Land to Asset Ratio

The ‘Land to Asset Ratio’ is a phrase we have been using since the early 2000’s to describe one critical assessment we undertake when reviewing the quality of investment properties. This phrase has steadily crept into the vernacular of other property professionals, but is not yet readily understood by most investors.

Knowing the Land to Asset Ratio is important because increasing land value is a primary driver of increases in overall property values. On most occasions, the dwelling is actually depreciating in value. For this reason, it pays to have an optimal percentage of the property made up of the land value.

From an investment perspective, you should strive to select an asset where the land represents 70 per cent of the value of the property, with 50 per cent as the minimum.

In the case of a renovation, the Land to Asset Ratio at purchase could be slightly higher, as you will pay less of a premium for a dated or rundown dwelling. As you renovate you will naturally increase the dwelling value, therefore reducing the Land to Asset Ratio.

Renovators should estimate the current land value, the current dwelling value, and the estimated value of the dwelling once completed.

This will enable you to determine your expected Land to Asset Ratio, which helps avoid overcapitalisation, which is common when renovating or completing small-scale developments. It’s important to remember that you are not increasing the land value by renovating the dwelling.

People often focus emotionally on the dwelling without understanding the land value of the property. This comes at the detriment of successful investment decisions.

Focusing on the Land to Asset Ratio can help remove or reduce emotion biases and attachments to the superficial or changeable aspects of the property, often the interior of the dwelling such as the kitchen, bathroom, flooring or wallpaper.

Thinking about the Land to Asset Ratio often leads to a logical question – should investors just purchase a block of land?

The answer is usually no, because vacant land generates no rental income and the debt is not tax-deductible because the asset is not an income-earning investment. Furthermore, the scarcity factor that helps drive up land values is usually lacking, and spare land is rarely available in highly sought-after locations.

You can have a high Land to Asset Ratio due to:

• Large land size
• A high land value per square metre
• An older dwelling

A high land value per square metre is better to focus on as it is more likely to occur in highly sought after locations. This often means that the land size can be a lot smaller, while still purchasing a property with a high Land to Asset Ratio.

Visualise a standard home on 300 square metres vs 600 square metres. The property with less land, but in a superior location, can have the same Land to Asset Ratio as one in a poorer location with twice as much land.

In superior locations (which is regularly closer to the CBD’s) you have more established suburbs, and therefore, a higher percentage of older dwellings and period homes.

In these situations, you are more likely to have a superior Land to Asset Ratio than a newly completed property because the new property is yet to complete its depreciation phase.

– By David Johnston, Founder and Managing Director of Property Planning Australia, and Co-host of the mini-series ‘The Property Planner, Buyer and Professor’ which is currently on the Mentor List Podcast.

There are many important facets to consider when selecting a good property, from cash-flow determination through to understanding what growth drivers are present. One really important concept which is often overlooked by investors, planners and accountants is the Land to Asset Ratio. In the pursuit of chasing ‘newness’, low-maintenance, no-renovations-required, or tax benefits (negative gearing and depreciation in the case of an investment), many investors and others alike overlook the negative impact on the short to medium growth potential of the asset because they get the Land to Asset Ratio (L-AR) so wrong.

This is where Land to Asset Ratio becomes interesting. As a property investment advisor, I generally limit the L-AR to 50%.

Let’s assume that the house is 60 years old and in original condition. It’s fair to say that the land value makes up the vast majority of the property itself and the house is not worth a significant proportion. In this case the L-AR could be around 90%.

If the house on the same block was then totally renovated to a desirable quality, the purchase price would be substantially more, and the L-AR could be closer to 70%.

However, if the house was brand new, we’d simply add the construction cost plus builder margin to the land value and the L-AR would most likely fall below 50%.

From a capital growth point of view, the land appreciates and the buildings depreciates. However, this doesn’t mean that the old original house is the premium investment. Finding a fantastic tenant who will pay a strong rental figure will be near impossible in most cases. The completely renovated 1950’s house represents a much more balanced investment because it meets the tenants’ needs in the area, will deliver a sound rental return and will still offer attractive capital growth, all the while also offering some depreciation benefits based on the internal renovations.

– By Cate Bakos, Co-host of the mini-series ‘The Property Planner, Buyer and Professor’ which is currently on the Mentor List Podcast.

Success certainly leaves clues, as the adage goes, but so too does failure. Over recent decades Australia has been through financial deregulation, a structural shift to lower interest rates, a resources boom fuelling rapid immigration, and strong credit growth.

And yet we know that many property investments have continued to underwhelm. When reviewing property portfolios there’s often an under performing asset, and the explanations nearly always lead back to a low Land to Asset Ratio.

Take the stylised example of a $200,000 house on the distant city fringe, where the value of the asset is mostly in the building, with the land worth about $50,000: even if local land values experienced a boom and doubled overnight, it would still barely be enough to move the dial. But city fringe properties are by no means the only under-performers; those shiny new inner-city apartments can produce dud results too.

In recent years we’ve lived through a paradigm shift towards the construction of high-rise towers, often targeted at landlord buyers and frequently to non-resident investors. In many cases the land value component of each individual new unit might just be a few per cent of the asset value, with the rest comprising land remediation costs, expensive construction techniques, marketing and sales expenses, and the developer’s handsome profit margin.

As too many investors are now finding out the resale price of new high-rise apartments can initially fall, and then remain stagnant for years. Of course, the supply and demand for the location and property type are key (reductio ad absurdum vacant land in remote locations has a high Land to Asset Ratio, but demand is low, and the rental returns non-existent).

Over the medium-to-longer term rising land values do the bulk of the heavy lifting for you as a real estate investor, which is where precision property planning and accurate asset selection becomes so vital.

And always remember to think Land to Asset Ratio.

Sydney