Building Wealth through prosperity and persistence

The recent financial crisis, which some experts say we haven’t seen the worst of, is a very tough reminder that share trading is a volatile game.

In property too, the past few years have seen a downturn in the market in many Australian cities.

Before the recent decreases, rising interest rates had also increased costs for homeowners. It has left plenty of us wondering whether we should invest in anything at all.

Shares have been hugely attractive because they’re regarded as a liquid asset and require very little money to begin investing.

Property is attractive too, mainly because it’s solid bricks and mortar and isn’t subject to the daily fluctuations of the share market.

These are all short-term benefits.

When you look at both forms of investing over the long term, however, a clearer picture forms.

For me, investing is a long-term strategy: if you have a sound strategy and understand the numbers, property can bring you most of the benefits that shares bring — and more.

Myth: Property isn’t a liquid asset

In my experience, property can easily be turned into cash and you don’t need to sell to get it.

If you have $100,000 and want to purchase a $500,000 property, the bank will often lend you the balance of 80 per cent (or $400,000).

If that property then grows to $600,000, rather than selling your property to access that $100,000, you could simply refinance.

Refinancing is just like selling, but without the legal fees, taxes and agent’s fees.

When you refinance, you can ask the bank for an 80 per cent ($80,000) loan on the increased equity. If you were to sell, your taxes, legal fees and agent fees could amount to a sum of $30,000 to $40,000.

To ensure my property portfolio remains very liquid, I revalue my properties every year to ensure I always have a spare buffer zone of cash I can withdraw whenever I want. It’s as simple as taking cash from an ATM or making an Internet transfer — that seems pretty liquid to me.

Myth: Traditionally, shares have performed better

Pro-share sites like the Australian Securities Exchange quote paid studies showing gross returns over 10 years (see table).

If we assume these figures aren’t weighted in favour of shares, it seems as though shares perform marginally better than property. But in property, leverage is essential for me.

Since most banks will lend up to 80 per cent of the extra equity on a property (or even 90 to 100 per cent on your first few), $100,000 can buy a $500,000 property. This is likely to grow at $40,000 to $50,000 a year.

However, the rent won’t quite cover the mortgage, so after other expenses, depreciation and tax, it will probably cost you $10,000 to $15,000 in negative cash flow. That gives you a net result of about $25,000 to $40,000 or 25 to 40 per cent return on your investment.

In share trading, banks prefer to lend against strong stocks, so it’s usually only blue chip stocks that can be leveraged to higher levels. And you can only safely borrow against 50 per cent of their value. Borrow more, and you are more likely to be subject to a margin call.

Based on that, a $100,000 investment will normally buy $200,000 worth of shares. This investment would need to grow by 12.5 to 20 per cent to equal the $35,000 to $40,000 you can make in property, and that’s not including the cost of borrowing to buy the shares.

This means the share market needs to rise by almost two times the rate of the property market to offset the leverage and tax effectiveness.

True: Investing in shares requires more knowledge

A good advantage of shares over property is that a few hundred dollars will get you started. But what do you invest in?

If you are to achieve the market average, you either need plenty of knowledge or enough money to buy a very large diversified portfolio.

I recently took part in a share tipping competition in a newspaper and it was amazing how the experts struggled to compete against the dartboard, astrologer and a school kid.

Residential property is a lot simpler. To get the market average return, it requires very little knowledge aside from these few simple rules:

n buy in high-demand areas that are close to work, leisure and transport;

n buy median-valued properties — as most renters can afford to live in these and they’re easy to offload if you have to;

n choose properties that are clean, light and well maintained; and

n get an independent valuation so you ensure you never pay too much.

You don’t need to be a genius to invest in residential property. If you buy well and can hold onto it for the long term, you will almost definitely make money.

However, if you want to make a real fortune, you need to develop your strategy, know your numbers, be comfortable with debt and keep buying better. And that’s where you may want to delegate to an expert.

Myth: Property is subject to more taxes

Investing in property normally produces a negative income and a positive capital gain.

This means you get a tax rebate for your cash flow losses and depreciation, while the real wealth from property, the capital gain, only gets taxed when you sell.

So if you refinance, you get 80 per cent of the cash to reinvest without having to pay tax until later, and even then it’s at half the rate. And if you never sell, you never pay the tax.

With shares, dividends get taxed at the normal income tax rate. If you decide to sell your shares to buy something else, you will also be required to pay capital gains tax. Both of these taxes give you less cash to reinvest.

In my example under liquidity, the truth is, rather than shares requiring twice the return to equal property, they really need four times the return, as tax will often have to be paid on the profits.

Don’t forget to diversify

While I am an expert in residential property, I don’t profess to have the same knowledge of shares.

But these insights reveal my personal reasoning behind building and holding the majority of my current wealth in property.

I gather that the majority of entries on the BRW ‘Rich List’ tend to either build their wealth or hold their wealth in property too.

Saying that, I do believe in the benefits of diversification and as shares and property markets often cycle at different times, it is wise to have a balance of both as well as some cash.

The shares versus property debate will never be won.

If you enjoy trading shares, reading about them and making judgments, you will probably end up making more money trading shares than investing in property.

But if you love property as an investment — as I do — then I believe your destiny is to make money through property.

Whatever you decide to do, always consult a professional adviser before making a financial decision.

Chris Gray is a property expert who provides opinion and commentary regularly on television and in other major media.