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. Sure enough, it will spark interest with certain ardent supporters of one asset class over the other, keen to add their 2 cents worth of homespun wisdom to the mix.
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.
First, Let’s look at the reasons for investing in property and shares.
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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. Walking through your investment property is much more satisfying 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 impact is only as great as their voting power.
Potential to add value – Property allows the investor to improve its value through renovation or development. This ability is unavailable with shares short of becoming a board member or creating your publicly listed company.
High gearing – Property enables investors with relatively small amounts of money to obtain exposure to rather 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. On the other hand, shares are generally funded at a maximum of 70%, and the lender has an alternative 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 compared to fixed interest and cash.
Tax efficiency – Property has high tax efficiency for several reasons. Its returns comprise 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.
High liquidity – Shares generally provide higher liquidity than property. While a line of credit facility secured against property can help, 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. In contrast, a property investor is forced to sell an entire property.
Low minimum investment – Shares allow investing 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.
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. On the other hand, the property requires stamp duty, inspections, legal on investment and advertising, agent’s commission, and permitted on removal.
Low ongoing costs – Shares involve substantially lower ongoing costs than property. Direct share ownership does not include any ongoing costs. In contrast, the property can consist of 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 spread it in $5,000 bundles across 20 different companies from 20 other market sectors. 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 assess their portfolio’s value and performance timely. The share investor can call their broker or view their portfolio value online. In contrast, the property investor must obtain market appraisals and valuations on each of their properties before being able to appraise their portfolio’s performance and value.
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 tax efficiency for several reasons. Its returns comprise 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.
The Returns
You can have all of the before-mentioned benefits, but most investors’ bottom line is returns. While 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 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 exceeding 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, aProperty and share values move in cycles as with all asset classes. Therefore, it 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, they each have peaks and troughs at different times in the cycle. Different measurement periods capture this and can provide substantial variations in results.
Below are the results from an ASX-commissioned report prepared by Towns Perrin. The measurement period is only one year apart and spans a considerable amount of time to provide more relevant information.
- 10 Years To December 2003
- Property 12.7%
- Shares 8.0%
- 20 Years To December 2003
- Property 15.1%
- Shares 11.7%
- 10 Years To December 2004
- Property 11.6%
- Shares 11.7%
- To December 2004
- Property 12.9%
- Shares 13.2%
- Source: ASX Investment Sector Performance Report by Towns Perrin
So, what can we make of these results? Well, property and shares have provided relatively high long-term returns over other traditional asset classes.
Conclusion
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 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 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 smartly by developing it at absolute developers’ cost. It’s easier than you think…
