Property and Shares - Which is the Better Investment? Or Should You Own Both?
Updated: Jun 24, 2019
Property as an asset class has its place in any portfolio. As Australians we tend to make the property weighting very high, usually by acquiring the family home then adding investment properties. There are many factors influencing this, and the purpose of this piece is to examine the investment merits.
Does property stack up as the fool-proof investment we grow up believing that it is? And how does it compare to other asset classes? Specifically, listed shares. This analysis aims to provide a more detailed assessment of the real price of each investment, including transaction fees and running costs. For the purpose of this research, I am going to keep it very Aussie-centric (apologies to the International readers), and before I go on, I will throw out a few disclaimers:
1. This piece addresses the investment merits of property. This is very different to buying somewhere to live
2. We look at averages in this piece, so there will always be exceptions
3. The content should not be seen as a recommendation
For the first part of it, we can take a simplistic view of the last 25 years and assess what the return would have been on a house purchase made at the end of 1993. Assume back then, you purchased a house for the national median average, which in 1993 was $111,524. By 2018, that house would have had a value of $571,441. Roughly a 5 to 1 return over 25 years, or an annual rate of return of 6.8%. Had you have bought in Sydney, that house would be worth $696,100 in 2018 (average return of 7.6% p.a.) and Melbourne did better still with a value of $781,650 (average return of 8.1% p.a.) Every other capital city was below the national average. (Source: CoreLogic)
So, would this have been a good investment? On the face of it, sure – especially if you bought in Melbourne, where you returned 8.1% p.a. But here’s the thing about property investment which is often overlooked – what were your other input costs? We’ll look at that in some more detail later.
Before we get to that, let’s compare how the property purchase compared to putting money into the share market. Let’s assume you invested the same $111,524 at the end of 1993 in the All Ordinaries. By 2018, that investment would be worth $817,680 – a return of 9.6% p.a. including dividends. A good 1.5% p.a. better than Australia’s top performing city, Melbourne.
There are so many ‘ifs’, ‘buts’, ‘what ifs’ etc. to this very simplistic comparison it’s hard to know where to start. But these are the bare stats of a comparison of buying an average house in Australia vs a share portfolio generating market returns, and for the purpose of this analysis we’ll stick with it.
The point of diversification is to spread and reduce risk so that one particular investment won’t have too dramatic an impact on a portfolio’s overall performance. The share portfolio in the example above is a diversified portfolio invested in hundreds of businesses and several sectors across multiple geographies. An adverse event in one industry won’t greatly affect the portfolio. The house, on the other hand is on one street, in one town, in one state, in one country. It’s about as concentrated as you can get. A costly repair to the house, for example, is going to hurt returns that year.
The Real Purchase Price
Looking to the next 25 years, let’s assume we were to go through the same investment all over again, starting at year 2018. Compare the purchase of a house in Sydney, paying the median Sydney house price today ($1,026,638), and a diversified portfolio of the same value. We can’t predict with accuracy what either asset class will do over the next 25 years, so for now we will just look at the purchase price of each asset. That is, the total purchase price, as outlined below. We’ll assume we don’t engage the services of a buyer’s agent (which are becoming more commonplace, particularly in the capital cities) for the property purchase.
As shown above, when ancillary costs are included, the asset now needs to appreciate before we’re back to square. In the case of the house, it needs to appreciate 4.22% to get to break-even, and the share portfolio needs to appreciate 1.11%. If we were to use the average rates of return from earlier, (7.6% p.a. for Sydney property, and 9.6% p.a. for the all ords) and apply this to the investments, you can assume the house will take 6 and a half months to break even, while the share portfolio will take just under 1 and a half months. In the scheme of things, the investor won’t be too worried about half a year for a long-term investment, which both assets are.
The investor has a long-term investment horizon – in this case, twenty-five years – so what are the costs to the investor for holding onto the asset over that time? A domain.com search tells me my median price purchase gets me something like a 3-bedroom, 1-bathroom house on an average size block somewhere in the greater Sydney area – obviously a high variance between different post codes. Depending on which council the house sits in, the rates are going to be somewhere around $1,500 - $2,000 per annum. Other ongoing running costs will include multiple types of building maintenance, e.g. landscaping, plumbing and other repairs. Over the course of the 25 years, it’s more than likely the house is going to incur some big-ticket items such as bathroom rebuilds, new kitchen, rendering, painting etc. Conservatively speaking, you could estimate there will be $50,000 in today’s money put into the property as ‘one-offs’ over the 25 years. If we accept that as a fair estimate and add it to the other running costs, let’s compare the assets again, using the average annual rates of return over the last 25 years and applying them to the next 25 years. We’ll assume running costs of $4,000 p.a. in today’s money for the duration to cover the outgoings listed above.
At this point it looks like the share portfolio comes out well ahead over the 25 years.
The year 2044 rolls around and we decide to liquidate the assets. The sale process and costs are as follows:
· Engage an agent and negotiate a contract for sale, with the help of solicitors.
· Dress the property up for sale, including any outstanding repairs.
· Run a campaign of open homes over a period of six weeks, give or take.
· At the conclusion, agree on a price with a buyer and sign contracts, which will include the settlement period – usually six weeks for a residential property. At current rates, you can expect to pay a real estate agent 1.75% plus GST to handle the sale of the house, plus advertising costs.
· Call your broker, ask them to liquidate your portfolio in an orderly manner. Trades settle in 2 business days’ time with cash transferred into your account the day after. The broker fees can vary but assume 1% plus GST.
So let’s look at how this affects the overall returns.
At this point, the shares are looking like twice as good an investment as property. BUT…
This is unavoidable. Of course, there are strategies to minimise your tax, however, in this scenario you’re going to be paying the top marginal rate of tax the year that you sell the assets. UNLESS… the house was your primary residence, in which case there is zero tax liability under current legislation. This gives the property asset an advantage, because tax on the profits of the share portfolio must be paid, after discounting 50% due to the asset being held for >12 months. So, the after-tax returns look like this, assuming the house is your primary residence:
Of course, if the property is not your primary residence, and it was purely for investment purposes, then there will be the tax liability and the property returns are closer to 322%. However, this is a little unfair because it hasn’t taken into consideration the rental yield the property would have generated over the 25 years, were it an investment property.
The share portfolio still comes out in front by some way, even after accounting for the hefty tax bill. This analysis is fairly simplistic, and houses are not homogenous so it’s difficult to apply a constant rate of return across the market. The measure that we’ve used is just an average, so there will be degrees of variability.
But when you break it down comparing the two asset classes, a house is a depreciating asset that requires continual upkeep, i.e. capital injections. Listed companies on the other hand, are living, breathing assets that are generating and growing profits. When you consider this, it’s no surprise that the share portfolio generates the better returns over the long term.
Based on the last twenty-five years, it’s clear the share portfolio is the superior investment. However, after the family home, it’s more common for many people to consider an investment property before a share portfolio. Why is that? There are several reasons, such as a greater familiarity and understanding of property, and conversely a lesser understanding and fear of the share market. At the end of the day, investing in shares is really just buying businesses, and often the simpler you keep it the better you will do. Unfortunately, an entire industry of financial markets commentary generates noise about the market, thereby clouding the important issues and often confusing investors.
Based on the last twenty-five years, while shares were clearly the superior investment, that’s not to say that property doesn’t have a place in a diversified portfolio, because it does. However there are more efficient ways to achieve property exposure without the concentration risk of one large asset (i.e. a house) taking up a disproportionate chunk of the portfolio. An efficient method is to acquire property companies within a diversified portfolio, thereby managing the appropriate exposure. In this example, it’s likely that the property companies will generate a superior yield to the single residential property too. Some well-known diversified listed property companies are currently yielding between 6-7% p.a. whereas the residential property yield in Sydney for a house currently sits just under 3% (source: SQM Research https://sqmresearch.com.au/property-rental-yield.php?region=nsw-Sydney&type=c&t=1). You would expect better prospects for growth from the property company too, as their function is to increase their asset base as well as yield, while the single house will depreciate and require capital injections to keep it up to standard.
Both shares and property have their place in a diversified portfolio and staying the course in both will serve investors well. This point can’t be stressed highly enough. Shares, just like property, are a long-term investment and when viewed as such, investors don’t panic and sell at the wrong time. The purchase of one house within a portfolio makes it difficult to achieve diversification and exposes the investor to concentration risk. An alternative to achieve the property exposure is to own a portion of property companies. As well as being a cheaper option (with reference to fees highlighted above) and a simpler transaction, this will also diversify the investment and, based on current conditions, enhance the yield.
If you would like more information, or you feel this is something you would like to explore as it relates to your objectives, please feel free to get in contact with us at firstname.lastname@example.org
General Advice Warning: Any advice given herein is general in nature and has not taken into consideration your personal financial objectives, situation or specific needs. You should consider the appropriateness of the advice as it relates to you before acting upon it. Where a specific product has been mentioned, you should always consult the PDS before making any investment decision relating to it.