“Land appreciates, buildings depreciate”, is the maxim you’ll hear in property investment frequently. Land goes up in value but buildings go down in value.
You may also have heard that only buildings can be depreciated, which means you’re better off getting as much improved value as possible to reduce your tax. You’ll also have heard that the cost of construction is increasing, which increases the value of buildings over time.
So what’s the real story?
If we look at the example of Brisbane from 1991-2011, we can see how much both land and buildings have increased in value per annum:
Based on these figures, if we invested $100,000 each in land and in buildings twenty years ago, what would each asset be worth today?
It’s clear that land is the stronger performer of the two. In fact, these figures should be even more heavily skewed towards land. After all, while the cost of construction has increased 4.29% per year, the quality of construction has improved as well. A house built 30 years ago won’t be as nice as a house built today.
This should not surprise us. It’s land in the right locations that is the scarce commodity, not buildings. There is no shortage of materials and labour to construct buildings, nor is there a shortage of places to build them. There is, however, an ongoing shortage of land with the best access to jobs, transport, schools, lifestyle and amenity. This is what drives capital growth.
WHAT ABOUT DEPRECIATION?
Depreciation is a handy way to boost your cashflow. But it’s not going to make you rich. If we use the same example as before, and depreciate the entire $100,000 invested in buildings at the highest marginal tax rate (49%), it doesn’t change the outcome much.
Depreciation is a useful tool for the investor, but it shouldn’t be the reason you invest. It’s not free money either - in the event of a sale, the amount depreciated reduces your cost base, increasing your capital gains tax.
BUT I CAN’T JUST BUY LAND, CAN I?
This is true. While you can buy a vacant block of land and hold it, most people can’t afford to do this, because it means foregoing a rental income. The loss of a rental return would also make the the long-term return of the property much lower, regardless of how strong the capital appreciation of the land was.
You can, however, buy properties with a higher percentage of land value, and a lower percentage of improved value. All things being equal, if you maximise your percentage of land value in your property purchase, you give yourself the strongest chance of capital appreciation. The key here is getting the balance right between long-term capital appreciation and short-term cashflow. To learn more how to find this balance, check out our Buy and Hold Strategies article.