It seems everyone is jumping on the property bandwagon in the fear of “missing out”. With property investment achieving a cult following, it appears anecdotally that investing in property is the only sure-fire way to making your millions.
Is the property party over?
With the Australian property market coming off the back of a recent boom, and respected economists warning people that residential housing and apartment prices are arguably overvalued, could the property party be coming to an end? And if so, are there alternatives? When deciding to invest in property, it is important to assess your potential investment opportunity for the two types of expected returns: 1. capital growth and; 2. income or yield.
Capital growth refers to the likelihood that an asset will increase in value over time. For example, if I buy an apartment today, do I expect the sale price to be higher in 5-10 years time? Income or yield is the net-of-costs income that you will derive from holding an asset year on year. Referring back to the above example, this would be the rental income received less the running costs such as strata fees, agents commission, council rates and maintenance/repairs.
While property prices in major east coast cities and even regional areas have grown a great deal in recent years, rental income has remained relatively stable. Price appreciation has outgrown rental growth significantly. Looking at the average price and rental data figures, it appears that when taking out a loan to buy a property, you are going to be significantly out of pocket year on year (negatively geared) as the average net yield on residential property sits at around 3% per annum (being generous), and borrowing costs sitting at around 5% per annum (being conservative). And while you are able to claim this out-of-pocket cash flow loss as a tax deduction (negative gearing), you have still gone backwards – you’ve made a cash flow loss. You would therefore, have to have received capital growth on the property to have made this loss back before you’ve actually made any real return.
In the last 30-40 years, there have been extended periods where it benefited property owners to make cash flow losses on their investments, as these losses were typically minimal and were made up for in corresponding capital growth. However, we are now facing losses that are bigger than ever before, as net rental yields are at an all-time low. With respected economists and property experts arguing that we are in a “property bubble”, it may be time to consider whether negative gearing and reliance on capital gains are still appropriate for your circumstance.
Are there alternatives?
There are several alternatives to property, one of which is a diversified portfolio of Australian shares that are listed on the ASX top 200. We’re not talking about a portfolio of ‘speckies’ or ‘penny-farthing’ mining companies, but rather major corporations who have been operating for decades and who report sound profit growth on a reliable and consistent basis.
The average yield (inclusive of franking credits) from a basket of 50-60 top ASX 200 listed companies sits at around 7%. Let’s assume that it costs 1% per annum to have your portfolio professionally managed, this would result in an after costs yield of 6% per annum (compared to 3% in the above property example). When borrowing costs sit at around 5%, this strategy has the potential to be cash flow positive as opposed to negative. This investment strategy actually provides you with a return on your investment as opposed to you paying it in the first example.
But what about capital growth and the volatility that accompanies shares? The All Ordinaries index which refers to a basket of all shares on the Australian Securities Exchange has grown consistently over the past 120 years, despite undesirable events such as The Great Depression, WWI and WWII, September 11 attacks, the global financial crisis, the tech bubble and other stock market ‘crashes’. Throughout history, each time the market has fallen, it has recovered and gone on to grow further.
Investing in property or securities should not be looked at as a quick and easy way to make a profit. It is likely that you will experience capital volatility and market downturns. Too often people panic and sell when the market experiences a downturn, however sometimes you have to ride the peaks and troughs.
When comparing these two strategies, there are a few things to consider. Firstly from an income perspective, investing in securities is more affordable whereby it pays you rather than you paying it. Secondly, from a capital growth perspective, both shares and property have the potential to increase in value over time. However, whilst the Australian property market is booming, there are claims that it is overvalued and economists are forecasting a downturn. We’re not saying that you should steer clear from the property market, we are simply recommending that you do not place “all our eggs in one basket” when it comes to your wealth.
Both property investing and securities investing have merit, but it is important to remember that the suitability of either strategy depends on the individual and their circumstance. Many people steer clear from shares as they perceive them as being too “risky” or “foreign”. But what many people fail to realise is that they have their benefits and their drawbacks, just like property. We can be quick to glorify property investing because it is a physical asset however, stocks provide enormous and somewhat untapped potential. If you are considering alternative investment strategies, we would love to discuss your personal circumstance with you. Please call us on 9545 0953.
Please note that the information provided is of a general nature only and has not been tailored to your personal circumstances. Please seek professional advice prior to acting on this information.