It seems as though property will spend the next five years in a slump. Already there's negative real price growth in certain areas. Furthermore, household disposable income is decreasing along with high inflation while any rental income you earn could push you into a higher tax bracket, causing you to pay more tax for every Rand earned.
Would investing in a well diversified share portfolio with an insurance company be a better investment in the next five years if we take into account tax constraints such as Capital Gains Tax (CGT) and costs involved in purchasing property.
Over the last few years the age old tradition of braaing has not been complete without the 'fire talk' turning to investing and more specifically the mouth-watering flavour of the month, South African residential property. The 'gold-rush fever' type responses led many an investor to choose property as their preferred investment strategy as opposed to its 'poor cousin' ? equities. Please don?t get me wrong ? many have reaped huge rewards from this decision, but perspective remains a key principle in investing and one should be careful to judge the last few years as an indicator of future performance.
The unprecedented gains we have witnessed over the past few years have only solidified the popular belief that property is the only sure-fire way to achieve solid investment returns. But before we all apply the 'safe as houses' principle to our investment strategy, let us take a closer look at where these gains came from and allow us all the opportunity to make an informed decision.
Reliable data on residential property only goes back to around 1980 and according to the ABSA house index house prices lagged inflation for 16 years (1986 - 2002). This can, in all probability, be attributed to political uncertainty and financial instability experienced at the time. From sanctions being tightened in 1985 to political unrest in the early nineties, change of political power in 1994 and the burdensome interest rates that hit an all time high 1998 (25 percent), it is no surprise that this sector stood little chance. The result of this was that early into the new millennium property was essentially 'undervalued'. As our economic and political environment began to recover there was a growing middle-class that sought the psychological comfort of owning a property. It also wasn?t long before the declining inflationary environment enabled the Reserve Bank to drop interest rates to a level that allowed rental income to cover bond repayments ? a deal quickly snapped up by many a business minded individual. This led to a mad frenzy of investors and first time buyers scrambling to get in on the action.
So in essence property would have lost you money in real terms for a large part of the past two decades. However, if you were fortunate enough to purchase over the past five years you would have benefited from the remarkable recovery this projected slump experienced. This led to an overall return of 3.3 percent per annum above inflation for the period (from 1980) and returns in the region of 20 percent for the past five years. So, although a few people did seem to benefit from 40 to 50 percent returns this does not represent the majority experience.
When we then compare this to the behaviour of equities of a similar period we see that there are some surprising insights.
Firstly, when we compare the average performance of these two asset classes over the period mentioned above we witness a massive outperformance on the part of equities ? 66 percent outperformance to be exact. Said in a different way, if you had invested R100 into each of the said asset classes your R100 would be worth R5125 in equities (ALSI) and only R3083 according to the ABSA returns. What about the past five years you might ask? Even after the dismal performance experienced in equities last year the overall performance was still 19.1 percent per annum ? a mere part of a percent lower than the 20 percent recorded over the past five years.
Can equities have really performed in line with the residential property boom? Yes. In fact when one considers these asset classes in a generic fashion, equities are expected to deliver superior returns to property over the long term. The principle of risk vs. return holds true to this and therefore property will generally attain those lower returns with less volatility.
There are a few other considerations besides the raw returns that one should also consider. Returns can be quickly eroded by costs such as transfer fees and duties, maintenance and estate agent commission on sale of the property. Although investing in the share market does have costs associated with it, they are comparatively substantially lower than this. Ever heard the phrase 'location, location, location'? Get this wrong and you will suffer negative consequences. Getting it right takes on a number of shapes and guises and gives credibility to the argument that investing in property is a highly specialised activity that gives rise to numerous risks.
So, in conclusion, we need to acknowledge that these are two very different animals that are going to behave in a very specific manner. The risk of getting it wrong on the property side is much akin to trying to pick a specific stock on the share market and punting it all the way home. If you get it right you?ll be smiling, get it wrong and the price will be heavy.
A diversified portfolio managed by professional fund managers that considers all asset classes in its strategic allocation makes for a very compelling option and although there is no conclusive answer to this, I hope the background will give food for thought as you best decide on your most suitable investment strategy.
As always, it is advisable to seek the services of a Certified Financial Planner to gain greater clarity on a strategy that best suits you, your goals and lifestyle objectives.
All the best.