by Scott Pape - May 20th 2006
Everyone has a preference – blonde or brunette, Ford or Holden, property or shares.
These choices will be made on the basis of your previous experiences. Perhaps you were unlucky enough to own a Camira, fell in love with a brunette, or owned property during the biggest asset bubble the world has ever seen.
I often meet self-proclaimed ‘property people’ who are convinced you can’t go wrong with bricks and mortar. Many see shares as risky, and argue that a property investment is something tangible you can touch.
Usually their experience with property has been positive – they’ve made a killing in rental property and received tax breaks to boot.
Australians love being landlords, so much so that studies show that one in 10 baby boomers have rental properties and many more people plan on getting in the game to beef up their retirement returns.
The cost of retirement
Last week a report by the University of NSW found couples will need $47,000 a year on which to retire; singles $35,000 a year. To achieve this, people need a serious superannuation strategy.
Financial planner Kevin Bailey says that “most people underestimate how much money they’re going to need in retirement”.
At the same time many people overestimate the future returns from their investments – especially from their investment property.
The attraction of any investment is the hard dollars it puts in our pockets.
The problems with property
Residential property has never been very good at putting money in your pocket. In most cases the rent fails to cover the outgoings.
It’s not all bad news though because for every $2 down the drain you’ll get back $1 in the form of a tax deduction. Negative gearing we’re told is the way to become rich with a helping hand from the tax man.
Yet on my last inspection of the tax office website I saw no reference to it being the property fairy that bestows love and allowances upon landlords.
The return on most rental properties is less than you’d get from an ING savings account. Anyone who has an investment property will tell you the real money is made at the end when you sell – not in the middle when it burns a hole in your pocket.
Back in the boom times, I remember driving past a Lego land development in Port Melbourne where people were camped out on the street like diehard U2 fans hoping to score tickets – except here they were hoping to grab an apartment off the plan.
One of my friends was lucky enough to secure what was then just a dusty vacant block of land and a glint in an architect’s eye. The price was a steal – $300,000 for a one bedroom apartment.
The real estate professionals promoting this deal weren’t licensed financial advisers – nor did they come under the watchful eye of the Australian Securities and Investments Commission.
My mate was fed lines like “property doubles every seven to 10 years”, “you can’t go wrong with bricks and mortar – it never goes down”.
As a licensed financial professional if I had given advice like this I would have been barred or jailed for making such ludicrous statements – yet they got a commission cheque.
Unlicensed liars
Let’s take a closer look at these porky promises. Based on the spruikers calculations, my mate’s $300,000 apartment would be worth roughly $9.6 million in 35 years.
If property doubles every seven to 10 years like the salesmen said, there wouldn’t be enough money on this earth to pay for a one bedroom flat in the backblocks of Bendigo (see table).
The second statement that “property is a safe investment” and it “never goes down” is another furphy. Somehow a lack of transparency and liquidity in the property market is seen as a good thing for investors – apparently ignorance is bliss.
All assets fluctuate, it’s just that property investors only ever think about the price in detail when they decide to sell.
Besides, getting an impartial reading on the real estate market is hard. Leading Real Estate advocate Neil Jenman says that “the house price data provided by the REIV is often misleading – skewed towards talking up the market”.
Comparing property and shares
I spoke to a real estate agent about the process of selling a $300,000 flat. The agent said it usually takes about five weeks to find a buyer willing to pay the seller’s preferred price.
Settlement of the sale is usually 60 days and the real estate agent’s fee of 2.5 per cent of the sale costs $7500, plus $2500 for advertising, plus $550 for conveyancing – all up about $10,550.
Compare this with selling a $300,000 share portfolio. You can go online, check the price, click, sell and the money will be deposited in your account three business days after the trade – and if you use a discount broker it could cost as little as $360.
If property is the surest path to riches why doesn’t the Packer family own 1000 residential properties? Why do banks sell their branches and lease them back, and smart profitable companies like Woolworths do the same by selling their supermarkets?
The answer is that there’s more money in owning a business than there is in owning a property.
Financial adviser and author Peter Thornhill says “if all that was required to become rich was to rent out residential property, why would anyone start a business?”
Your preference for shares or property is likely to be clouded by the money you’ve made in the past.
Look ahead
Given that most of the return generated from an investment property is the capital gain, let’s focus on the future.
According to leading economic thinktank the OECD, Australian property is 52 per cent overvalued.
United States-based research group Demographia has found that Australia has the most expensive real estate in the world on an adjusted basis.
It’s now three years since my mate signed the salesman’s contract. The recent increase in interest rates, body corporate fees, and ensuring a tenant stays to pay the rent are at the forefront of his mind.
According to Matusik property insights second-hand apartments are selling for up to 40 per cent below the price for new apartments. It will be a long time before he gets square, let alone ahead.
Luckily he has a bright future and youth on his side.
Unfortunately the baby boomers piling into property today may soon find out they don’t have either.
Last week I wrote about the newly listed Global Masters Fund, a company which proposes simply to invest in shares in Warren Buffett’s Berkshire Hathaway – and to extract a fee for the privilege.
Just to see what that fee could amount to I punched some numbers into the managed funds calculator on the ASIC website, assuming Global Masters started at the same time as Berkshire Hathaway in 1965.
The result says it all.
A $10,000 investment with Buffett turned into $8,393,000. With Global Masters the same investment, minus a 0.85 per cent trailing fee, produced $6,105,000.
A whopping $2.3 million would be scooped up in fees.
Tread your own path!
DOUBLING UP
Property doubles every seven years? The value of a $300,000 apartment in the future:
2003 $300,000
2010 $600,000
2017 $1,200,000
2024 $2,400,000
2031 $4,800,000
2038 $9,600,000
2045 $18,200,000
Photo: http://www.flickr.com/photos/stonebridgedapper/4510918163/
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2 comments
Scott, wouldn’t value of unit be $19,200,000 in 2045? (being picky)
If you take some median prices from back in the 1970′s and apply the same rule you’ll end up with wildly different prices for 2011 than for what they are in reality. If you look at Melbourne medians for the mid 90′s you’ll see that the median barely went up at all over about five years. Look at some areas between 2004 and 2011 and they’ve nearly quadrupled in value.
That whole “doubles in seven years” is a catchy phrase that is just about as shonky as a Nigerian scam email promising thirty two million dollars for parking one hundred million dollars for a week or two in your bank account!