Buying your Home, Investment Property or Building a Share Portfolio
This is an old
discussion especially in Australia where buying your own home is the Australian
dream. What I plan to cover here is some myths, and provide some raw data and
thoughts to help you make a decision on if you plan to buy a property for
investment and or build a share portfolio.
Looking at the chart
below we can clearly see that CPI adjusted returns for buying property in the
US. Since 1975 your return is only 30%. Obviously a very poor return on
investment if that is why you are buying the property. Meanwhile you can see that the Australian
property market was stagnant till about 1995-2000 from where it took off. The
Australian property market since 1975 has risen 181.5%. Based on 39 year time
frame this means that the average return P.A for the US market is 0.69% and the
Australian annual growth rate is 2.76%.
Formula used: =((End Value/Start Value)^(1/(Periods - 1)) -1
When we look over the
same time period for stocks we can see that the Australian Stock Market increased
in value about 6.7% and the S&P500 had an increase of 7.59% P.A. A
considerable difference.
To give this all some
sort of perspective if you earned 6.7% from your investment per year for 30
years with a starting balance of $40,000 and no other contributions this
account would be worth a touch over $279,000. If you earned 2.76% over that same
time period your 40,000 would be worth $90,000 and change. What a massive difference.
This is the power of compounding and being aware of what real returns are
available. A difference of 3.94% P.A. made a difference of $189,000 or 210%.
I guess the point is
that buying investment property can have the figures worked to prove it is
a myth and not a good investment as shown above. If you go to a property seminar they will
easily show you growth rates of 10% etc. It is easy to manipulate figures but
you can see from the CPI adjusted property prices if someone is telling you it
is above 3% p.a. they are not being realistic and your dreams will be over
promised and under delivered.
I have noted it
multiple times that buying a property does not guarantee any sort of wealth,
what it does guarantee is that you have a high probability of keeping up with inflation
and that is about it. When you buy property, you need to look and invest in
property with the strategy of cost basis reduction. What I mean by that is when
you buy property you need the ability to reduce your cost basis, by ensuring the
property is subdivisable, or maybe you are buying the house cheap so you can
fix it up and the equity difference ensures you have significantly reduced your
cost basis. There are other ways to do this but I am sure the point is getting
across.
My biggest problem
with property, outside of the numbers provided above, about the low rate of
return, is the lack of ability to have real transparent pricing and real cost
basis reduction strategies. What I mean by that, is that with the stock market,
once you have completed your analysis and are ready to trade, there are multiple
instruments that you can use to invest in that particular stock. If the stock
goes against you, you have the ability to reduce cost basis by using options
and/or reducing your break-even price through buying more stock. Property on the
other hand, you can only do a renovation once, and you can only subdivide once
and can only buy that property once. With property investing you get one shot
at making the real money by reducing cost basis. As shown in the figures if you get your figures wrong, you
can hang around for the next 30 years for your property to grow in value and
keep up with inflation, but your still stuck with that one cost basis reduction
strategy, and if the market goes against you, and your property reduces in
value, all you can do is wait it out.
To put it another way;
If you decide to
invest your deposit vs. use your deposit for your home this is how it would
turn out.
Based on the medium
prices of homes in Australia and Medium rent and current variable mortgage
rates on the market, you can see there is difference between paying a home off
and Renting. In the example of medium pricing the average home loan repayment
would be about $2820 based on a 475,000 mortgage. The medium rent is $1860. If
you used your deposit of $50,000 for investments in the share market, and added
the difference between the home loan repayment and rent to your investment
account, based on 6.7% that investment would be worth $2.3M and change after 30
years. Assumptions are that 6.7% is net after tax's.
Based on 20% returns, as shown that this sort of return can be achieved, those figures would jump to $35M and change, over that time period.
So after 30 years you
can have a home fully paid for or have an investment earning you $154,000 a
year. I am not endorsing this strategy, just pointing out that buying a house
and home to live in is not all that it’s supposed to be. You can make your own
decision on what’s right for your personal circumstances. Obviously the point
here is that for a small capital outlay/deposit and regular ongoing payments to
an investment account you can have a substantial capital and investment base
when you retire. If you can combine this with owning your own home, this would be a good financial plan.
Note; I can only vouch
for the formulas and figures I have put together. As I had no hand in putting
together any CPI adjusted figures, we have to assume they are correct.
