One-Bedroom Units: The Hidden Investment Goldmine (But Watch for This Critical Trap)

The latest Q2 market data has delivered a surprising revelation that’s challenging conventional investment wisdom. While most property investors chase three-bedroom homes, believing bigger equals better returns, the numbers paint a dramatically different picture. This shift could represent either your biggest opportunity or your costliest mistake – depending on how well you understand the hidden trap lurking in these figures.

The Great Bedroom Reversal: Why Smaller is Winning

Traditional property investment logic suggests three-bedroom homes are the safe bet. They appeal to families, offer stable long-term tenancy, and seem like the obvious choice for building wealth through real estate. But Q2 2024 data shows this conventional wisdom is failing investors.

Three-bedroom properties are delivering the weakest returns nationwide, with average gross yields of just 5.7%. In Auckland, where property investment competition is fiercest, three-bedroom homes are showing the poorest cashflow performance across all property types.

Meanwhile, one- and two-bedroom units are quietly outperforming the market. In Auckland, two-bedroom units achieved yields of 5.6% – already better than their larger counterparts. But here’s where it gets interesting: one-bedroom units recorded yields of 16.4%.

That’s not a typo. One-bedroom units are delivering nearly three times the yield of three-bedroom homes.

Why One-Bedroom Units Are Outperforming

Several market factors are driving this performance gap:

Lower Entry Costs, Higher Returns
One-bedroom units typically cost significantly less to purchase than three-bedroom homes. This lower entry point means your deposit goes further, and the rental income represents a higher percentage return on your investment. In today’s high-interest-rate environment, this improved cashflow can make the difference between an investment that pays for itself and one that drains your resources monthly.

Strong Tenant Demand
Despite investor preferences for larger properties, tenant demand for smaller units remains robust. Young professionals, students, and downsizing older adults create consistent demand for well-located one-bedroom properties. This demographic often prioritises location over space, accepting smaller living areas to access better suburbs, transport links, or lifestyle amenities.

Faster Tenant Turnover Can Mean Higher Rents
While some investors fear higher turnover in smaller units, this can actually work in your favour. More frequent lease renewals provide opportunities to adjust rents to market rates, whereas long-term tenants in family homes may stay for years at below-market rates.

Lower Maintenance and Management Costs
Smaller properties generally mean lower maintenance costs. Less space equals fewer fixtures, fittings, and potential issues. Landscaping costs are minimal or non-existent for apartment units, and overall upkeep is more manageable both financially and logistically.

The Critical Trap: Leasehold Distortion

Before you rush to invest in one-bedroom units based on these impressive yield figures, there’s a crucial detail you need to understand. These standout yields are significantly skewed by leasehold properties, particularly in Auckland’s CBD.

This distortion is creating a dangerous trap for unwary investors. The 16.4% yields look extraordinary on paper, but many of these high-performing properties come with serious structural problems that could devastate your investment over time.

What is Leasehold Property?

Leasehold properties represent a fundamentally different ownership structure from the freehold properties most New Zealanders understand. When you buy a leasehold property, you’re purchasing the building but not the land underneath it. The land remains owned by someone else – often the government, iwi, or private landowners – and you pay ongoing ground rent for the right to use that land.

While leasehold arrangements are common in other international markets, New Zealand’s property investment landscape makes leasehold properties particularly problematic.

The Hidden Risks of Leasehold Investment

Ground Rent Escalation
Ground rent isn’t fixed forever. Most leasehold agreements include regular rent reviews, often every seven or 21 years. These reviews can result in dramatic increases that completely change your investment mathematics. What looks like a high-yield property today could become a financial burden tomorrow when ground rent doubles or triples.

Limited Lending Options
Banks view leasehold properties as higher risk investments. Many require deposits of 50% or more, compared to 20-30% for equivalent freehold properties. This higher deposit requirement immediately impacts your return on investment and limits your ability to leverage your capital across multiple properties.

No Land Ownership
In traditional property investment, you benefit from both building and land value appreciation. With leasehold properties, you only benefit from building improvements and have no claim to land value increases. Given that land typically appreciates more consistently than buildings over long periods, you’re missing a crucial component of property investment returns.

Resale Complications
When it comes time to sell, leasehold properties face a much smaller buyer pool. Many investors and owner-occupiers avoid leasehold properties entirely, limiting your exit options and potentially suppressing sale prices even when rental income remains strong.

Lease Expiry Risk
Every leasehold property has a finite lease term. As the lease approaches expiry, the property value can collapse dramatically, regardless of its condition or rental performance. Unless you can negotiate lease renewal (often at significantly higher ground rent), you could face losing your entire investment.

Learn more: Leasehold Properties and New Zealand Property Investors

Real Investment Opportunities in Smaller Units

Strip away the leasehold distortions, and one- and two-bedroom freehold units still represent compelling investment opportunities. Here’s how to identify and capitalise on these opportunities properly:

Focus on Freehold and Unit Title Properties
Ensure any one or two-bedroom investment is either freehold or unit title (where you own your specific unit plus a share of the common property). These ownership structures provide the long-term security and growth potential that leasehold properties lack.

Location Remains King
Smaller units in excellent locations typically outperform larger properties in average areas. Look for properties near transport hubs, universities, business districts, or lifestyle precincts where your target tenant demographic wants to live.

Consider Future Development Potential
Some areas zoned for intensification may see your small unit become part of larger development opportunities over time. While this is speculative, it adds potential upside that doesn’t exist with leasehold properties.

Evaluate Body Corporate Costs
Many smaller units are part of apartment complexes or townhouse developments with body corporate fees. Factor these ongoing costs into your investment calculations to ensure your returns remain attractive after all expenses.

Market Conditions Favouring Smaller Units

Several current market factors are creating particularly favourable conditions for smaller unit investments:

High Interest Rates
When borrowing costs are high, cashflow becomes critical. Smaller units’ superior yield profiles help offset increased interest expenses better than lower-yielding larger properties.

First-Home Buyer Competition
First-home buyers often compete directly with investors for three-bedroom properties. Their owner-occupier advantages (lower deposits, better lending rates) can make it difficult for investors to compete. Smaller units face less first-home buyer competition, creating better opportunities for investors.

Housing Affordability Crisis
As housing becomes less affordable, more people are choosing smaller spaces in better locations rather than larger properties in outer suburbs. This demographic shift supports long-term demand for quality one and two-bedroom properties.

Remote Work Trends
While some assume remote work increases demand for larger homes, many remote workers prioritise location flexibility over space. A well-located smaller unit near cafes, coworking spaces, and amenities can be more attractive than a larger suburban property.

Due Diligence Checklist for Smaller Unit Investment

Before investing in any one or two-bedroom property, ensure you:

• Verify ownership structure – Confirm freehold or unit title, never leasehold
• Research tenant demand – Understand local demographics and rental demand drivers
• Calculate true yield – Include all costs: rates, insurance, body corporate fees, maintenance
• Assess building quality – Older apartment buildings may have significant upcoming maintenance costs
• Review building reports – Check for weathertightness issues, earthquake compliance, or other structural concerns
• Understand lending implications – Some banks have restrictions on apartment lending or minimum floor areas
• Evaluate exit strategy – Consider both rental growth potential and future sale prospects

The Path Forward for Property Investors

Current market data clearly shows smaller units are outperforming larger properties in terms of rental yields. However, this opportunity comes with the significant caveat that leasehold properties are distorting the numbers and creating potential traps for unwary investors.

The smart approach is to focus on freehold one and two-bedroom units that can deliver sustainable returns without the structural risks of leasehold ownership. These properties offer genuine opportunities for investors who understand the market dynamics and choose carefully.

In an environment where interest rates are high and capital growth is lagging, cashflow-positive investments become increasingly valuable. One and two-bedroom freehold units may offer the most sustainable path for investors looking to grow their portfolios while maintaining positive cash flows.

Frequently Asked Questions

Q: Are one-bedroom apartments really better investments than three-bedroom houses?
A: It depends on your investment strategy and the specific properties involved. Current data shows one-bedroom units delivering higher gross yields, but you need to consider total returns including capital growth, ongoing costs, and exit strategies. One-bedroom units can be excellent for cashflow-focused investors but may not suit those prioritising long-term capital appreciation.

Q: What makes leasehold properties so risky compared to freehold?
A: Leasehold properties carry multiple structural risks: ground rent can increase dramatically over time, you don’t own the land (missing out on land value appreciation), banks typically require higher deposits, and resale can be difficult. Most importantly, when the lease expires, you could lose your entire investment if renewal isn’t possible or affordable.

Q: How can I tell if a property is leasehold or freehold?
A: Check the property title and marketing materials carefully. Leasehold properties must be disclosed, but the information isn’t always prominent. Your lawyer will identify this during due diligence, but you should ask specifically before making any offer. Be particularly cautious with CBD apartments and properties showing unusually high yields.

Q: Do banks treat smaller units differently for lending?
A: Some banks have restrictions on lending for apartments, particularly those under certain floor areas or in specific buildings. However, freehold units generally have much better lending options than leasehold properties. Shop around between lenders as policies vary significantly.

Q: What ongoing costs should I budget for with apartment investments?
A: Factor in body corporate fees, which can range from $2,000-$8,000+ annually depending on building facilities and age. Also budget for insurance, rates, property management, and maintenance. These costs can significantly impact your net returns.

Q: Are smaller units suitable for long-term buy-and-hold strategies?
A: Yes, if chosen carefully. Look for units in areas with strong long-term demographic trends, good transport links, and amenities that attract your target tenant market. Avoid areas dependent on short-term trends or single industries.

Ready to Explore Smaller Unit Investment Opportunities?

The data is clear: smaller units are outperforming larger properties in today’s market. But navigating the opportunities while avoiding the traps requires expertise and careful analysis.

Don’t let leasehold distortions or incomplete information lead you into a costly mistake. Whether you’re a seasoned investor looking to diversify your portfolio or just starting your property investment journey, understanding these market dynamics is crucial for success.

Get expert property accounting guidance. Contact our team today to discuss how we can help you along your property investment journey. 

Learn more: Property Investment in NZ: Essential Ownership Structures and Tax Considerations