Sydney residential house prices VS Share Portfolios

The past decade in Sydney has seen periods of strong, above average house price rises but also declines.  When prices were rising some clients were asking us if they should buy a residential property.  Now that prices are falling, others are asking whether now may be a good time to take advantage of lower prices.

In order to buy an investment property, many investors may need to sell down their share portfolio to release the necessary funds. So, should residential property be considered a substitute for shares?  In short, our answer is no, but this article provides further explanation.

Over the very long term, the expected return of residential property is akin to inflation.  This is because one of the primary drivers of residential property prices is household incomes, and their growth is strongly linked to inflation.   The cost of debt is also a key driver of property prices.

There is an upmarket neighbourhood in Amsterdam that has house price information back to 1628 – the longest sequence of house price data in the world. The graph below shows the performance of this neighbourhood to early 2008, just prior to the GFC (the analysis hasn’t been updated since):

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The graph shows there have been some wide fluctuations in returns, however over the 380 year period analysed the average return was +0.1% pa above inflation.  Depending on when you were born during this period would have determined whether your experience with property investing was good, bad or indifferent.

Norway, one of the world’s wealthiest countries with limited available land like Australia, saw real house prices (adjusted for inflation) decline between 1900 and 1950, and only recover to their 1900 inflation adjusted levels just before 2000[i].

The final graph tracks US house prices during the 20th century, and demonstrates that prices effectively underperformed inflation from 1890 to the 1940s, then kicked upwards after the end of the war (no surprise given the demand for new housing with the baby boom) before tracking the rate of inflation for the remainder of the century.  However just prior to the GFC they rose sharply, before falling back to earth[ii]:

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Sydney house prices have experienced quite different returns over the past 50 years.

Since 1970, the average annual return of Sydney houses has been approximately 7.5% based on data compiled by Stewart Partners[iii].  According to the Reserve Bank of Australia inflation calculator[iv], inflation over this period averaged 5.2% pa, resulting in a real return of 2.3%.  This is a very strong result over a long period of time compared to most cities in the world.

But would you have been better off putting your money into the sharemarket rather than Sydney houses, even though property returns have been so solid?

We have compared Sydney house prices over rolling 7 and 10 year periods to two global share portfolios[v]:

·       Portfolio 1 – Mainly Australian shares[vi]

·       Portfolio 2 – Mainly International shares[vii]

It is important to note that listed public companies typically have borrowings on their balance sheet to help finance their operations, which implies a degree of leverage.  We have not made any assumptions on how borrowing to invest in residential property may impact upon after tax returns, just as we haven’t considered a geared share investment portfolio.

For residential prices we have made adjustments for stamp duty and selling costs, but the expenses we’ve assumed are less what many investors actually pay[viii].  We have assumed no rental income but also no agent fees, maintenance costs, renovations, strata fees or special levies either – it is difficult to factor in appropriate percentages over such a long period of time, and location can also have an impact – maintenance costs for a house near the coast are typically much higher than average. Nor have we considered tax – you can tailor this analysis to individual circumstances, but all we wanted to do was try to draw out any clear patterns.

The two graphs below compare Sydney residential house prices to the two share portfolios over rolling 7 year and 10 year periods.

The blue line is Sydney house prices.

Note that our analysis was limited to 30 June 2018, so the known recent property price falls over the past 11 months are not included in this analysis. In April 2019, CoreLogic estimated that the median Sydney house price fell 13.9% from the September 2017 peak to 31 March 2019, which equates to a $125,000 loss.

Note – The data range for this data is January 1970 to June 2018 for residential house prices and January 1980 to June 2018 for the share portfolios (all available data).

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 If you look at the data in terms of average, best and worst outcomes, the results are:

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  Some observations from the analysis:

  • Between the years 1980 to 2002 the share market strongly outperformed Sydney residential property and after a short period of underperformance, the stock market bounced back again in 2016.

  • We can see over the period 2003 to 2016 (rolling 7 years) and from 2008-2016 (rolling 10 years) Sydney’s residential market intermittently outperformed the share market portfolios.

  • However, when we look at the total average return over the entire time period (1980-June 2018) the share portfolio achieved a significantly higher return.   

  • On average, at the end of 10 years the share portfolio would be worth 20% to 25% more than the property portfolio (based on our assumptions).

It must be remembered that property investment also has some inherent deficiencies when compared to share portfolios:

  • Lack of liquidity – residential property is not liquid and involves significant selling costs.  In comparison, 100% of the share portfolios we manage for clients can be sold to cash within 5 business days.

  • Price transparency - your share portfolio is priced daily, whereas a true market value for your property is only known when you buy or sell it. You may think you ‘know’ how your property is priced based on market trends or valuer opinions, but it always requires a ‘buyer’ to agree with you and pay that price.

  • Lack of diversification – within the context of the international equity market,  Australia has a market capitalisation of 2% and by investing in residential property you are taking one asset class from the 2% and, as the saying goes, you are ‘putting all of your eggs in one basket’. In comparison, a share portfolio developed by Stewart Partners gives you access to over 7,000 global stocks.

  • Time – managing an investment property, even with the assistance of an agent, will require a far greater time commitment than investing in the public financial markets.

As one final example, we recently calculated the return a client achieved on an investment apartment they’ve owned in the eastern suburbs of Sydney since 1993. Without considering any holding costs - including several renovations and special levies, the real return (net of inflation) was 2.6% pa, which is largely consistent with the RBA results above. A diversified share portfolio over the same period produced a real return of 6.3% pa, and this included a Global Financial Crisis.

On balance we espouse that residential property be primarily considered as a lifestyle asset for clients, with investment portfolios focused on the key asset classes of bonds, listed commercial property, Australian shares, International shares and Emerging Markets to minimise the time and effort clients spend thinking about or managing their investments, so that they can pursue more enjoyable things in life. 

 

Author: Rick Walker

[i] Source: ‘Long-run house prices’, The Australian, 23 May 2010

[ii] Source: GMO

[iii] Source: for 1970 to 1999, 1970 to 2003, Paul Abelson & Demi Chung, Housing Prices in Australia.  For 2000 to June 2018, QBE Australian Housing Outlook 2018-2021

[iv] https://www.rba.gov.au/calculator/annualDecimal.html

[v] Australian share performance based on the S&P/ ASX 300 and International share performance on the MCSI World ex Australia (net, div, AUD).

[vi] 65% Australian shares and 35% International shares

[vii] 40% Australian shares and 60% International shares

[viii] Stamp duty assumed to be 3.5%, Selling Costs 2.0% and annual holding costs are 0.5%.

Rick Walker