Property vs Shares: Why I Chose to Invest in Property

Property vs shares

My Background with Property

Here is my detailed analysis of whether to invest in property vs shares.

I, like many Aussies, am a bit obsessed with real estate.  Buying an investment property was always something that interested me.  Browsing the local real estate paper is a holiday highlight no matter the destination!

But this was a massive financial decision, important to make based on logical analysis, not emotion.

My parents followed a traditional plan of buying as much house as they could afford and paying down the mortgage.  They eventually realised a wonderful capital gain that helped fund their retirement.

Dad worked six days a week for years and mum was a shrewd household money manager, working as an enrolled nurse.  They worked hard for years, money always tight.  I realised I didn’t want to be tied down by a huge mortgage.  Buying two less expensive houses, and renting one out, appealed to me from quite an early age.

Many years have passed since that time, between exams, work, having kids and taking time off to travel, we didn’t get further than paying down the mortgage, and then borrowing heavily to make it in to our dream home (oops, not sorry!)

Time to Get Serious

In 2017, the house freshly renovated, with a new and much bigger mortgage, it was time to get serious.

I returned to work after a wonderful six months travelling with my family.  I wanted freedom to take more time off holidaying with the kids, freedom to volunteer and freedom to take on new challenges without money being a barrier!

I set my goal of reaching financial independence (not needing to earn income through work) within 16 years.

Whether to Invest in Property vs Shares

Whenever there is an endless debate like whether to invest in property vs shares, there is not an easy answer.  There are fierce champions of each investment approach.  The right answer comes down to what’s right for your individual situation.  Below is a summary of the pros and cons in general for property vs shares.

PropertyShares
Barrier to entryNeed a substantial deposit or equity (paid off value in home loan)Invest via robo-advisors from as little as $5.  Invest via broker from $500
ReturnsLong term returns ~7% but extremely variableLong term returns ~9% but extremely variable
Power of leverageCan leverage up to 90% turning 7% returns to potentially 90% (minus interest)Can leverage up to ~70% turning 9% returns to potentially 63% (minus interest)
Volatility (stress from prices moving up and down)Low volatilityHigh volatility
Liquidity (ability to sell quickly in an emergency)Low liquidityHigh liquidity
Potential for investor to speed up growthPossible through smart renovationsNot possible
HassleReduced by property manager, but still some hassleMinimal hassle
Effect of economic crisisMay reduce tenants’ ability to pay rentOften crashed stock market prices
Unexpected expensesCan occur and can be financially cripplingDon’t tend to happen apart from if leveraged and stock market crashes – margin calls
Buy and sell costs5-6% purchase cost & 2% selling costCan be $10 / $10,000 (0.1%)
Management costs8-9% of rental income if use a property manager.  Plus maintenance and repairs0.1-0.3% considered reasonable for passive ETFs
Ease of entry into investmentSlow, need mortgage application, asset selectionAsset selection after financial education can be made within hours, and purchased in minutes
Diversification“Lumpy asset”. Large amount of net worth tied up in a single property (if renters turn to squatters that’s bad news!).  However a rental property does diversify away from stock market risk exposure with superannuationCan build a diversified portfolio quickly, easily and with little cash.  Once the US stock market crashes, the ASX follows suit.

Can diversify into Real estate investment trusts (but these act more like volatile shares due to liquidity)

TaxTax incentive of negatively gearing for capital growth properties.

Can be hugely advantageous, but also a distraction that can lead people to buy terrible assets for a tax deduction.

Asset selection critical

Rental income taxed as income not capital gains so not maximally tax efficient.

ETFs are tax efficient.  Franking credits with Australian shares mean no double taxation (taxed at your marginal rate)

The Options: Invest in Property vs Shares

I had a $2,200 surplus cash to invest every month.  That’s a great starting point (although I wish I had started a decade earlier with less!).  I decided I had three options:

  • Use it to pay down the mortgage and be mortgage free in around 7 years
  • Dollar cost average into ETFs to reach investment goal and then pay down the mortgage to finish by my goal date in 16 years
  • Invest the surplus in a high growth property to grow my wealth in a tax-free environment and receive a tax benefit (negative gearing) that could also be used to pay down the mortgage in about 10 years

I went around and round these options in my head for many months, I have considered eight factors below: Risk, Volatility, Return, Liquidity, Transaction costs, Tax, Diversification and emotions

RISK

Pay off mortgageETFInv Property
As close to risk free as possible

Minimises risk if interest rates were to rise significantly

No Debt used (Our risk profile is not appropriate for margin loans)Leverage – can magnify gains but also losses.

More debt – without careful management could threaten our family home.

Total debt (PPOR + IP) repayments (if investment property remained untenanted) work out ~ 30% of net income

VOLATILITY

Pay off mortgage

ETFInv Property
Low volatilityHigh volatility

Can I stomach the volatility or will I sell (the worst possible action!)

Need to commit to investing for 7years + to ride out potential volatility that does exist

RETURN

Pay off mortgageETFInv Property
Opportunity cost – other options very likely to outperform current interest rates (4%)Likely to be higher than 4% and historically around 7% but very variable with different time periods, return for next 16 years obviously unknown.Seems highly dependent on asset selection.  As a result sinking >$500K into a single asset can be very risky

Capital growth can be trapped inside the asset – property in Australia is low yield so hard to build a significant income stream in the short term

LIQUIDITY

Pay off mortgage
Can redraw easily in case of emergency  But can also redraw easily in case or an “Emergency” temptation

If paid into an offset can act as an emergency fund for many years

Can redraw easily which is helpful in a true emergency, but investors are often their worst enemiesPretty illiquid.    A bad investment property could spend years on the market!

TRANSACTION COSTS

Pay off mortgage
Reduced by paying off early  Plan for ongoing management costs <0.5% plus brokerage $20 per purchaseHigh! 6% to buy, 3% to sell.  This is not an asset suited to trading

TAX

Pay off mortgageETFProp Inv
None!Depends on investors’ tax rate.  We have a stay at home parent, so returns would be tax free for a long timeCapital growth – which compounds untaxed unless it is sold.

Negative gearing benefit –I could invest my surplus  into the investment property, and use tax benefit to pay off PPOR mortgage faster.

However. this would require the property to be in the high income earners name.  And it will eventually become positively geared – and taxed at potentially 45%

DIVERSIFICATION

Pay off mortgageETFInv Property
I already have exposure to the stock market in super, but the diversification within the equity class is good if I buy broad based ETFs If a GFC type event occurred during retirement, my rental income would shelter me somewhat from the fall in income

I would be over exposed to property for the first few years

EMOTION (Many would say should pay no part.  But in reality there were huge emotions involved in this decisions…fear & excitement mainly, and implicit bias FOR property. I would rather acknowledge them so I am at least conscious of their effect on my decision making)

Pay off mortgageETFInv Property
Would feel so good to be debt free!Could be a roller coaster!An asset that wont “run out” to pass on to our children

More debt

“Always wanting to buy an investment property”

Invest in Property vs Shares: Why I Chose Property

The major deciding factor for me in deciding whether to invest in property vs shares was diversification.  If I could fund 30% of my desired retirement income with rental income, I would be less susceptible to changes in economic conditions both prior and after retirement.

I also consider the potential positive effect of leverage to outweigh all the negatives listed above for property.  If I had not needed the leverage to meet my goals on time, I perhaps may have been more tempted to avoid property.

Everyone I knew who had owned an investment property seemed to regret it!

Their complaints ranged from the properties achieving no capital growth, or worse ending up in negative equity long-term due to massive house price falls.

Others told me of tenants destroying their property and maintenance issues and dramas being a hassle they could do without.

I suspect careful asset selection is where most of those family and friends have gone wrong.

If I had not identified an expert I felt I could trust I would have avoided physical property as an asset class.  A-REITs were briefly considered, but due to their liquidity, have far more correlation with the stock market than physical property prices – and so lacked the strong diversification I desired.

It also involved choosing an A-REIT, and that seemed fraught with risk as well!

Professional Help

In 2018 I had stumbled upon the property couch – a podcast about property investment by the Empower Wealth team.

Through greedily consuming over 200 episodes in under a year, listening to helpful content rather than a sales pitch, and encouraging those wanting it to “do it themselves” to have some idea of what makes a good investment, I had built trust in the company.

This gave me confidence to move forward and engage them to assist in buying my first investment property.  We closed on a property in July 2019, hired a rental agent and had tenants competing, offering to pay over market rent to secure the property.

We have had that fateful federal election, a global pandemic with an unemployment crisis and the Australian property market was predicted to crash (up to 30%!).  Find out if I regret investing in property here.

Conclusions

The age-old debate between paying off your mortgage, investing the share market and buying an investment property has still not been resolved!

Read about my experiences buying our first investment property. I hope reading through my own reasoning has helped you organise your own thoughts on the pros and cons of each.  Maybe there are factors you have considered that I have neglected?  Where do you sit on this debate?

Do you have an overall investments strategy?  Take a step back and planning your wealth building strategy.


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