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Avoid comparisons: shares and property are vastly different beasts

  • Comparing property and shares is inherently difficult.

  • Outcomes are in part dependent on each investor’s personal situation.

  • Comparisons over long time periods show they perform similarly.

Author: Jeff Miller, Chief Financial Officer, ABN Group.

So, you’d like to compare shares with property? Well, let’s use a “simple” example of two different investors to see how they fared: 

Investor A owns two investment properties. The first is considered her primary place of residence, and was purchased with the first homeowners grant. It will be subject to preferential capital gains tax treatment if sold within a certain time frame. The second property was financed using a significant amount of equity in the first; she is thinking about renovating the kitchen and bathroom to add to its value. She is on a medium tax bracket.

Investor B owns a variety of shares – including an index fund that is 50% geared, and a range of small to large companies that he tends to either buy and hold, or sell short with the intention of buying the securities back when the market has gone down. He also has a retail super fund that is heavily invested in Australian shares, and being a super fund it is subject to more favourable tax treatment on earnings than his other shares. He is on a high tax bracket.

These investors have vastly different portfolios. Even though you could compare annual percentage returns, this example highlights one of the problems with comparing shares and property. That is: from investor to investor, the actual returns are so distorted by different tax outcomes, varying levels of leverage and market dynamics that it is difficult to compare the true rate of return.

The other reason this comparison is difficult to make is, well, it’s just that: difficult. As asset classes, shares and property are vastly different, and their performance is impacted by different factors.

One comparison that makes a fair fist of it is a regular study by Russell Investments and the ASX (the most recent is from May 2011). It’s one of the better efforts, because it looks at ''real'' returns after accounting for taxes and costs.

The results? Well, shares and property have both done well, even accounting for the impact of recent economic turmoil. Before tax, residential investment property outperformed shares over ten (10.1% vs. 8.4%) and 25 (11.6% vs. 10.8%) years, while shares shaded property over 20 years (11% to 10.2%).

The after-tax results were different again: property was best over ten years at both low and high tax rates, while shares were the winner over 20 and 25 years for both tax rates.

Importantly, the effect of tax can be significant and needs to be counted as a cost of investment. Over ten years, property grew 10.1%. For someone on the highest marginal tax rate, that was actually 9.2%. At the lowest marginal tax rate, it became 7.6%. On a property bought for $400,000, that equates to a difference in capital gain of $10,000 once you take tax into consideration.

The fact is both shares and property can provide sound returns to investors and may outperform each other during certain time frames. And each has their positives. In the example at the beginning of this article, the investor who owns property took advantage of two unique things about property: the ability to leverage up to 90% its value (this is much higher than shares and can help greatly in building a property portfolio) and the ability to make improvements to a property to increase its capital value.

Hypothetical investors A chose property because it suited their situation – and that’s something everyone needs to weigh up before making important investment decisions. 

 

DISCLAIMER:This information is of a general nature only and does not constitute professional advice. We strongly recommend that you seek your own professional advice in relation to your particular circumstances.