“Is property the smarter investment choice..?”
“Should I borrow money to leverage my investment..?”
“Will a share portfolio provide me with a better return..?”
“What is the right solution for me..?”
These are all common questions that I’m asked by my clients. There is no ‘one-size-fits-all’ answer to the property vs. shares debate and in short, both can have their place in wealth creation strategies. Property and shares are the two key growth assets that you can invest in to increase your wealth over time.
Let’s therefore look at some of the key differences between investing in property vs. investing in shares.
Risk and Return
As most investors will know, risk is correlated with return. As we take on greater risk, we generally do so with the expectation of a higher return on our investment (it would be foolish, although not uncommon, to take on greater risk without the expectation of greater return). Property is regarded as having both a lower risk and lower expected return when it’s compared to shares. This is shown in the graph below.
Let’s look at what the data tells us when it comes to performance of each asset class in Australia.
When we look at the last 20 years in Australia, residential property outperformed shares earning an annual return of 9.9%, compared to just 8.7% in shares.
When we look further back, 90 years in fact all the way to 1926, we see a similar return generated between the two, with shares delivering 11.5% per annum and residential property delivering 11.1% per annum. The two have delivered similar returns to investors over time.
Investing in property will generally offer greater transparency, given that the investor can physically inspect the property themselves, and/or employ the expertise of those experienced in the sector to carry out these inspections on their behalf. This is in contrast to shares, which is reliant on the directors fully disclosing all relevant information to shareholders as well as shareholder protection laws being adequate across various jurisdictions. We know that the requirements and disclosure obligations for directors vary greatly across jurisdictions, particularly throughout some of the developing markets through Asia.
Size of the Market
The size of the residential property market in Australia is much larger than the Australian stock market. The property market is estimated at over $5 trillion, while the market value of the Australian Stock Exchange is closer to $1.5 trillion, less than 1/3 of the size of the residential property market. This highlights the popularity of investing in property and the desire amongst investors for ‘bricks and mortar’.
Property transactions have much higher upfront costs to be considered than purchasing shares. This costs can include stamp duty, registration fees, deposits, inspections, transfer fees, mortgage costs etc. This therefore results in property investment typically being a longer-term strategy.
Most people who have used margin lending in the past when it comes to investing in shares have likely had the gut-wrenching experience of a margin call. This is a situation whereby your lender calls you requesting that you ‘top up’ your investment account with cash, typically by the next morning, because the value of your shares has fallen. This is often a dangerous strategy and can result in many sleepless nights. As shares are ‘mark-to-market’ assets, it is important that you consider leverage with caution before progressing.
Given that property is not a ‘mark-to-market’ asset, the bank generally does not call requesting more capital if the value of it drops. As long as you continue to make your interest repayments, the bank is happy for the value of your property to fluctuate and you can remain focused on your long-term wealth creation. This provides greater peace of mind than using leverage to construct a share portfolio.
To put this into context, you may borrow 80% to invest in a $600,000 property in Australia or you could borrow 80% to invest in a portfolio of shares. If the value of your asset drops 10%, or $60,000, you can generally expect a call from your lender requesting that you ‘top-up’ your share account as you will have exceeded your allowable loan-to-value ratio.
‘Safe as houses’ – we often hear this phrase and there is certainly a reasonable amount of truth to it. This high level of confidence continues to encourage people across the globe to invest large amounts of capital in property. This is also represented by the banks in Australia who will lend 80 – 85% against investment properties, which compares generally to 50% against shares. Property is considered the lower risk asset of the two and therefore typically has lower expected returns than shares.
If you needed your funds back quickly, having all of your funds invested in property will make this difficult given the time and costs involved with liquidating a property. This includes advertising it for sale, showing potential buyers through the property, arranging the contracts and finally going through the settlement process. Typically, with shares, you can sell your shares quickly and have the funds within a matter of days.
So what is the answer..?
The short answer is DIVERSIFICATION
Sit down with your Independent Financial Adviser today and start looking at how your assets will play their part in achieving your financial goals. Remember, there are pros and cons to each asset class and it’s important that you get the right advice for each. At the end of the day, you should ensure that you’re clear on the role that each will play in your own journey towards financial freedom.
To your financial success!
Jarrad Brown is an Australian-trained and qualified Fee-Based Financial Adviser with Australian Expatriate Group of Global Financial Consultants providing specialist financial advice and portfolio management services to international and local professionals in Singapore.
Book a complimentary consultation here.