Last Sunday morning I attended a family get-together. I’m not at the top of my game before midday on a Sunday, and my mother, sensing this, pounced. She told me how smart she’s been by investing in a two-bedroom property.
At first I attempt to deflect her with humour.’If we use the property pundits’ appreciation mantra, which states that property doubles every seven to 10 years, your unit will be worth close to $10 million – if you manage to make it to centurion status. If that’s the case, I’ll happily visit you in the nursing home I will have you locked up in’, I tell her.
Yet she is resolute. ‘I’ve done well Mister Barefoot Investor’. ‘Compared to what?’ I enquired.
She explains that she bought the unit 10 years ago for $79,000 and has recently had it valued at $185,000.
After a fruitless discussion on the shares or property debate I decide not to argue with my mother so early on a Sunday morning – clearly I cannot win. Instead I promise to write her this article.
Assessing your assets
Residential property is a difficult asset to quantify because there are so many inherent variables: location, quality of the home, gearing levels and renovations for example. Still, my mother’s unit in Bendigo is a prudent investment. It’s been tenanted for the full 10 years, requiring only $1000 in upkeep throughout that time. She’s also achieved strong capital gains – but the cast of Big Brother could have made money in property in the last decade – it’s hasn’t exactly been rocket science.
In mum’s case I chose to use the Commonwealth Bank as the share-based comparison, and not just because it’s a company that everyone knows. While the CBA is a reliable dividend-paying company (not the best performer on the ASX and not the worst) I really wanted to compare the difference between taking a loan from the bank and owning the bank.
A few financial footnotes to begin: in this example I have assumed that both investments were negatively geared. I also took one short cut. I let the benefits of the franking credits that are attached to CBA shares cancel themselves out with the depreciation benefits that property investors claim.
So let’s get down to the numbers. When mum bought the property she was attracted by the high yield of 8.2 per cent – a superior rate of return than the bank would pay for her savings, safer than backing a greyhound, and better than CBA shares were offering at the time.
For the best part of the decade mum has had a smooth ride as a landlord, but let’s not burst her bubble by factoring in the costs of managing her property (around 6 per cent of her rent each year), council rates and the $1000 spent in body corporate fees and minor repairs.
At the end of the decade her long-term tenant managed to pay off $70,200 of her $79,000 investment. This final point, along with the fact that the value of the property has grown by 134 per cent in the last decade – a before-tax profit of $106,000 – is what my mother is hanging her hat on.
Comparing to shares
Now let’s look at how the situation would have played out if she had invested the same amount purchasing 5448 shares in the Commonwealth Bank at an average price of $14.50 and become a part owner in Australia’s biggest bank. The value of the dividends to my mother would have paid back her $79,000 investment, plus an additional $2447. Also remember that CBA shareholders didn’t have to reach into their pockets to pay council rates, property management fees, worry about finding and keeping tenants, or fixing a hot water service on a Sunday. Nice result.
Yet we often hear that property investors don’t invest for cash flow. The real reason they jump into property is for the capital gains. The comparable holding on CBA shares has risen 257 per cent, for a total before-tax gain of $202,934. This means my inheritance would have been worth $96,934 more had she invested in CBA shares instead of the unit. Some might say that’s tantamount to neglect.
Looking at income
Let’s also compare the income payments, given that both investments have now been paid off, and my mother is now using this income to fund her twilight retirement years.
Her rent has increased 17 per cent in the last decade, from $125 a week to $145 per week, whereas the income from the CBA shares has increased 119 per cent over the same period. In hard dollars, which is my mum’s payment of choice, she would have $4663 more in her pocket each year if she’d invested in the CBA shares (close to 60 per cent more income than her rental payments provide).
Mum’s investment unit is typical of landlords everywhere – they’ve achieved strong capital growth, but poor income growth as rents lagged the price increases. We’re now in a situation of catch up, which is why rents are increasing. The Reserve Bank’s statement on monetary policy this week confirmed this, revealing that rental yields on investment properties have halved over the past decade, and showing that the cost of rental properties is growing out of reach for would-be landlords. In other words, the numbers simply aren’t stacking up.
It’s hard to see my mother being able to lift her rent from $145 to $234 to get a comparable income return to that of shares. Principal of Motivated Money, Peter Thornhill says, ‘I cannot handle the volatility and risk of term deposits and prefer the boring predictability and safety of shares – especially for retirees’.
The final advantage that mum would have had if she’d invested in shares instead of property is the ability to sell part of her holding if the need arose. The money would be deposited in her account three days after the trade and for the commission would be as little as 0.5 per cent.
Selling her unit on the other hand is a much more difficult process. She would have to pay a real estate agent up to 2 per cent of the sale price (plus advertising fees), co-ordinate open for inspections, find a buyer and then wait 60 to 90 days for the settlement period to get access to her cash.
After presenting my research to mum she agreed that she would have been much better off investing. But she still reverted to familiar excuses – ‘but I can touch and feel the unit, and I can control the tenant and see the money coming through each week. I can’t do that with shares’. It was then that I reminded mum that she’d paid $32,500 in interest to the bank, and part of the profit they made on the loan was no doubt being redistributed back to its shareholders’ pockets! So don’t wait, you can use our guide to get started in the stock market today!
Tread your own path!
|Two bedroom unit||CBA shares|
|Investment outlay in 1997||$79,000||$79,000 (5448 shares at $14.50)|
|Income at time of purchase||$6500 – 8.2% yield (gross)||$6019 – 7.6% yield|
|Value currently||$185,000 (estimate)||280,027 (approximately)|
|Pre tax profit if sold||$106,000 (gross)||$201,000|
|Current Income||$7540 – 4.1% yield (gross)||$12203.52 – 4.35% yield|