What’s the better investment, shares or property?

The shares or property debate remains alive and well, especially in housing-obsessed New Zealand.

I like investing in businesses so I lean toward shares, but I understand why property is so popular.  

At the same time, I think some people have a rose-tinted view of housing as an investment, overestimating the returns and underestimating the risks.

Since 1990, NZ shares have returned 8.5 per cent annually, which includes cash dividends.

Over and above that, imputation tax credits come with those dividends, meaning local investors have little additional tax to pay on the income.

Any capital growth is obviously untaxed, assuming you’ve bought your shares as a long-term investment.

The US market has been stronger still, returning 10.4 per cent per annum over the same period (in NZ dollar terms).

International shares are taxed differently, and you’ll pay away 1.4 per cent each year if you’ve invested through a PIE investment vehicle.

A share portfolio doesn’t manage itself either, so that’s an additional cost to consider.

After taxes and fees, those historic annual returns will have likely ended up in the 7-8 per cent zone.

Turning to property, New Zealand house prices have risen 5.9 per cent per annum since 1990.

Beyond that, we need to make some assumptions about rental income, as well as costs.

The average rental yield, based on CoreLogic figures, is 3.8 per cent.

As for the costs, insurance, rates, maintenance and a vacancy allowance for a few weeks each year might amount to about 1.5 per cent of the property value, each year.

That could be a little generous there, the way some costs have been increasing.

Property management and accounting fees erode a little more of the rental income, and if you tax what’s left at 33 per cent your net yield of just 1.3 per cent.

If you’ve got a mortgage the interest payments can quickly push you into negatively geared territory, which means you’ll need to tip extra money in each week.

You can see why property investors are so reliant on capital gains.

We haven’t seen much of those lately, although house prices are expected to rise modestly from here.

Reserve Bank projections suggest annual gains of five per cent over the next three years, and most economists are picking something similar.

That’s more subdued than we’ve seen historically, which could be due to the high starting point.

House prices are 15.9 per cent below the peak of three years ago.

However, they’re still 23.5 per cent above pre-COVID levels, such was the magnitude of the increase during 2020 and 2021.

The prospective gains are only one consideration, and there are other equally important characteristics to consider.

In exchange for the higher returns share typically deliver, investors must live with greater volatility and more frequent ups and downs.

House prices can fall too, even though the declines tend to be more modest.

There have been four distinct periods of slumping house prices since 1990, this last one being the worst.

One drawback of real estate is that it’s difficult to diversify, while share investors can very easily spread their risk across different countries, markets and industries.

Property is also less liquid, whereas you can sell all or part of your share portfolio quickly, easily and cheaply.

That flexibility works well when you’re buying too, as you can invest in instalments rather than going all in at a specific point in time.

A key reason many people favour property investment is because it’s much easier to use leverage, given the willingness of banks to lend heavily against housing.

Debt supercharges your returns so this can work very well in a rising market, although it can have damaging effects when prices fall.

You could borrow against your house and do the same with shares, but that can be risky given the higher volatility so it’s best left to those who know what they’re doing.

Some property people will never touch shares, while some share investors see property as too much work for relatively modest rewards.

The two asset classes have many fundamental value drivers in common, but they are also very different which makes it difficult to declare a clear winner.

Shares and property can lead to wealth creation and prosperity, so each to their own.

I also suspect the most astute investors don’t waste their time with the debate anyway. They acknowledge the pros and cons of each, and simply own both.

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