Property Vs Shares: Why I Choose to Invest in Property

Property vs shares

My Background with Property

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.  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. 

Property Vs Shares

The idea of an investment property appeals to me.  It is an easy to understand asset, everyone needs somewhere to live.  I have seen property prices increasing over the years and it’s less volatile than equities.   However, almost 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. 

The Options

I had a $2200 surplus cash to invest every month after paying all bills and allowing a set amount for fun money.  It’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 mortgage

ETF 

Inv 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

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

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

Reduced by paying off early

 Plan for ongoing management costs <0.5% plus brokerage $20 per purchase

High! 6% to buy, 3% to sell.  This is not an asset suited to trading

TAX

Pay off mortgage

ETFProp 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 earners 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

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 mortgage

ETF

Inv 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”

There is no right answer! 

The weighting of each factor is going to be very individual based on previous experience, risk profile of investor, pre-existing debt etc. 

The major deciding factor for me was diversification.  If I could fund 40-50% of my desired retirement income with rental income, I would be less susceptible to changes in economic conditions both prior and after retirement. 

The biggest factor putting me off property was the risk in putting so much in to a single asset, which has to be selected correctly!  I suspect this 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 this house one month ago, hired a rental agent and had tenants competing, offering to pay over market rent to secure the property.  There were a few phone calls from the rental agent in the first 2 weeks of rental with teething problems- the toilet wasn’t flushing properly, a cracked window that I had forgotten about from inspection.  SO far the rental agent has been fast and efficient with getting these fixed at a reasonable price.  I will update this blog every year, or more often if there are lots of issues, to let you know how the investment is performing…and how much hassle the whole deal is. 

 Conclusions

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

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