildings depreciate. So, how can investors best apply that intel?

Some buy houses instead of units. Some buy houses on big blocks. Some professionals suggest you should aim for a larger than average block size.

I’ve even read one blog, where the apparent expert claimed to have discovered the ideal ratio of land size to house size. And guess what, they just happened to be selling some stock that matched this precise ratio. What are the chances!

But it's not about square metres (sqm). It's about...



It's a measure of how much of your invested dollars have gone toward acquiring an appreciating asset (land) vs a depreciating one (building). Obviously, we want a higher LAR to maximise capital growth.

Picture 2 properties:

• Property A
  • Year 0: $500k
    • $200k land
    • $300k building
    • LAR = 40%
• Property B
  • Year 0: $500k
    • $300k land
    • $200k building
    • LAR = 60%

Now imagine the following happens to BOTH properties:

• Land appreciation = 10% pa
• Building depreciation = 2% pa

We would then have...

• Property A
  • Year 1: $514k
    • $220k land
    • $294k building
    • Total growth = 2.8% ($14k)
    • New LAR = 42%
• Property B
  • Year 1: $526k
    • $330k land
    • $196k building
    • Total growth = 5.2% ($26k)
    • New LAR = 63%

The capital growth is almost double for just a 20% difference between their LARs.

Note that a 40-year old unit worth $800k will have a high LAR despite not having much in the way of sqm.

 

But Property B has 50% more land than Property A. (300 - 200)/200.

 

Property B has 50% more land value than Property A. It might actually be a smaller block in square metres.

 

Thanks. But have to compare apple to apple. A small block with the same land $ value suggested higher value land. So, the potential of appreciation might be different. Only useful if they are blocks next to or very close to each other. I have seen even on the same street just different suburb names make a difference in $/sqm. Anyway, just contrasting experience vs. research. No right or wrong.

 

But do houses depreciate? Fittings do .......

 

Yeah...nah mate.

Maybe some do.

 

Buy all land no buildings
in 1994 I brought a building for $257k the Net return was 19% funding cost 10%.
Then in 1996 I brought the land for $126k the Net return was 4.8% funding cost still 10%
Fast forward to 2021
The building is now worth $0 the land $1.6m
The net return of the building is negative while land it would be still 4.8% (if I continued to maintain the same perpetual contract with the land owner ...which in reality I became the owner in 1996)
That's the oldest land deal of the thirty land only purchases I have made since 1994. (The other forty deals are all normal land with a building )
I was pretty dumb
It took me twenty two years for the penny to drop....if only I realised this fact earlier
@datageek why did you not let me know this fact forty nine years ago. Forty nine seconds at the datageek school is better than forty nine years at the school of hard knocks

 

I live in a place where views matter to the resale value. Unfortunately the proposition in this post doesn't seem to hold true. Now i am all for Land value and think that is long term, but it is realised through the building.

I don't agree with the proposition of straight line depreciation of a building (but do with the fittings). If property does change hands in a 7 year time frame, a good block realises its value via a good building, and loses value through fittings.

The building has a replacement cost. It is worth refreshing my building via refurb (showing the fittings are at end of life) but the building has a long life.

This kind of spreadsheet analysis abstracts the business we are in (house and home for ppl) to digits on a page and accounting rules. It misses the point completely. Buy land with a view, realise that value, get a good tenant (or sit back and enjoy).

If you want to do what the spreadsheet says may as well go and dig up iron ore ...... the spreadsheet looks better.

 

"Buy land, AJ, 'cause God ain't making any more of it" -Tony Soprano

 

Yes, if property A and property B were right beside each other, then you'd have to say property A had a bigger block. But they could be on opposite sides of the country.

The point is, if they both have the same rate of appreciation of land and the same rate of depreciation of building, then the one with the higher land asset ratio wins and that's irrespective of land size - it's dependent on land value.

 

No worries Boganfromlogan. Everyone is entitled to an opinion.

What I like about the data (spreadsheet as you call it) is that it's less subjective. It may not tell the whole story, but it does so in an unbiased way.

It also tells more stories than a human can personally experience. E.g., I can only attend a handful of auctions in a city in a weekend (busy day). But I can analyse auction clearance rates for thousands of suburbs countrywide in a few minutes.

 

BTW, if anyone believes buildings don't depreciate, only fittings do, please don't tell the ATO - how embarrassing for the ATO to find out it's not real after all these years.

 

I think my point was straight line depreciation. I know every structure has a life, and a lifecycle.

The key component for a long term asset that underpins its value is condition, not time. So my house with a $M view can appreciate even as it ages, and if it is in pristine condition depreciation doesn't happen. If the view doesn't depreciate the house doesn't depreciate.

Even if you and your tax office buddies pore over your spreadsheet for a different result, you are just in the land of accountancy not real life.

 

This seems a bit simplified because building cost and labour cost are always increasing. Which would create upward pressure on the building price.

Also, I feel there is value in older buildings due to the generally better materials (hardwood) and the fact that everything has settled with the slab and foundations.

 

You are exactly right!!

 

I agree. I have sold after houses after 5 years for 15% more than I paid spent nothing on maintenance claimed depreciation, of that may be the land appreciated 5% and the house 10%. The new owner has had some good GC so he or next owner might cop the depreciation . At the momment things have flipped where before you could build a new house cheaper than you could buy. Now you can buy much larger superior established houses with unique character in better and elevated locations way less, like half the price of what they would cost to build for the same price as boring cookie cutters in new estates. Government incentives have caused disparity so you cant generalize about depreciation. Point in time of purchase and cycles will determine depreciation.

 

Problem is banks in their wisdom are more willing to lend for poor returning , depreciating, high cost property and they are the only property they will lend for. 4%, returns in their eyes is better than 13%. But I guess the difficulty of people getting finance is the reason for the high returns.

 

Yes, the bank is interested in short term returns not long term gains, and land banking doesn't seem to resonate with them, but high gloss fixtures with a life of 5 years seems to be on point.

Maybe they are greedy?

 

If the view doesn't depreciate, the land doesn't depreciate. Buildings definitely depreciate.

Move the house to a block w/o a view, it won't maintain it's value. The view doesn't follow the house, the view stays with the land. The value of the view is in the land, not in the house.

 

A change in building costs would need to be dramatic enough to not only turn depreciation into appreciation, but to do so to such an extent as to overwhelm the rate of appreciation of the land. Only in that case could property B outperform property A by having a lower land to asset ratio. Mathematically possible, but how likely?