26 Giffard Street
Williamstown 3016
Ph. 03 9397 7275
Fax. 03 9397 1734
Mobile. 0428 310 165
Email. reidcont@tpg.com.au
ABN: 65 111 801 079
www.reidconsultants.com.au

This newsletter tackles the curly issue for many folk, which is better as an investment; property or shares? The answer of course is simple – it depends. Now we have answered that critical question, let us cover some of the fundamentals that underlie an investment decision between the two asset classes (see our Oct '06 newsletter discussing Asset Allocation).

There are two components of an optimum portfolio decision, the first component is the investment decision , the second component is the finance decision, how much do you borrow (or lend)? Each of these needs to be considered and factored in to your final strategy. Perhaps the key factor in deciding between the two forms of investment asset classes is the finance decision.

Let us outline some basics and characteristics of the two asset classes.

Property

• You can be a direct investor, owning your own properties in a variety of ways, as an individual, jointly with a partner, in a company or in a trust vehicle. I am not covering the pro's and con's of investment vehicles today.
• You can be an indirect investor, owing units in an unlisted or listed property trust (LPT), again able to use a variety of investment vehicles. For an LPT, the units are traded similar to shares. An LPT generally follows the share market yet being less volatile
• There are a number of categories within property, the main categories being residential and commercial. Within each category, there are a number of sub-categories, each with differing characteristics. Residential includes free standing houses, off-the-plan purchases, units, apartments, student accommodation etc. Commercial is represented by Retail, Office or Industrial as general categories. There are also special categories of purpose built premises.
• Property has high transaction costs, stamp duty being a major cost. There are potential land tax issues, there are rental tenancy risks (vacancy and damage) and it is considered to be an illiquid form of investment (unable to easily convert to cash). There are taxation benefits through depreciation.
• Due to the high individual cost for a property purchase, most investors have only one or two investment properties, usually residential. The high purchase cost discourages most from entering the commercial property market other than as indirect investors in LPT's. There is the issue of diversification risk, where investors are unable to eliminate non-market risks as they can with shares.

Shares

• The share market is now reasonably well understood by many in the community, with a relatively high percentage being direct shareholders, of Telstra, AMP, BHP Billiton and/or the major Banks. All who invest in superannuation funds will most likely have shares as part of their investment portfolio, either directly or through managed funds.
• It is generally a highly liquid form of investment, shares able to be sold quickly to realise cash.
• There are now means to access low cost transactions, through on-line brokers etc.
• Diversification can be obtained, through random selection of 20 to 30 different stocks thereby minimising non-market risk. International markets can be accessed through a variety of means. There are a number of options to increase exposure and/or minimise risk, through options, warrants, futures, CFD's etc. There are a number of investment styles that can be used, from an aggressive trader to a passive investor using a low cost fund like a Vanguard Index Fund.
• Selection can be based to favour a high growth/low income return or vice-versa. There can be significant tax advantages of owing shares in a company that pays fully franked dividends.

Investment Returns over Time.

The graphs below give an indication of the returns available over time. The returns fluctuate between years and as you can see, the share market represented by AXJO (S&P 200 index in blue) had some negative returns in 2002 and 2003 (as most of us realised especially when we got our superfund statement). The LPT (being AXPJ in red) has a more consistent return stream over the same period.

Looking at a longer time scale for both shares and residential property, the following two graphs below indicate that both asset classes perform strongly and consistently, taking a long-term view.

The All Ordinaries graph above shows the growth over 20 years, with periods of negative return. The graph below using ABS measures of established house prices, shows a sharp jump in 1988 (just after the stockmarket crash of 1987) with steady growth until the next cycle starting in late 1990's and continuing until 2004. This shows average prices across Australia , however with each state and within each state, different areas have differing performances. It is reasonable to conclude that the share market overall has a higher return than the property market (712 to 5,400 or 7.6 times as compared to 100 to 430 or 4.3 times) This is consistent with risk/return theory, the higher the risk, the greater the return demanded.

http://www.aph.gov.au/library/Pubs/rn/2006-07/07rn07.pdf

The second and perhaps most crucial decision is the finance decision. This is what separates the two forms of investments. Ask yourself the question, why are you investing?

If the answer is to make money, then the critical difference between the two forms of asset investment is what you can borrow against the respective asset class

With shares, the limitation is the amount you can borrow against those shares. Margin loans are generally used where lenders are willing to take a limited position against the market value of those shares (see our Aug '06 newsletter), generally between 25% to 70%. The main drawback with margin loans is the possibility of a margin call, occurring if the share price decreases below the loan value limit. With individual volatility being high, unless you limit the gearing (amount you borrow versus your own equity), margin calls may occur at an inconvenient time and they need to be met.

The benefit of property, especially residential property, is that lenders are willing to loan 100% of the value, thus you gain the full advantages of gearing or leverage of using other people's money to make money. This is how the wealthy continue to improve their position, using other people's money and pay minimum or no tax on the way. There are effective ways to utilise your existing equity to assist in financing investment properties and still be able to meet cash flow requirements of a negatively geared property without compromising your existing lifestyle.

Give me a call to find out whether this type of investment strategy would work for you and how to structure your finances accordingly. We will work with your accountant or advisor if needed to structure a solution that suits your needs and circumstances. We take the approach of looking at your long term goals and working to find a solution through finance for you. This appointment is no-cost and is obligation free, call – 9397 7275

Helping People through Finance