Property or Shares?

Property or Shares?

One enquiry we often deal with is whether a client should invest in residential property or the share market?

Trying to compare property and share indices is fraught with difficulties as there are very few residential property indices and research available for properties.  Many providers have a vested interest in the information provided and the property indices have absolutely no tracking of any capital improvements that may vastly increase a property’s final sale value. Further to all of this, the calculation itself is complex and uses extrapolated data (because houses are not all the same nor are they for sale at the same time).

The alternative to trying to compare indices is making a forecast based on a number of set assumptions. The drawback to this approach is that the final result will be tilted in favour of whichever bias I choose to use in my assumptions. Effectively, if the annual returns assumed for a property were higher than those assumed for shares, then the final forecast result will obviously favour the property.

Further, any forecast outcome is based on pure guess work, because we realistically have no idea what will happen in the future. As such, most forecasts extrapolate from historical information and again, if the historical information used favours one investment over the other, then Blind Freddy can see that the investment with the best recent history is going to appear to be more likely to outperform in a forecast.

Finally, the two assets are completely different. Shares are an investment made into a company with the objective of providing a share in a company’s profit. As such, the asset is generally intangible and its value purely based on an assessment of future profits. Property on the other hand is bricks and mortar (very tangible) and the owner is paid a fee (rent) by a tenant for the use of the property.  As we’ve seen in Australia recently, the price is not purely related to the future rental expectations but a number of lifestyle factors.

Property Considerations

  • Indivisible – one of the major drawbacks with a property investment is that the investment in property is an all or nothing decision. It’s often said that you can’t sell a bathroom to buy a holiday. You may be able to redraw on an offset though if you are managing your debt successfully.
  • Illiquid – whilst the recent market activity has promoted sales of property at the click of a finger, the market doesn’t always provide a ready sale. Once the property does sell there is still the settlement period which generally runs around 40 days.
  • Purchase and Selling Expenses – there are a number of costs in purchasing a property that mean that property should be taken as a medium and long term investment. These costs include stamp duty and conveyancing on the property purchase. On the sale of the property there are agents fees and further conveyancing.
  • Location – the old adage “location, location and location” mostly rings true when it comes to making a purchase. However, as any specific location gradually gets more expensive, the surrounding areas will enjoy a similar lift because purchasers gradually trade proximity to a location for savings in the property purchase price.
  • Repairs and Improvements – in order to keep the property liveable there is an onus on the owner to make any repairs on a property where required. In addition to this, especially in areas where attracting tenants is more competitive, the owner may need to make improvements and keep the property attractive for future tenants. This could involve quiet a lot of additional cashflow being sunk into the property investment, reducing the final net rental.
  • Ongoing costs – such as strata costs and rates. On some casual rentals costs for cleaning and advertisements can quickly erode the rental income obtained.  Strata and sinking fund costs are a very important consideration with purchasing an apartment, future issues with the property can dramatically impact on the charges levied for these and leave owners massively out of pocket and with a property that is difficult to sell.
  • Gearing – one of the benefits of investing in property is the level of gearing available which can magnify the profit from your own money. The banks will loan a considerable portion of the property value generally up to 80%, which allows a five times increase on the profit attributable to your own money. Of course the flip side is that gearing also magnifies the losses if you make a poor purchase decision. The final risk with gearing is the impact of interest rate increases which can rapidly make a cashflow positive property a drain on your cashflow.

 

Whilst there are a number of important considerations here, and for a property investor, the implications of each of the above should be fully assessed prior to committing to a purchase

The same rule applies to all investments – the better you understand the investment the more likely you are to make a wise choice.

Finally, a recent comment from the well-respected economist, Dr Shane Oliver would suggest that the present market is more challenging than it has been.

Dr Oliver said there “remains a case to be cautious” regarding housing as an investment for now.

“It is expensive on all metrics and offers very low income (rental) yields compared to other growth assets. This means a housing investor is more dependent on capital growth.”

Sacha Loutkovsky
sacha.l@orionfg.com.au
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