INVESTOR EDUCATION – Can You Bet The House On It?
In this article we assess investment performance of equities compared to property over the last 12 years in both New Zealand and Australia. Performance a side, we then review the investment case for both equities and property and find a significant number of advantages of investing in equites compared to property.
A comparison of Equities vs Property as an Investment Class
Australians and New Zealanders have been obsessed with property prices over the past 20 years and many have enjoyed watching the valuations of their real estate investments skyrocket. However what they have failed to notice is that they may have actually been better off investing in the equity markets instead.
If you had invested $10,000 into the New Zealand stock market at the beginning of Equity prices in NZ 2003 it would be worth $30,735 today. Conversely, assuming it was possible to invest have outperformed $10,000 into the performance of New Zealand house prices you would have only the return generated retuned $24,544. That’s a difference of $6,190 of almost 62% over the 12 year time frame.
Figure One: New Zealand House Prices vs the NZX 50 since January 2003 rebased to 100
However, this is not the case for Australian house prices. Over the 12 year time frame, the Australian stock market has returned 164%, while house prices actually retuned Australia house prices slightly more at 185.2% a difference of 21.2%. However, as depicted by Figure 2 below and the Australian we can see that during the peak of the mining boom in 2006/2007 the equity market equity market have significantly outperformed housing by a whopping 86.8%. Further, the performance of had similar returns over the past 5 years housing and equities post the 2006/2007 period have largely tracked together and it has only been in the last 12 months that equities have begun to underperform the performance of housing. This coincides with the end of the mining boom.
Figure Two: Australian House Prices vs the ASX 200 since September 2003 rebased to 100
Therefore, it is evident that equities as an asset class has performed significantly better in New Zealand and in the same order as property in Australia over the investment time frame. The hype that has been associated with property prices may not be as warranted as it first appears.
But apart from performance alone there are a multitude of other factors that investors
consider when making the decisions of whether to buy equities or invest in housing.
Below we analyse the investment cases:
Rent vs Dividends:
A popular preference for purchasing a house compared to shares relates to the fact
that house owners have a physical place to live and interest payments go towards
repaying their mortgage. This is all very true, but when you compare the financial
outcome compared to shares, investors are actually indifferent. For simplicity if we
assume no taxes and both shares and hosing return 10% capital appreciation for the
year. In addition to this the share investment also pays 5% dividend yield. In total
Person A receives $15,000 from his share investment ($10,000 capital appreciation
$5,000 in dividends). Person B only receives $10,000 from the return on their
investment. However, Person A has to pay 5% rent ($5,000) while Person B is living in
their own house and therefore has to pay nothing. Therefore, both Person A and B are
indifferent and have return $10,000 or 10% on their original capital.
Therefore, despite paying back their mortgage financially Person B is not better off.
There is a common misconception owning your own house is more advantageous
because it means that you are paying your own mortgage while renting you are paying someone else’s. Although this is true, financially you are no better off because you forego dividend returns from shares by owning a house. These dividends are what
Person A uses to pay for his rent.
Figure Three: Comparison of Equity Returns to Property Returns
Diversification and Risk:
Another common misconception among investors is that investing in equities is more
risky than investing in property. This generally not the case and in fact property is more risky than equities.
If we take a portfolio approach to risk and look at all the assets and liabilities of an
average property investor, what we will typically observe is that the majority of their
wealth is invested in housing. They tend to hold a significant portion of their total
wealth in property and very little in percentage terms of other assets. This means the
value of their total portfolio is heavily reliant on the outcome of the property market.
They are very exposed to the up and down swings of the property market.
Part of the reason an investor has such a large portion of their assets allocated to
property is the fact that houses are expensive and therefore when compared to the
value of their other investments it is very large. In general, hosing investments are not
segmental. That means you have to buy the entire house and not a percentage of it
and this may mean you have to borrow to fund the investment. Equities on the other
had are very segmental as the investor can elect the exact they wish to buy or sell down to the last dollar.
Investment liquidity refers to the ability of an investor to move in and out of their
investment without causing drastic change in the asset’s price. Shares tend to be very
liquid in nature as there is a deep and active secondary market where investors are
able to buy and sell shares as they desire and in the amount they generally desire
without causing the share price to move by a substantial amount. Liquidity in property
when compared to that of equities is much lower. XXXX Investment liquidity is
important because if the fundamentals of the market suddenly change for your
investment, investors want to be reassured that if they need to sell an investment they
are able to at a fair price.
Finally, property investments are typically mortgaged and therefore leverage is used
to finance the investment. This makes the investment far more risky given that if things turn sour you may end up owning the bank a significant amount. In other words, property owners may end up with negative equity. In contrast, shares have limited liability and therefore you cannot lose more than your original investment.
Feasibility and Ease:
In the current market, banks typically require 20-30% deposit of the value of the
property in order to secure a loan for the investment. A $1,000,000 house means that
the investor needs at least $200,000 before they can actual invest. This often requires
the investor to save for a significant amount of time or have ample financing available
to them. With shares on the other hand, you able to begin investing at almost any
amount and therefore it makes the ability to begin investing far easier.
A major issue that first home buyers have today is that house prices are now so high,
that they are no longer able to stump up with the deposit needed to buy a house.
Instead, perhaps they should look to invest in equities instead given the lower
requirements. This way they will not miss out on gains if asset markets increase in value collectively.
Prior Knowledge:
A major reserve investors have with shares is that they don’t believe they know enough about the investment and that property is easier to understand. Or they want to invest in shares but they either don’t know how or what to invest in.
Share valuations are based on fundamentals with a number of analysts valuing the
company based on a range of factors. This helps to ensure that the shares are fairly
valued and also gives investors ample information to understand the business and form and outlook on what may happen to the investment in the future.
House valuations have a large portion of value determined by uniformed investors
acting on feelings and emotions rather than investment fundamentals. Generally,
people buy houses based on whether they like it, while shares investors tend to be far
more stringent on their premise for investing.
By researching and reading about stocks potential investor can more educated about
their investment and therefore overcome their hesitations on stock investing.
Costs:
The cost of investing in shares is minute compared to the cost of buying and selling
houses. Saving money on costs means higher returns for your investments.
Trading shares you will typically incur brokerage and exchange fees. On the average
transaction are typically less than 1% of the investment value. You may also subscribe
to research which you pay for.
While investing in housing you pay real estate and lawyer fees. You are also likely to
get a property valuer and builders report and if you plan to live in the house you have
to spend time and money moving all your possessions. Further, you will also need
house insurance no both your house and your content. Council rates and fees will also
need to be considered when making your investment decision.
Evidently, property investing incurs far higher transaction costs which means investors
realised potential returns are likely to be a lot lower.
Summary
1) Property does not always give better returns than equites
2) Equities can have a lower risk profile than property
3) Equities as an investment tend to be more flexible and easy to transact
that property
4) Investors believe that they have a better understanding of property as
opposed to equites, however this may not be the case
5) Significantly less costs are incurred when investors transact equities
than with property
