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Property VS Shares

By Dan Sowden

It’s one of the great barbecue-stopper conversations of Australia.

It’s right up there with Ford v Holden, Carlton v Collingwood, league v union: are shares a better investment than residential property?

Residential real estate is almost the sacred cow of Australian investment. But in the past two decades, Australians have become per capita the world’s most enthusiastic share investors.

Each asset class has its devotees who will not hear a word in favour of the other, swearing that “you can’t go wrong” with their preferred investment and that it beats the other one hands down.

As to who is right, it depends on what statistics you use.

Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors, says the reliable data for shares goes back further than that for property.

“The furthest back I can get total return data for housing — that is, capital growth plus rental yield — is March 1983, from the Real Estate Institute of Australia,” says Oliver.

“On this basis, over the period March 1983 to December 2009, which is the latest date for which I have REIA data, capital growth from residential property has been 8 per cent a year, and once allowance is made for net rents, the total return is 10.9 per cent a year.

“Over the same period, capital growth from Australian shares has been 8.8 per cent a year, and once dividends are allowed for, the total return is 13.3 per cent a year.”

Every year, the Australian Securities Exchange commissions Russell Investments to study asset class performance over 10 and 20-year periods. As part of the performance comparison, the Russell report considers the real-life impact of tax, costs and borrowing on the ultimate investment returns.

In the 2010 report — for the 10 and 20-year periods ended December 2009 — Russell found that residential investment property achieved the highest return (before tax, after costs) of 10.4 per cent a year for the 10-year period, while Australian shares returned 8.4 per cent a year. Residential investment property also beat shares over 20 years, at 9.8 per cent a year versus 9.7 per cent a year.

Since tax is a cost of investing, an investor should always be thinking in terms of after-tax returns. On the 10-year comparison, residential property beat shares at both the lowest and highest marginal tax rates, generating a return of 9.5 per cent a year and 7.9 per cent a year respectively, compared with shares on 8.6 per cent a year and 8.3 per cent a year.

But over 20 years, on an after-tax basis, Australian shares beat all other asset classes at both the lowest and highest marginal tax rates, generating a return of 9.9 per cent a year and 7.8 per cent a year respectively. Residential investment property came in second, earning 8.8 per cent a year and 7.2 per cent a year respectively.

Due to the benefits of franking credits, tax takes less of the return from Australian shares than from the return of any other asset class. The lower the investor’s tax rate, the more the after-tax return exceeds the before-tax return. The effective tax rates for investors on the top marginal tax rate for each asset class are as follows:

Russell Investments also considered the effect of gearing, assuming that half of the initial investment amount was borrowed, that the loans were interest-only and the loan rates were lower for residential property than for shares.

Michael Yardney, director of Metropole Properties, agrees that property and shares perform “about the same” over the long term. “Historically, well-located properties double in value every eight to 10 years, with an average capital growth of eight to 10 per cent a year, and rental yield of around four to 5 per cent a year, so you’re looking at about 12 to 15 per cent a year. So unleveraged, they do the same.”

But on a risk-weighted basis, says Yardney, property outperforms because it is not as volatile as shares. “Residential real estate has a volatility of 3 per cent to 4 per cent a year, which is about one-sixth the volatility of shares. That is the reason why banks will lend 80 to 90 per cent on property, but only 50 to 60 per cent on shares. And because residential property will bear more leverage, it outperforms in the long run.”

Christopher Joye, chief executive of real estate research and advisory firm Rismark, says his firm’s figures show residential real estate has generated total net return of about 10.8 per cent a year over the period June 1982 to December 2009, with a volatility of 3 to 4 per cent a year. But he says the biggest mistake property investors make is extrapolating index volatility to their own home.

“If you own a home, you have one large asset in one specific location, with very high ‘idiosyncratic risk’. We estimate that the volatility of a single family home is between 15 and 25 per cent a year. This is akin to the risk of holding a single security listed on the ASX, relative to the much lower volatility of the well-diversified All Ordinaries index.”

A house price index is not a volatile index, says Joye, because it captures thousands of house sales a month. “It’s simple portfolio theory: the larger the sample size, the better the diversification, the lower the risk. A house price index is a proxy for literally millions of homes worth billions or trillions of dollars. An index is, therefore, an incredibly well diversified portfolio. In contrast, an individual home owner is making an economic commitment to one highly idiosyncratic asset. This is, by definition, a poorly diversified investment with a much larger prospect of loss.”

He gives the example of the All Capital Cities House Price Index, compared with a family home in Leichhardt. “The index captures 30,000 home sales a month. The home in Leichhardt is an individual property with unique characteristics: what direction does it face, how old is it, what is the build quality, how many bedrooms and bathrooms does it have, what is the size of the block, does it have a garage, what is the street like, what is the local economy like, what is the zoning risk? It’s exactly the same as comparing the volatility of Fortescue, or a microcap, with the volatility of the All Ordinaries index. You can’t extrapolate the characteristics of the index to each of its components.”

If the residential property investment is considered as a national portfolio of established residential real estate, Joye says the investment gives you a low-risk, strong long-term performer that gives significant diversification benefits, through low correlation to the other main asset classes — in fact, negative correlation to the sharemarket. Statistically, this means residential real estate rises when the sharemarket is falling.

For these reasons, portfolio investment in residential real estate makes sense for superannuation funds, he says, because residential real estate is Australia’s “largest investable asset class”, worth more than $3.4 trillion — or 2.5 times the value of the stocks listed on the ASX. But he says the super funds need to have access to the required investment vehicles.

Retail investors who own homes also need the ability to diversify their highly localised residential real estate exposures through a broader portfolio holding, says Joye. “I think this is the next step after we come to grips with the very high idiosyncratic risk and volatility of a single property.

“We’re working with the ASX to list a security that covers an index of Sydney housing, which will give investors exposure to the performance of residential real estate but, more importantly, will give them the low volatility of the index.

“Whether people want to hedge their own exposure, or start their kids investing in an index that will keep up with property prices, it would work the same, ” he says. Joye says this listed product should arrive on the ASX next year.


Source: The Australian | James Dunn | 28th July 2010

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