IMPORTANT PLEASE READ: The information in this article is not personalised advice. The findings and conclusions relate to a specific client situation which may or may not be relevant to your situation. Furthermore, the analysis herein is relatively academic as it is based on historic returns which are not a good indicator of prospective future returns. You should seek professional investment advice BEFORE deciding whether or not to invest in any type of investment.
A retired couple we know recently announced that they had bought an apartment at a retirement village. It is expected that they will move in early next year. When they do, they will also have to decide whether to sell their current property (a small 1 bedroom apartment on the shore) and invest the proceeds or keep it as an investment property.
The variables behind this decision led me to do some research around which of the two options would be better from an investment viewpoint. What follows are my findings.
Investment property often gets a bad wrap in the financial planning world for a number of reasons perhaps the biggest being that having a large sum invested in a single asset runs counter to one of the key principles of investing; diversification. If we park this for a moment how does residential investment property stack up against for example a managed fund? One of the key benefits of investment property over other types of investment is the ability to easily leverage returns by borrowing to fund the purchase. So, for example, if you were to borrow 80% of the purchase price of a property, the return on the funds you actually invested will be enhanced fivefold.
Let’s return for a minute to our retired couple’s situation….they are debt free on their current home so by holding on to the property, they won’t be gaining the benefits of leverage. This means we can conduct a relatively direct comparison between property and (for the purposes of simplicity and available data) a managed fund.
So let’s take a look at the numbers over the last 25 years. For this exercise I have used a couple of relatively broad brush measures of return for each investment type.
Variables and assumptions
- For residential investment property, I have used the New Zealand housing price index for the last 25 years. ..link here.
- For an alternative, I have used a highly regarded balanced growth fund from one of New Zealand’s leading superannuation schemes.
- I have only looked at property values over time and have ignored rental income on the investment property for the sake of simplicity and due to the fact that such income will depend on the nature and location of the property. Furthermore, there are maintenance and operating costs associated with investment property which dont apply to managed funds.
- For this exercise, I compared the relative value of $1 invested into residential property (using the Reserve Bank all NZ housing index) versus $1 invested into the reference fund (Balanced Growth) on the 31st March in each reference year. I used 5 year, 10 year, 20 year and 25 year reference periods.
Key Results
|
Value of $1 invested
|
31st March 2013
|
31st March 2008
|
31st March 1998
|
31st March 1993
|
|
Property Value 31st March 2018
|
$1.565
|
$1.586
|
$3.394
|
$4.951
|
|
Fund Value 31st March 2018
|
$1.508
|
$1.991
|
$2.790
|
$4.297
|
It was interesting to note that, with the exception of the 10 year timeframe, investment property provided better growth than a balanced growth fund.
As a result of this initial analysis, I took the opportunity to explore results over the last 18 years (I only had data going back to 1993 for the balanced fund in question) and the results provided some interesting reading. The following table summarises my findings. For the year ended 31st March in each year, the table shows which option performed better over the timeframe indicated and the relative difference in overall growth (measured by reference to the end value of the investment e.g. for the 20 years ended 31st March 2017 a $1 investment in property would have been worth approximately $3.56 versus an approximate $2.97 for $1 invested in the reference balanced growth fund. – a difference of 22%.
Results and Materiality
| Year ended 31st March | 25 Years | 20 Years | 10 Years | 5 Years |
| 2018 | Property 15% | Property 22% | Fund 20% | Property 4% |
| 2017 | Property 20% | Fund 4% | Fund 3% | |
| 2016 | Property 5% | Property 24% | Fund 29% | |
| 2015 | Property 0% | Property 10% | Fund 22% | |
| 2014 | Property 20% | Property 14% | Fund 41% | |
| 2013 | Property 15% | Fund 15% | Property 11% | |
| 2012 | Property 8% | Property 21% | ||
| 2011 | Property 18% | Property 17% | ||
| 2010 | Property 53% | Fund 10% | ||
| 2009 | Property 35% | Property 3% | ||
| 2008 | Property 14% | Fund 25% | ||
| 2007 | Property 3% | Fund 14% | ||
| 2006 | Property 12% | Property 1% | ||
| 2005 | Property 21% | Property 41% | ||
| 2004 | Property 34% | Property 78% | ||
| 2003 | Property 36% | Property 70% | ||
| 2002 | Property 62% | |||
| 2001 | Property 35% |
So what should this couple do with their property?
When I first started looking at this, I had expected to find their best option (from a purely economic viewpoint) would be to sell the property and invest into a diversified portfolio of stocks and bonds or managed funds. However, my (albeit limited) analysis suggests otherwise – at least in their situation (this is important – see below!!). On the basis that they won’t need the funds invested in the property for many years (if at all), there is no really compelling argument to sell just yet – in fact, the findings and their other investments suggest otherwise. There are, of course, other factors which may influence their decision – such as the practical aspects of owning a property – maintenance, collecting rental, tax implications, etc, but from a purely economic viewpoint, it would make sense for them to hold on to the property and use the rental income to supplement their other income sources (to the extent they need to.
IMPORTANT PLEASE READ:
My conclusions for this article are specific to this couple’s situation. There are some important factors which affect the recommendations which are unique to them;
1. They have no other property.
2. They have access to a substantial well diversified portfolio of shares, bonds and fixed interest investments which supports their income needs during retirement.
If you would like to discuss your investment needs, please get in touch with Miles – 021 645 000.