Should you sell an underperforming apartment? Part 2 

In Part 1, I analysed the performance of apartment markets in the eastern capital cities over the last decade. I highlighted the reasons behind their underperformance compared to houses and explored potential factors that might lead to a new growth cycle. 

In Part 2 below, I’m going to help you decide whether you should sell an underperforming apartment.  

When will prices start to rise?  

Apartment values are on the rise in Brisbane.  

Sydney’s apartments are the cheapest compared to house prices, and with a historical growth rate of 6.3% p.a. since 1980, there’s no indication that the market is overvalued.  

However, Melbourne faces potential challenges. Firstly, the ongoing flat cycle may need to persist to further dilute the robust growth experienced between 1980 and 2010 (9.1% p.a.). I anticipate another 5 to 7 years of relatively modest growth at 2.6% p.a. would bring the long-term average growth since 1980 down to around 6.5% p.a., a more sustainable level. Secondly, as discussed on LinkedIn (here), the additional land tax imposed by the Victorian government could dampen investor demand. However, if your apartment primarily attracts owner-occupiers, the impact of this land tax might be less significant.  

Matters you must consider when divesting  

There are a few important matters that you should consider before deciding to divest an underperforming apartment.  

Can you afford to wait?  

All markets move in cycles. We know for sure that apartments will enter a growth cycle, eventually. Therefore, the question is whether you can afford to wait for that to happen. The last thing you want to do is sell your apartment this year and in 10 years, read that it’s resold for double the amount. You’ll kick yourself. However, if you can’t afford to wait, then the opportunity cost is too high.  

Selling and repurchasing costs  

Selling a property is not a costless exercise. You must undertake repairs and improvements to get the property ready for sale. Of course, you will pay an agent a commission to sell the property in addition to advertising and legal expenses. You may have to pay Capital Gains Tax – remember, any depreciation that you have claimed reduces the assets cost base. If you are going to reinvest in property, you will need to pay for stamp duty and possibly advisory fees.  

Not all apartments are created equal 

This chart illustrates that over the very long term, house prices exhibit an annual compounding growth rate ranging from 7.5% to 8% per annum, inclusive of inflation. 

Considering the lower land value component in apartments, it’s logical to anticipate a comparatively lower capital growth. As indicated by the chart above, this growth rate for apartments has fallen within the range of 6% to 7% per annum. 

However, not all apartments are equal. Older-style two-bedroom apartments, with a higher land value component and increased demand, are likely to experience growth toward the upper end of the range, perhaps at 6.5%+ p.a. over the long term. Conversely, one-bedroom apartments, being less desirable, may grow at the lower end of the range or slightly below it, around 5.5%+ p.a.  

4-question decision-making framework 

There are four questions you must answer to determine whether you should divest your underperforming apartment.

Question 1: Is your apartment high quality?  

Admittedly, this is a very subjective question. However, there are several objective factors that you can consider, including:  

• Number of bedrooms. With work-from-home becoming more popular, 2-bedroom apartments, especially ones with a separate study will be in high demand.  
• Attributable land value. If your apartment is in a high-rise tower with 200 other apartments, your land value is tiny. However, if there are only 6 apartments in your block, you’ll likely have a higher land value.  
• Location. Is it located in a blue-chip suburb, close to transport and shops on a quiet street?  

Question 2: Can you afford to reinvest in a higher-quality asset?  

If your apartment is not high quality, it’s crucial to explore alternative investment options. For instance, if you were to sell your current apartment, could you afford to reinvest in a higher-quality apartment, a villa unit, or even a house? This depends on many factors including borrowing capacity, cash flow, equity, stage of life and so on.  

Question 3: Can you make cosmetic improvements?  

Ensuring your apartment is well-maintained can significantly enhance its rental income and overall value. Cosmetic upgrades such as renovating the kitchen and bathroom, replacing floor and window coverings, and applying a fresh coat of paint are often cost-effective measures. These improvements increase the likelihood of your apartment experiencing a rise in value when the next growth cycle commences. 

Question 4: Can you sell the whole block?  

The total value of a block of apartments is sometimes more than the combined value of each apartment. Perhaps this is the best evidence that apartments are intrinsically undervalued. Some of our clients have successfully collaborated with fellow apartment owners, selling the entire block to a developer, and realising significantly higher returns, if there are few development restrictions. Nevertheless, this process can be challenging and time-consuming.  

If your answer is ‘no’ to all 4 questions… 

Then you might be better off divesting your apartment and allocating the equity and cash flow towards better investment opportunities.  

It’s important to get tailored advice  

Engaging a reputable buyers’ agent to assess the investment quality of your apartment is critical. Your mortgage broker can help you assess your ability to reinvest or renovate. Your holistic accountant will identify any tax liabilities. And of course, a financial advisor with deep direct property experience can ensure you make smart financial decisions.