LukeSnedden.com

I have noticed a fair amount of literature floating around extolling the virtues of property investment over every other investment out there.

Realestate.co.au has recently published this article. It explains why property investment is the only vehicle into which you should invest.

If your goals are to:

• Retire richer?
• Retire earlier?
• Supplement your income?
• Give up your day job?

The article recommends property over shares because they offer greater benefits such as:

• Capital growth
• Rental income
• Hedge against inflation
• Tax benefits
• Greater degree of control
• Lower volatility
• High demand.

They are not alone when preaching the benefits of investing in real estate

The lists above are common when extolling the virtues of real estate investing. I want to explore the benefits and pitfalls of taking this information for granted from professionals whose bias is obvious.

I hope that this post also exposes some bias on my part

As a budding investment advisor I have not recognised where I sit on the investment horizon, am I driven by my need to derive income (from placing clients funds in vehicles from which I can derive commission) or my future clients needs to build wealth.

I cannot fault the goals provided, generally a person who is looking to build wealth by investment will have goals such as these.

The benefits of property over shares are where we begin to deviate in out beliefs. These benefits are masked by one important factor, leverage.

Capital Growth.

Capital growth can be achieved with both shares and property. Shares have grown on average 1.64% per year since 1925 (this is an inflation adjusted figure). This is based on the Dow Jones Industrial Average (DJIA). The author of this analysis used a DOW starting value of 8.42 for the year 1924. The real annual rate of return on the DOW over the past 82 years has by his careful calculation been 1.64%. The DOW beats the real estate market in the US, which has stayed even with inflation for the past 100 years.

Rental Income

Both shares and property offer rental income, property in the form of rents (duh!) and shares in the form of dividends.

Rental returns provided by property a larger, however that is offset by the amount of leverage one takes on when investing in property. If you were to pay $400,000 cash for property you would receive the full benefit of the rents, in the same way if you were to pay $400,000 for shares you would receive the full benefit of the dividend. If both investments yield the same return then the overall capital growth may be the deciding factor, as discussed above.

Hedge against inflation

This is correct if you are going to buy without using leverage. If historical returns have been equal to inflation then you have hedged against inflation, however you have not beaten inflation, and it is possible that you have not beaten the returns offered by the bank or treasury bonds which are seen as risk free. Once you bring leverage into the picture it is possible that you will not hedge against inflation. This is dependant on the rate of interest you are charged, as historical yields have matched inflation once you factor in the cost of leverage, you may find that you are lagging inflation.

Greater degree of control

I’m not quite sure what the implication here is. You have no control over interest rates, market rentals, and demand for your property. Just as you have no control over the price of your share, the company’s direction and demand for your shares. It is important to remember that there are risks involved with all investments and your ability to control how they operate is often a myth propagated by salesman.

Lower volatility

In the long term share and property offer returns which are pretty similar, in the example above a 1.64% difference is not a huge swing. As people are recognising now, the property market can decline, just as shares do. Volatility is also propagated by the flow of information. As share prices are valued continuously and an investor is able to watch their price change every second it gives the illusion of volatility.

If houses were valued as regularly and if the following point (‘higher demand’) holds true then we would see a higher volatility.

Higher demand

Higher demand indicates that the market is very liquid. Ask a person trying to sell their house at the moment if they are in a market that offers higher demand. The share market is a very liquid market; you are able to sell at any time during trading hours. Houses are not as easy to sell, mainly due to the trading platform and legalities involved. I am not convinced that the property market offers higher demand.

Why do I care?

You may think that I am completely against property as an investment and that I think shares are the absolute bees knees when it comes to investment.

This is not the case.

Property has a part to play in an investment portfolio. It is important to recognise its importance in a well diversified portfolio. People in Australia and New Zealand see it as the be all and end all for their investment portfolio. Now they are finding out that it may not be.

In a depressed market where liquidity is low and many who are leveraged highly are finding themselves in a situation where they are negatively geared. Banks are putting the heat on them to repay loans. These people are facing the fact that their wealth is being eroded because they have concentrated on one asset class because of perceived long term stability in that market.

Sure the share market has taken a hammering in these hard times as well, the market is in a depression not seen in 80 years, and in the same way if you were fully weighted in equities you would be facing the same situation as if you were fully weighted in property, it has been a bad time for all investors!

Diversification is the key

Those who have been able to diversify are not in a situation where they are over exposed to certain investments have found themselves in a beter situation than those who have put all their eggs in one basket.

So before you dive into the property market or the share market, make sure your investment fits into your portfolio, invest as part of an overall plan not because you are sold on the idea of one asset class by someone or some organisation that has a vested interest in you purchasing from their industry.