Property or Shares? – The Great Debate

July 14, 2010

It has been a hot topic for debate from barbecues to boardrooms and it seems everyone has their own opinion but the question remains un-answered: “So what’s a better investment, property or shares?”

In this article we will examine the pros and cons of the two investments vehicles and attempt to put an end to the debate once and for all. We will compare the investments side by side on many important factors and offer a winner on each factor.

The great Australian dream of owning a little slice of our cherished country remains an important desire for many Australians which ensures purchasing residential property is also an emotional decision. This should be quite distinct from looking at property as an investment. For the purpose of this article we will compare the assets on the basis of investments and so therefore assume the property is generating income in the form of rental income.

Affordability

Relative to incomes, Australia is now the second most expensive country in the world to purchase property. Many consider current property prices to be over inflated which begs the question are we likely to see the bubble burst any time soon? The existence of or risk of a property bubble bust is another topic for debate for another occasion. However, prices cannot continue to rise forever regardless of supply and demand. In the end, property as an investment must revert to a price resembling the total value of its future income payments and land value combined.

This question of correct valuation is also relevant for shares. A shares value should reflect the present value of future dividends plus the terminal capital value. Shares are more often than not priced incorrectly as income resulting from corporate earnings can be uncertain. However a shares value is quickly corrected once information becomes available to the market.

Affordability is a question of the scale of the purchase cost not the accuracy of the valuation. To purchase an investment property requires a large amount of capital expenditure. As of September 2009, the median price for an existing house in Sydney was $500,000. Although many properties can be purchased for less than this, the fact remains that you will need a 6 digit sum to enter the market.

Shares on the other hand can be very affordable. Theoretically a share can be purchased for as little as a few cents depending on the company the shares are purchased in. However in this example your cost of the transaction will exceed your initial investment.

Result: Shares win this one due to their low cost of initial investment. However for large investors this is not a contributing factor in their investment decision.

Tangibility

This is a very important issue for many investors, particularly those who have a lesser understanding of shares. Property is a tangible asset. You can touch it, see it and live in it. Most people have either owned their own or rented a property so they understand the workings of the investment.

On the other hand shares are not a tangible asset. You cannot see or hold your shares, and if it wasn’t for your dividend cheques or shareholder correspondence you would not have anything to show that you owned the asset.

Result: Property wins this one hands down.

Separability

If you found yourself needing money and wanted to fund your shortfall from your investments, you could sell a portion of your share portfolio. You can’t put a part of a house on a market. The exception is holding property through a listed vehicle, however for the purpose of this debate we are comparing direct property investment.

Result: Shares win. You can cash out a parcel of shares, but you can’t sell the study.

Liquidity and Transaction Time

Shares are highly liquid. Thousands of shares change hands every second during trading hours and for the vast majority of listed companies, there is always a buyer. You also receive your funds quickly after the transaction. If you sell shares today, you will receive the payment in three business days. If you hold shares via a managed fund, you will receive the payment within a week or so.

You may not be able to sell your property when you want. You need to find an agent, then arrange inspection times and an auction date. Then once the property has been sold settlement can take months before you receive your payments.

Result: Shares win again. They are more liquid and payments are received quicker.

Income Yields

Income yields for shares and property are both fairly stable. The capital values of both shares and property are derived by the principals of demand/supply, so higher rentals or dividends are reflected in higher prices. This holds the income yields fairly stable.

Australian share income yields have held fairly constant at close to 4%. The benefit of dividend imputation must then be factored into the share income yield.

Result: Shares by a whisker. The added tax incentives of dividend income cannot be ignored.

Costs

When comparing the investments we have to measure the benefit to the investor net of the costs of the investment. So what are the costs?

In trading shares you will pay brokerage on acquisition and on disposal. However there are no ongoing management or maintenance costs. Unless of course the shares are held via a managed fund which will have a management fee deducted from the investment.

Property on the other hand will have expenses for upkeep and fees associated for management. Property also has substantial transaction costs at purchase and sale in the form of stamp duties and other taxes, as well as agent fees.

In terms of lifestyle costs, shares have a very low burden on investors. A share holder is not responsible for the day-to-day management of the company and besides the right to vote at an annual general meeting, the shareholder has no input at all to the company’s management. Property on the other hand, can have a significant burden on investors if they choose to actively manage the property themselves.

Result: Shares win hands down. The cost of buying and selling shares is insignificant when compared to the costs of buying, selling and holding property. Property may also be a burden from a lifestyle and time perspective.

Volatility

It is a common misconception that Property has a lower level of volatility than shares.

A property investor is only aware of the true value of their investment twice during the term of the investment; at purchase and at disposal.  The true value of your investment is what another investor is willing to pay for the asset at the time of the transaction.

The graph below shows the median price of an established home in Sydney. If you had bought the property in March 2002 you would have paid $365,000. If you then had sold the property in September 2009 you would have received $500,000. The return is represented by the red line. However median prices fluctuated during this period. The blue line represents the quarterly median price of an established house in Sydney. We can see this fluctuates above and below the red line, hence it is showing volatile characteristics.

Median Price of Established House Price - Sydney

All Ordinaries Index

While share prices may appear more volatile as they are priced on a daily basis, shares have historically provided high long-term returns, particularly when compared to capital stable investment classes like fixed interest and cash.

Result: A tie. Both assets include a level of volatility due to capital risk, interest rate sensitivity, supply and demand, and legislative risk.

Verdict

And the winner is… Both. A valid argument can never be made that property is a better investment than shares or vice versa. Both asset classes have pros and cons which may be important to particular investors when making their investment decision.

If a conclusion needs to be made, it is that true income and asset diversification is important and that each investment needs to be considered within the context of the investor’s broader investment portfolio.