Shares beat property in investment race

By MARY HOLM

Q. I have been following with interest for the last couple of years the debate over property versus shares.

I am interested in how the Auckland property market has fared over time against international shares.

Do you have access to this limited information? If so, could you either guide me (and others) towards an appropriate internet site or maybe include your response at some stage in your column.

A. It all depends what you mean by the Auckland property market.

I have been able to get numbers on commercial property from the Property Council of New Zealand.

For rental residential property it is trickier. Each property is different and it would be practically impossible to gather information on all or even many of them.

I've got data, though, on Auckland and New Zealand median house prices from Quotable Value New Zealand.

This is valid for home owners and is useful input for landlords in calculating their returns.

In some cases, the information goes back to the end of 1989.

If you put $100 into those investments in December 1989, here is what you would have had last December:

Auckland houses $165

NZ houses $155

Auckland CBD offices $148

NZ shares $236

International shares $322

Inflation 1989-2001 27%

In other cases, the numbers go back only to the end of 1992.

For those, if you invested $100 in December 1992, here is what you would have had last December:

Auckland industrial properties $299

Auckland non-CBD offices $242

NZ shares $249

International shares $293

Inflation 1992-2001 18%

The commercial property data includes capital gains and rental returns net of expenses. The share data, based on the NZSE Gross Index and the MSCI World Share Index, includes capital gains and dividends. House prices, however, show only the capital gain. International shares are in New Zealand dollars.

Some observations:

* The periods are rather too short, but they are all I could get. If you look at a decade of share or property data you might, for instance, see two booms and one bust, or it might be two busts and one boom. And that could make a lot of difference.

The international share numbers reflect the recent falls as well as the long 1990s bull market.

If I had looked at a period that ended in September 2000 instead of last December, the international share returns would be 24 per cent higher.

* Two of the three numbers for commercial property are on a par with shares. But the third one, for CBD offices, is not.

Those who know what they are doing in commercial property can certainly do well.

I am not so sure about those who don't. From the horror stories I sometimes hear, commercial property is pretty risky.

But if you invest in shares, you don't need to know about the market.

You can simply put your money into an index fund, which holds the shares in a market index, and go to the beach.

Q. The rental yield quoted in the rental property example in your column two weeks ago was 7 per cent.

Publisher Andrew King (of Residential Property Investor Magazine) was quoted as saying: "Unless it [the rental yield] is greater than 7.5 per cent you are probably relying on capital gains to make the investment work.

"This is not a good idea in today's economic climate".

A. An interesting comment from somebody who, presumably, knows.

Q. Thank you for publishing my letter two weeks ago, and allowing this interesting debate (which I am sure you will stamp out shortly). It is good to get many points of view aired in the one place.

I am a property investor on a modest scale and have experienced bad tenants and maintenance hassles.

Your column has persuaded me to reduce my exposure in property.

However, right now with house prices going up I am glad I have not taken any action, just yet. It is tempting to hang on with rents going up a little and the prospect of zero input while the property pays itself off.

That has always been the aim for me, 10 years of discipline followed by a growing income.

I am not inclined to argue against your other correspondents but I would like to comment on a few points made last week.

The $100,000 house price I used was simply a round figure, which makes it easy to see percentages and proportions, never intended as a realistic house price, especially in Auckland. The financial planner's addition of fixed costs to this small figure skews his results quite a bit.

Also, could he please explain how the internal rate of return of 2.51 per cent is arrived at on 100 per cent finance. What is this a percentage of, in this case?

Maintenance costs are not as high as you all think.

If you own a $300,000 property the house is probably worth about $150,000. One per cent for 10 years is $30,000, and I bet nobody spends that kind of money on their own house purely for maintenance. If you do, well I've allowed for it.

With geared investment, even a rise in house prices below the rate of inflation can produce a return.

I did leave out some significant costs. But the example looks even better if you allow for house inflation of more than 3 per cent. And do not forget it produces a tax-paid return.

Compare these returns, even if modest, to investment in international shares recently. As I said, I'm scaling back. But no one should deny the possibilities in residential investment.

One last comment: residential investment is attractive to a lot of us because it is something we can dive into if we own our home and have a small income surplus, whereas it can take a few years even to save $10,000 for an alternative investment, especially when we should really be paying off the last of our own mortgage.

A. What's all this then? A rental property investor getting two long letters in this column within three weeks.

You must be making some interesting points. Some of which beg a response.

First, the non-technical stuff. On your point about tax-paid returns, shares arguably do better than property.

Rent is taxable. Many dividends are not, in the investors hands, because of imputation. Capital gains on either are usually not taxable.

Sure, you can deduct depreciation on property. But if you sell your property for more than you paid for it, which almost always happens, the depreciation is clawed back by the IRD.

You have had the use of the money in the meantime, but that doesn't usually amount to a lot.

You suggest comparing rental returns with international shares. Recently, yes, practically everything has done better than international shares.

But, as I have said, shares and property are long-term investments. Over the last 10 years international shares have been hard to beat for the ordinary investor.

On your last point, it is quite wrong to say you need $10,000 for an alternative investment.

You can get into many share funds for as little as $100 a month, either drip-feeding directly into the fund or through a programme run by a stockbroker.

I put your question about the 2.51 per cent internal rate of return - the return investors receive, taking into account the timing of cash flows in and out - to the financial planner in last week's column.

He replied: "When I constructed my first spreadsheet, I too was confounded by the 100 per cent financing results.

"The 2.51 per cent figure is arrived at by taking into account all of the cash flows as they occur. Thus $100,000 is noted as an inflow upon receipt in year nought and summed up with all the other year nought costs.

"It is noted as an outflow at the time of sale. This balances the books! Any other method is not a true representation of the amounts, as they occur."

On your point about maintenance, he says: "Adjusting maintenance to $500 a year produces a 2.93 per cent result in the tenth year, on 100 per cent financing." In other words, it doesn't make much difference.

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