Greville Pabst says the recent sharemarket ructions have investors questioning their investment strategies and revisiting the need to include property in a diversified portfolio.
As the US debt crisis worsens, international stock-markets are taking a battering amid fears of another global recession. Wiping tens of billions of dollars off the Australian sharemarket within only hours of news of a drop in the US credit rating, an acute nervousness has taken hold of local investors.
With sharemarket activity volatile, investment security concerns have left many questioning their investment strategy, giving rise to the long debated argument of bricks and mortar versus shares. There is no denying that both investment vehicles have created significant wealth for astute investors; but while there is no right or wrong answer to which is the best, there are clear fundamental differences that set them apart.
Of course the biggest difference between the two investment vehicles is cost; cost to buy and cost to trade. Property typically requires significant capital to invest and has a high transactional cost due to tax, legal and service fees associated with the sale or purchase. For this reason, it is considered a long-term investment and is therefore infrequently traded.
On the other hand, shares are relatively inexpensive with low-cost entry and comparatively low transactional costs, which means they can be traded daily. Also, unlike property, whose investment growth and profit are best measured over years, share growth and decline can be measured daily – and so can returns.
The second biggest difference between shares and property is the state of the holding or degree of liquidity of the asset. While shares are considered liquid and are based on a paper economy, property is considered illiquid and is a tangible asset with a physical value, underpinned by land and improvements (building).
‘For this reason, bricks and mortar are typically more popular during a downturn’
There are many differences between these two investment vehicles, but it is these two fundamental distinctions that create the divide between those who primarily choose to invest in shares and those who opt to invest in property. That is, because of the perceived exposure or risk that each brings.
When short-term needs take priority over long-term plans, illiquid assets such as property can prove problematic for those who need quick access to liquid funds, or more specifically, cash. This is because a property can take weeks, or even months to sell. However, investment property, the majority of which is typically purchased in the affordable range of the market, in many cases represents a relatively low-risk, long-term investment asset class because it is less exposed to the impact of wavering or short-term changes in economic conditions. Because property values change over a period of years, minor fluctuations are eliminated with prices generally weathering any inconsequential decline.
Property in most Australian capital cities is also underpinned by significant demand from an increasing population as a result of a growing national housing shortage, and isn’t plagued by oversupply issues, as is the case in some overseas markets.
While property has its own set of risks, so too does the sharemarket. In a paper economy, share values are closely tied to the underlying health of an economy. They are subject to daily fluctuations, impacted by movements in the dollar, employment, interest rates, commodity prices, GDP and geopolitical factors to name just a few, and can respond dramatically overnight, as seen recently.
For this reason, bricks and mortar are typically more popular during a downturn and are considered a haven for investors who’ve taken their money out of shares in reaction to negative financial market sentiment. Attracted by the asset class’s relatively steady performance and stable long-term growth, property offers a non-liquid, tangible asset that is more resilient to economic decline. Figures show that Melbourne property values increased by more than 50 per cent in the five years to June 2011, boasting an average annual growth of 9.95 per cent per annum. While an investment return of this kind may seem unremarkable to some risk-averse sharemarket investors, in average terms it meant an annual growth of more than $55,000 in 2010 and a five-year growth of more than $230,000 for property owners whose property is on par with Melbourne’s current median house price growth trend.
While Melbourne was the country’s standout performer, strong long-term growth was also recorded for capital cities Darwin, Adelaide and Canberra, with a combined average annual growth for all capital cities over the last five years of 6.32 per cent.
During this same five-year period hare prices saw a rise, before plummeting as a result of the GFC, and currently remain well below their peak achieved in November 2007. Analysis of historical sharemarket data reveals that a typical cyclical recovery for shares can take more than three years to occur. But with the recent blow to confidence recovery is expected to be hampered further, with positive implications for some property segments.
However, while Melbourne property owners are probably feeling a little smug right now, the city’s trend of exceptional growth is not likely to continue. Though values aren’t expected to fall, projections for the next decade suggest more conservative growth across the city with mixed results for specific asset classes and locations.
Despite the current disparity, long-term comparison of residential property and shares reveals very similar returns. As markets respond to changing conditions, asset selection – that is, the type of share or property – will become increasingly important but will depend upon investors’ individual circumstances and appetite for risk.
