If you have not asked yourself the question you have probably heard it raised – ‘so what’s a better investment, property or shares?’ The forum is typically a backyard BBQ between family and friends and sure enough, it will spark interest with certain ardent supporters of one asset class over the other, keen to add to the mix their 2 cents worth of homespun wisdom.
Having heard one too many ill-informed responses to this question, I have decided to write this short article outlining my view on the question. As a property investor, share investor and qualified financial planner I will hopefully provide you with a more intuitive response than those you may have heard in the past.
Let’s first take a look at the reasons for investing in property and shares respectively.
Reasons to Invest in Property
Easier to understand – Property investment is generally more easily understood than share investment. Although property investment requires a certain level of sophistication it does not require the same degree of technical understanding that shares investing does.
Tangibility – Property investment provides tangible evidence of where your hard earned money is going. It is much more satisfying walking through your own investment property than through the aisles of a Woolworth’s store in which you are a shareholder.
Control – Investing in property provides the investor with a greater level of control over their investment. When making decisions the property investor has complete influence over their investment, unlike a share investor whose influence is only as great as their voting power.
Potential to add value – Property provides the investor with the opportunity to improve its value either through renovation or development. This ability is not available with shares short of becoming a member of the board or creating your own publicly listed company.
High gearing – Property enables investors with relatively small amounts of money to obtain exposure to relatively large assets. The property is a favored form of security for banks and under certain circumstances may be fully financed with no recourse beyond the property. Shares, on the other hand, are generally financed at a maximum of 70% and the lender has recourse by way of margin calls against the investor when the LVR is breached.
Low volatility – Property has historically provided low volatility relative to shares, although the infrequency of its valuation does bias the results.
High long-term returns – Property has historically provided high long-term returns, particularly in comparison to fixed interest and cash.
Tax efficiency – Property has a high degree of tax efficiency for a number of reasons. Firstly, its returns are comprised of a growth component that may be concessional taxed (if held for over 12 months) using the capital gains tax discount. Secondly, the property can be highly geared which results in a high deductible interest component. Thirdly, the property allows the deduction of a depreciation component for building write off and plant and equipment which improves the after-tax return.
Reasons to Invest in Shares
High liquidity – Shares generally provide higher liquidity than property. Whilst a line of credit facility secured against a property can help the matter, it is not always desirable to increase one’s borrowings when cash is required.
High Divisibility – A share portfolio is much more easily divisible than a property portfolio so when small amounts of cash are required a share investor can sell down a similar value of shares where a property investor is forced to sell an entire property.
Low minimum investment – Shares provide the opportunity to invest smaller amounts of money than property. If you only have $5,000 to invest you will have no problems finding shares to purchase but good luck finding an investment property for this amount of money.
Low transaction costs – Shares involve substantially lower transaction costs than property. The only costs involved in transacting shares are brokerage on both acquisition and disposal. The property, on the other hand, involves stamp duty, inspections, and legal on acquisition and advertising, agent’s commission and legal on disposal.
Low ongoing costs – Shares involve substantially lower ongoing costs than property. In fact, direct share ownership does not involve any ongoing costs whereas property can involve body corporate fees, insurance, land tax, letting fees, maintenance costs, management fees, rates, and repair costs.
Diversification – Due to the lower price of a share relative to a property it is possible to obtain greater diversification for your dollar by investing in shares. For example, if you have $100,000 to invest you may decide to spread it in $5,000 bundles across 20 different companies from 20 different sectors of the market. For an equivalent amount of money, you would be lucky to purchase just one property without gearing.
Timely performance appraisal – Shares in publicly listed companies enable the investor to make a timely assessment of the value and performance of their portfolio. The share investor can simply call their broker or view their portfolio value online whereas the property investor must obtain market appraisals and or valuations on each of their properties before being in a position to appraise the performance and value of their portfolio.
High long-term returns – Just like property shares have historically provided high long-term returns, particularly in comparison to fixed interest and cash.
Tax efficiency – Shares have a very high degree of tax efficiency for a number of reasons. Firstly, its returns are comprised of a growth component that may be concessionary taxed (if held for over 12 months) using the capital gains tax discount. Secondly, shares can be relatively highly geared which results in a relatively high deductible interest component. Thirdly, many Australian shares provide franking credits with their dividends that may be used to offset the investor’s other tax liabilities. Put another way, the dividend income from a fully franked share provides tax-free income to a share investor on the 30% marginal tax rate.
At the end of the day, you can have all of the before mentioned benefits but the bottom line for most investors is returns. Whilst we all know that past performance is no guarantee of future performance we are all nonetheless interested in how asset classes have performed in the past. As such, let’s now turn our attention to the property and share historical returns.
Over the years I have seen ardent supporters from both sides of the camp waving research papers in the air substantiating their claim that their favored asset class has historically provided the highest return. Some have property marginally outperforming shares and some have shares marginally outperforming property on either a pre-tax or post-tax basis.
How is this possible you might ask? Well, it all comes back to the measurement period of the research. As with all other asset classes, property and share values move in cycles. It, therefore, stands to reason that a measurement period incorporating more peaks and fewer troughs will provide a greater return for the period. Given that property and shares generally do not move in harmony with one another they each have peaks and troughs at different times in the cycle. Different measurements periods capture this and can, therefore, provide substantial variations in results.
Below are the results from an ASX commissioned report prepared by Towns Perrin. The measurement period is only 1 year apart and spans for a considerable amount of time to provide more relevant information.
10 Years To December 2003
20 Years To December 2003
10 Years To December 2004
To December 2004
Source: ASX Investment Sector Performance Report by Towns Perrin
So what can we make of these results? Well, simply that both property and shares have each provided relatively high long-term returns in excess of any other traditional asset classes.
Property or shares? Given the comparability in historical returns and the many benefits they each present it should be obvious that the question shouldn’t be property or shares, but instead how much property and how much shares.
So next time you are at a backyard BBQ and your ill-informed friend pipes up about property or shares being far superior to the other, politely reveal to them their ignorance and encourage them to seek professional financial advice!
Oh, and when it comes to purchasing property for your portfolio, don’t pay the retail price like everyone else, acquire your property the smart way by developing it at absolute developers cost. It’s easier than you think…