Apartments Intrinsically Undervalued and Well Overdue for Price Growth

Wemyss’ research demonstrates that following a period of relative underperformance compared to the freestanding housing market, current apartment prices do not reflect an inherent underlying value underpinned by recent land appreciation.

Further, his analysis indicates a high likelihood of significant price growth in the coming ten years to rectify the current misalignment, making it an asset worth holding onto or considering investing in.

The following provides a summary of the report findings:

Implied land values indicate that apartments are currently intrinsically undervalued. Houses have displayed strong capital growth rates over the past eight to 10 years due to appreciating land values.

Logically, therefore, despite limited price growth recorded during the same period, apartments (which tend to have a 45-55 per cent land value component) must also be worth more.

In fact, intrinsic land values implied by house price growth during the previous seven years suggests that apartments may be fundamentally undervalued by 30-40 per cent.

All markets and asset classes move in cycles that include periods of growth, contraction/correction and sideways drift (no change in value). That is why, in the short run, returns can be inconsistent. However, it is well documented that investment returns eventually revert to their long-term mean (or average).

That is, periods of below-average growth tend to be followed by periods of above-average growth.

Additionally, there is strong evidence that three factors are predominantly responsible for the recent underperformance of the apartment sector compared to houses, being:

• A substantial increase in new apartment supply between 2011 and 2017;
• A significant number of foreign purchasers incentivising the delivery of a substantial volume of cheap, poor-quality stock; and
• Tightening in credit laws since 2009 disproportionately impairing the borrowing/purchasing power of the typical apartment buyer demographic.

Given a sharp decline in new apartment supply since 2017, foreign purchaser numbers having fallen by more than 75% and the recent relaxation of “responsible lending” regulations, these factors no longer remain an impediment to future apartment price growth.

On this basis, it is very likely the capital growth rate for apartments over the next ten years will substantially exceed the growth rate over the past ten years. 

Indeed, it’s possible the capital growth rate for apartments will adequately compensate investors for the sector’s price-growth underperformance in recent years.

Generally, apartment growth cycles tend to last between five and ten years (although Brisbane’s extended growth period between 1980 and 2002 is a clear exception). The average capital growth rate for apartments over the next ten years would need to exceed 9.2 per cent a year, to make up for the past eight to 10 years of under-performance.

This is not unrealistic, with historical growth rates over the previous 40 years, indicate this has occurred multiple times in the past.

To paraphrase Warren Buffett, “markets reward patient investors”, and in this case apartment investors are looking to be rewarded very well.