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 realized 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, and money was always tight. I didn’t want to be so tied down by a huge mortgage. Buying two less expensive houses, and renting one out, was an idea that appealed to me from my teens.
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 into our dream home (oops, but no regrets!)
Time to Get Serious
In 2017, the house was freshly renovated, and with a much bigger mortgage, it was time to get serious.
I returned to work after a wonderful six months of traveling with my family. I wanted the 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.
| Property | Shares | |
| Barrier to entry | Need a substantial deposit or equity (paid off value in home loan) | Invest via Robo-advisors from as little as $5. Invest via a broker from $500 |
| Returns | Long term returns ~7% but extremely variable | Long term returns ~9% but extremely variable |
| Power of leverage | Can 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 volatility | High volatility |
| Liquidity (ability to sell quickly in an emergency) | Low liquidity | High liquidity |
| Potential for investors to speed up growth | Possible through smart renovations | Not possible |
| Hassle | Reduced by property manager, but still some hassle | Minimal hassle |
| Effect of economic crisis | May reduce tenants’ ability to pay rent | Often crashed stock market prices |
| Unexpected expenses | Can occur and can be financially crippling | Don’t tend to happen apart from if leveraged and stock market crashes – margin calls |
| Buy and sell costs | 5-6% purchase cost & 2% selling cost | Can be $10 / $10,000 (0.1%) |
| Management costs | 8-9% of rental income if use a property manager. Plus maintenance and repairs | 0.1-0.3% considered reasonable for passive ETFs |
| Ease of entry into investment | Slow, need mortgage application, asset selection | Asset 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 superannuation | Can 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) |
| Tax | Tax 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
Can deduct interest used to buy income producing shares, similar to negative gearing property |
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 round 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 mortgage | ETF | Inv Property |
| As close to risk-free as possible
Minimizes 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 | ETF | Inv Property |
| Low volatility | High 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 mortgage | ETF | Inv 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 | ETF | Inv Property |
| 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 enemies | Pretty illiquid. A bad investment property could spend years on the market! |
TRANSACTION COSTS
| Pay off mortgage | ETF | Inv Property |
| Reduced by paying off early | Plan for ongoing management costs <0.5% plus brokerage |
High! 6% to buy, 3% to sell. This is not an asset suited to trading |
TAX
| Pay off mortgage | ETF | Prop Inv |
| None! | Depends on investors’ tax rate. We have a stay at home parent, so returns would be tax-free for a long time | Capital 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 earner’s name. And it will eventually become positively geared – and taxed at potentially 45% |
DIVERSIFICATION
| Pay off mortgage | ETF | Inv 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 from super
I would be relatively overexposed to property risks for the first few years |
EMOTION (Many would say should play no part. But in reality, there were huge emotions involved in these 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 mortgage | ETF | Inv Property |
| Would feel so good to be debt-free! | Could be a roller coaster! | An asset that won’t “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 to 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 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 the 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 to secure the property.
We have had that fateful 2019 federal election, a global pandemic with an unemployment crisis, and predictions of a 30% Australian property crash. Find out if I regret investing in property here.
Conclusions
The age-old debate between paying off your mortgage, investing in 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 organize 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?
Changes to the Victorian residential tenancy act are discussed here.
Do you have an overall investment strategy? Take a step back and plan your wealth building strategy.
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