I have noted before at this blog that comparing share prices and house prices is a terrible way to examine the real differences in returns in these two markets. My key arguments are:
1. The share market is and equity market, and to compare like with like you would need to subtract the debt against housing to compare the volatility of equity.
2. The negatively geared investor usually sets the market price (they are the marginal buyer). That means they are losing money each year on the house, so a certain degree of price growth is necessary to break even.
3. The cost of home ownership is high, as are the transaction costs. In one trade of a home you would need to make an additional 10% return compared to a share trade.
So today I note again that an incomplete comparison has been undertaken by a prominent property analyst. The general finding is clear. There is no doubt that property (in Sydney and Melbourne at least) has outperformed the share market over the past four years. But I thought is wise to add some modifications to compare like with like.
The original graph is below.
Again, the problem is that this graph fails to consider returns, and in particular, comparing the position of a negatively geared property investor. So I made my own comparison of the house price and ASX200, along with my own housing equity accumulation index taking into consideration the negative returns (and tax breaks at the highest marginal rate), compared to the ASX accumulation index. I also added the returns to cash at 5.5% average over the period (a bit of a guess at the average term deposit rate), and an accumulation index for residential property bought with cash (click for larger image).
As you can see, when you consider the higher annual positive returns on shares, the losses are not a severe as the price index would make out. For housing bought with cash, the accumulation index shows the same effect of increasing returns, but to a lesser degree due to the lower net rent compared with dividends in the ASX200.
What stands out is the tremendously better position the leveraged housing investor is in if they bought a home in 2007 with a 20% deposit (and capital growth similar to the index – this is not the case in Brisbane and Perth). This investor would have made over 80% on their equity in 4 years due to capital growth alone. This is especially impressive since the annual cost of ownership is 9% of their equity. (As a side note, the high transaction costs in property mean that to convert that return to cash will cost in the order of 3.5% on the purchase price, and 3% of the sale price, or 36% of the original equity, giving a 'sold up' return of 46% return on equity of over the period- still VERY impressive.)
However, there are important things to note. First, leveraging works both ways. The leveraged accumulation index fell for 3 months longer in 2008, and for a house price drop of just 4.9%, the index fell by 27.5%. Also, at the April 2009 trough, although the house price was still 4.1% higher than when they bought in June 2007, their equity was only 3.7% higher.
This is particularly important to note during the current falling trend in house prices, which has so far amounted to just 2%. The leveraged investor has already lost 9.6%, and every extra percent decline leads to a 5% decline in this index (and more still for a similarly leveraged investor who bought during 2010 or 2011).
Given these leverage considerations, the question of whether housing investment is a way to soften the downside from your investment portfolio is not so clear cut. For someone with plenty of cash looking for a home, perhaps a cash purchase of a well located home with potential to add value is an option. Of course, you need to expect some early losses in value, and low returns, but when the alternatives are looking quite bleak, there might be no harm. I would be waiting a couple of years to buy in Sydney and Melbourne, but perhaps sooner in Brisbane and Perth where prices have already fallen substantially.
Of course, in the mean time, anything could happen. Please don't take this as investment advice.
One final question for readers. If Australia is headed the way of the US, with negative real returns to bank deposits, and housing market that will seemingly not find a bottom, will we see a surge in the share market simply due to lack of other options to invest locally? Perhaps the bottom of the share market will be in later this year and some good value can be found.
*note to readers, the CBA cut its fixed rate mortgage rate this morning. Next interest move is down.