Investing in property through the sharemarket
- Fri 04 June 2021
Ord Minnett’s Vera Lin considers the pros and cons of listed property versus investing in property directly. Shaw and Partner’s Felicity Thomas shows how prospective home buyers can build their deposit up faster through the sharemarket.
The attractive features of investing in property include positive cashflow, tax benefits, scarcity (if buying land), a “stable” asset value, and access to leverage (through debt).
By investing in a property that yields a net positive rental income, investors can pay off their mortgage sooner without reducing their own disposable income to meet repayment obligations. In the meantime, investors can utilise various tax-deductible benefits, such as interest repayments, depreciation on fixtures, upkeep costs and, if applicable, negative gearing.
Real estate can be a scarce commodity because land space is finite, and Australia has an ageing population. It also offers a stable asset value that is not subject to daily volatility. Investing $100,000 in real estate may equate to buying a house worth $1,000,000 (subject to other variables).
Vera Lin, Ord Minnett
It is the only type of investment that offers this high degree of leverage. Accordingly, investors can amplify their returns from real estate compared to a share portfolio with the same investment amount.
Disadvantages
The disadvantages of investing in real estate include lack of liquidity, lack of diversification, large capital requirement, time and cost of management, and risk of serviceability.
A property owner requiring funding is unable to sell a doorknob or a hallway to raise the cash needed. The lack of liquidity can be quite costly if investors are forced to sell during a property downturn or due to a deceased estate.
Furthermore, if investors only hold real estate assets, the lack of diversification would compound the lack of liquidity issue.
Also, a significant amount of capital is required to start investing in real estate. Australian house prices have seen remarkable growth of around 7% per annum over the last 30 years, which raises the question of housing affordability today.
The Reserve Bank monitors this trend closely as the Australian household-debt-to-income ratio reached around 185% as of November 2020, of which 76% is housing debt.
Managing an investment property requires time commitment. This can be outsourced to a real estate agent for a fee or managed by the property owners themselves. Either way, there is an added cost (both financially and mentally) of dealing with extended vacancies, bad tenants, and damages.
Finally, there is a long-term risk of serviceability in the event of rising interest rates or loss of salary due to role changes, retrenchment, illness or disability.
Listed property
In contrast, the advantages of investing in listed property include having greater liquidity, better diversification, access to specialist property managers and a wider range of investment options, a lower capital requirement, and receiving a high yield.
By investing in listed property via Australian Real Estate Investment Trusts (A-REITs) or Exchange Traded Funds (ETFs) on the ASX, investors have daily liquidity and can time their investments to buy during market downturns or share-price weakness.
There is also the ability to raise cash within a short timeframe if funding is required by selling a portion of their investment. Investors can hold a well-diversified portfolio with exposures to retail, office, and industrial listed properties, both domestically and globally, which can help reduce the overall investment risk.
Investors are not required to have extensive knowledge of the sector as they can access a wide range of expert managers operating high-quality property assets. During market downturns, economic recessions, or event-specific sell-offs, investors have the ability to switch out of particular sectors that are underperforming and increase their exposure to other sectors that are likely to perform better in a recovering economy.
There are low barriers to entry as investors can start with a small investment and add to it over time. Listed property shares can pay high yields that are generally considered defensive income as it is derived from rent rather than corporate earnings, which may be more volatile.
However, as with all listed investments, the risk of listed property includes market risk, timing risk, rising interest-rate risk, exposure to currency risk if holding global property assets, and the risk of total loss of investment.
Ultimately, depending on your personal circumstances, level of risk aversion and income needs, you may find one investment type to be more appropriate than the other. This will naturally change over time based on your stage of life, so it might be prudent to periodically reassess your financial goals and adjust accordingly.
Felicity Thomas, Shaw and Partners
Cut the time taken to get on the property ladder
Saving to buy a property is hard, which is why first-home buyers need to plan ahead and consider other avenues to grow savings for their deposit.
They first need to set some goals and plan ahead. The goal considered in this article will be to buy a property in five years. In this example, the home is currently worth $750,000. The investor is able to save $40,000 a year.
The first problem is figuring out what this property will be worth in five years. In this case, it is likely to be worth around $1 million. Sydney property historically has roughly doubled in value every 10 years, a return of 7 per cent a year. This figure can vary depending on where you are investing as Sydney has historically been a strong performer.
Generally, prospective homeowners will aim to get a 20 per cent deposit before buying a property. In this example, they will need to save $200,000 before buying in five years. They will also need to consider State stamp duty and taxes.
As they build up their deposit, their money often sits in a savings account offering returns below 1 per cent. In most cases, this is lower than inflation each year, so the “real” value of their cash is depreciating. Also, any interest earned is taxed at your marginal rate, making this option even less appealing.
So, what other options do investors have? For long-term returns, investors often look towards assets expected to grow over the long term at a higher rate than cash. These “growth” assets generally fall into two segments, stocks and property.
Shares are significantly more accessible than property in Australia, mainly due to the lower amount of money you need to invest. With new trading platforms and low-cost ETFs, investors can now invest in shares for as little as a few dollars. This makes shares an attractive option for first-home buyers saving for a deposit.
When investing in the sharemarket, it is generally recommended you invest for the medium to long term to reduce your chances of losing money. If you plan to buy a property within the next few years, this can be quite a risky strategy as stock markets can be very volatile.
Over the last 10 years, the S&P/ASX 200 (the 200 largest listed companies in Australia) has had an average annual return of 6-7 per cent. The SP 500 (500 of the largest companies in the United States) has averaged 13-14 per cent. Both returns have been significantly higher than cash over that period, but with significantly higher volatility.
There are numerous ways to get exposure to shares but we will focus on two of the most common options.
First, there is a large range of Exchange Traded Funds (ETFs) available on ASX, with most classified as index funds. These funds mirror a particular index.
For example, an ETF may mirror the S&P/ASX 200 and invest your money in all 200 of the largest Australian companies proportionally to their weighting in the index. This provides a low-cost, diversified portfolio and takes away stock-picking risk. These ETFs can be accessed through almost all trading platforms with normally only a minimum investment of $500 required.
The second option is managed funds. These funds pool investors’ money and each investor receives a certain number of units, depending on how much is initially invested. The pooled funds are then invested in shares and a diversified portfolio created. These funds are run by fund managers and will aim to outperform the various indexes. They can be listed on ASX or unlisted. The minimum amount invested in these funds varies, but often starts at $5,000.
Investing in shares gives you the potential to gain higher long-term returns than cash investments. This, in turn, will likely reduce the amount of time and savings you will need to build up to buy a house.
In the example used above, the investor will more likely be able to buy a property in four years rather than the five years it would take going the cash route. If you have the risk tolerance and the time horizon, investing in shares can be an attractive way of bringing your home-ownership goals to fruition in a shorter time.
About the author
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