Gearing into Property or Shares

Gearing into Property orShares

Gearing into Property or Shares

The question of whether to invest in property or shares is often asked by many investors. Many will argue that one is better than the other; regardless both have their pros and cons.

Property and shares are very different investments with varying features, but it is important to note that you can generate income and capital growth from both. While an investment property allows you to earn income through rental payments, a share portfolio can provide dividend income which is generally a distribution of company profits.

One benefit of investing in property is the perceived lower volatility of its value over time. As shares are listed on an exchange and can be easily bought and sold, their values appear more volatile as they are priced daily and tend to move up and down over short periods. However, imagine auctioning your home every day. The fluctuations in the daily price could be amazing, but as you are not actually selling you would not be too worried. Investing in shares simply requires discipline as individuals investing for the long term often get caught up in the short term price movements and make decisions they later regret.

Another benefit of property investment is the ability to potentially borrow a larger percentage of a property’s value compared to shares. Borrowing to invest in shares using a margin loan can also result in a margin call if your share portfolio falls in value. It may require you to reduce your outstanding loan or sell some of your shares.

If you are borrowing to invest in property, you can generally obtain a lower interest rate than if you were borrowing money to invest in shares using a margin loan. If you have equity in your home you could borrow against your home to invest in shares at a lower rate.

A benefit of investing in shares is the ease in getting started. A relatively small amount of capital is required to invest in shares, compared to the large amount required to buy a single property. Property carries the risk associated with concentrating a large amount of your capital in one asset. As you’ll have all your eggs in one basket, if you’ve picked the wrong property, chosen a bad location or experience a bad tenant your investment may not perform well.

Gearing into Property or Shares

Investing in shares allows you to create a more diverse portfolio and spread your investment risk across different assets, sectors (including property), or even global economies.

If you require funds down the track you can quickly and easily sell all or part of your share portfolio and receive the proceeds within days. If you had invested in property this asset must be sold as one, as you cannot just sell a bedroom. A property may also take some time to sell.

The entry and exit costs of shares are also relatively low compared to property investment. The fee charged by a broker to buy and sell shares is called brokerage and the amount charged is generally around 0.15% of the transaction size. There are some significant costs that come with buying and selling investment property with the largest being stamp duty when purchasing (approximately 3-5% of purchase price depending on the value and which state or territory the property is located in) and agent sales commission when selling (around 2% of sale price). There are also various ongoing property holding costs such as insurances, rates, land tax, maintenance and repairs. While it is very important to consider all the costs, investors often focus on the potential growth and income when making their investment decision. Costs can be significant and can have a large impact on your overall investment return.

So which asset should I invest in?

Both types of assets have their pros and cons and it can be quite difficult to objectively look at the performance of each over the other. Historically the average returns of property and shares have been similar. There are many published articles and reports which compare the two assets. Each using a different approach including investment period and concluding one has outperformed the other. Published performance figures are historical averages only. Irrespective of who you believe, at the end of the day investors should be reminded that past performance is not a reliable indicator of future performance.

Your financial success regardless of which asset class you choose will ultimately depend on your personal circumstances, whether you have bought quality, purchased it at a fair price and have taken a long term view to investing.

SUMMARY

SHARES INVESTMENT PROPERTY

Investment Size You can create a portfolio of any size to suit your available capital or borrowing capacity.

To invest in a single property you need a large amount of capital or need to borrow a large amount of money. It may only suit investors with sufficient equity and/or income to service a mortgage.

Volatility Investment values are generally more volatile than property. Property values are generally less volatile than shares.

Diversification You can easily diversify your share portfolio across different sectors including property.

If the property is your only investment then you have little to no diversification. If you also own a home a very large proportion of your wealth may be concentrated in property.

Purchase costs Brokerage costs

Example per trade:

• $33 or 0.15% of transaction value

Examples

• Title transfer stamp duty• Conveyancing & disbursements• Pest inspection• Building inspection• Strata inspection• Survey report• Lender’s valuation fee• Loan establishment fee

Gearing into Property or Shares

SHARES INVESTMENT PROPERTY

Holding costs • Loan interest (if borrowing to invest) Examples

• Landlord insurance• Building insurance• Body corporate fees• Property management fees• Property maintenance and repairs • Land tax payable annually• Council rates• Loan interest (if borrowing to invest)

Sale costs Brokerage costs

Example per trade:

• $33 or 0.15% of transaction value

Examples

• Real estate agent sales commission (approx. 2.0% of sale price)• Property advertising

Income Income is usually paid half-yearly. Only companies that are profitable will generally pay a dividend.

Some shares pay franked dividends. Franked dividends provide you with tax credits which may be used to reduce your tax on the dividend. This franking tax credit represents the tax already paid by companies on the profits from which dividends are distributed.

Rental income is generally paid fortnightly or monthly by your property manager. There may be periods where you don’t have a tenant and may receive no rental income.

Control Little to no influence on income. Dividend amounts are declared by the company.

You have the flexibility to adjust the rent your tenants pay.

Liquidity Shares are considered a liquid investment. All or a part of your portfolio may be sold. The sale proceeds are generally available three working days after the sale.

Property is considered an illiquid investment. Selling a property can take some time and when you do the proceeds are generally not available for up to 6 weeks after exchanging contracts. You cannot sell just a portion of your property if you require some funds. Liquidating your property may also trigger capital gains tax consequences on your entire investment earlier than necessary.

Capital Improvements

None. You can undertake renovations to increase the value of your property.

Gearing into Property or Shares

SHARES INVESTMENT PROPERTY

Managing your investment

If you have a financial planner a review of your portfolio holdings may be undertaken on an annual basis.

Most investors engage a property manager however investor involvement/decisions may be required to address property maintenance and tenancy issues, attend property inspections, body corporate meetings, arrange insurances and pay rates and other expenses.

Interest rate if borrowing to invest

Generally higher interest rate relative to borrowing to invest in property. Generally lower interest rate relative to borrowing to invest in shares.

Percentage of asset value you can borrow

Generally up to 70% of the share value. Generally up to 80% of the property value.

Other Risks Subject to potential margin calls if portfolio value falls. Subject to potential costly maintenance and repairs, tenant not paying rent or damaging property and fixtures.

Depreciation None. Depreciation of plant, fixtures and fittings may be claimed as a tax deduction.

COMPARING THE COSTS OF INVESTING*

The following is an example of the costs of borrowing $250,000 to purchase a $500,000 investment property or a $500,000 share portfolio.

Purchase costs (approximate)

$500,000 share portfolio

$500,000 investment property (unit) located in:

NSW VIC QLD SA WABrokerage (0.15%) $750 n/a n/a n/a n/a n/aConveyancing/Legals n/a $1,500 $1,500 $1,500 $1,500 $1,500Stamp duty n/a $17,990 $25,070 $15,925 $21,330 $17,765Registration of mortgage n/a $105 $108 $158 $148 $160Registration of transfer n/a $209 $1,362 $1,111 $3,560 $250Strata report n/a $300 $300 $300 $300 $300Pest inspection n/a $0 $0 $0 $0 $0Building inspection n/a $0 $0 $0 $0 $0Survey report n/a $0 $0 $0 $0 $0Total cost $750 $20,104 $28,340 $18,994 $26,838 $19,975

Gearing into Property or Shares

Annual holding costs (approximate)

$500,000 share portfolio $500,000 investment property (unit)

Landlord insurance n/a $250Building insurance n/a $0Property management fees(5% of rent)

n/a $1,000

Property maintenance and repairs n/a $500Council rates n/a $1,200Water service charges n/a $600Body corporate fees n/a $2,800Land tax payable annually n/a $0Interest costs on $250,000 loan $20,000

(based on average interest rate of 8.00% p.a.)$15,375

(based on average interest rate of 6.15% p.a.)Less depreciation n/a $900

(average over 10 years)Total cost $20,000 p.a. $20,825 p.a.

Selling costs (approximate)

Let’s assume that each investment is sold for $800,000 after 10 years.

$800,000 share portfolio $800,000 investment property (unit)

Real Estate Agent sales commission (2%) n/a $16,000Advertising n/a $2,000Brokerage (0.15%) $1,200 n/aTotal cost $1,200 $18,000

Total costs (approximate)

$500,000 share portfolio $500,000 investment property (unit) located in

Total cost NSW VIC QLD SA WA

$21,950 $58,929 $67,165 $57,819 $65,663 $58,800

* The figures used in this example are for illustrative purposes only and do not represent all investment scenarios. The figures provided are not intended as forecasts and actual outcomes may vary significantly. Actual figures will vary depending on the type of property, location, transaction value, and size of any loan.

This information is published by CommSec Adviser Services, a brand of Commonwealth Bank of Australia (CBA) ABN 48 123 123 124 AFSL and Australian credit licence 234945. As this information has been prepared without taking into account the investment objectives, financial situation and needs of any particular individual you should assess with the help of legal, financial and taxation advice, whether the information is appropriate in light of your own circumstances before acting on it. This example is hypothetical and for illustrative purposes only and is not a recommendation. Any names or identifying features do not reflect any particular person or time period. Information on taxation is based on the continuation of current laws and their interpretation. This document should not be regarded as a representation, guarantee or warranty by or on behalf of the CBA or any other person that such outcomes or their underlying assumptions will be met or that capital will be repaid. When investing, past performance is not a reliable indicator of future performance. This example is not advice and is neither an exhaustive statement nor a summary of any matter. CBA and its related entities do not accept any liability resulting from a reliance on the information provided in this example. CAS2143 (10/15)