Over the years I’ve seen many articles and had a lot of discussions regarding which is the better investment, an investment in shares or property investment.
There are a number of lessons i’ve learnt personally which i’d like to outline here;
1. Banks love property – Banks don’t tend to like shares.
This is a really important fact as it limits your ability to leverage your equity and grow your asset base.
When i was in my late 20’s my wife and I finally decided it was time to buy our own house. At the time we had a share portfolio but very little cash savings. We had continued to purchase shares from the time we were first married in 1993 and would purchase shares with our savings in lots when we had saved enough – this was based on the advice of our peers that shares was a good investment and some advice saying that shares was better than property.
When we applied for our housing loan we were told that it would be best for us to sell our shares and use that as our deposit for our home, but that didn’t suit me as the market had dropped and it wasn’t the best time to sell. The other problem we had was that we were going to have to pay capital gains tax on our profits when we sold, which would mean a tax debt that year. To summise, the banks really looked at my shares as ‘cash on hand’ and not really as an investment. They also valued the shares under the going share price because the market fluctuated and no one could guarantee what the share price would be when we would decide to sell.
This really made it difficult to get the savings required for a home, and while it wasn’t too important at the time, the same scenario becomes a lot more important when you consider growing a portfolio of property as an investment strategy.
2. Equity Mate…
After buying our first home we were fortunate enough to make a large capital gain through the boom period of housing prices in Perth. Essentially it meant we ended up with 50% of our property value as equity. A portion of this equity could be used towards a deposit on a new home, so, being in building we decided to build our new home – designed for our needs and lifestyle. The banks simply used the equity in our existing home and cross-collateralised our loans, meaning each home loan was linked. If we were to sell one of the homes the banks could basically move a portion of the sale amount into the remaining home loan so our equity position was at least 20%.
This example is a basic outline showing how the ‘rich get richer’ using property as their vehicle of choice. The rule is quite simple; purchase a property using the equity from your current home. Once the new home rises in value and has 20% equity, do the same thing again adding another home to your property portfolio. Rinse and Repeat as they say until you build a portfolio large enough to support you financially after retirement.
The graph below shows an investment property, and how the equity builds over years using average growth predictions;
You can see in the above figures that the property value is forecast to grow from $410,000 to $667,000 over the next 10 years. The debt remains the same ($384,273) as it’s based on an interest only loan that is tax deductable (this is referred to as negative gearing). After only 3 years using this forecast, and if property prices were to rise steadily each year this property would have $90,000 equity in the home. So if you were to sell the home in that third year, you would pay capital gains tax on 50% of the profit, and also GST unfortunately (though no GST is payable if we held the property for over 5 years.)
As you can see, based on the figure above you would have approximately 20% equity after 3 years. This would then allow you to refinance, remove the cross collateralisation from your owner occupied home and this investment property, and purchase another investment property using the equity in your own home again. As a side note, any additional payments you make on your own home would increase your equity and reduce the timeframe you could do this.
For what it’s worth, in my humble opinion, Shares simply don’t have the same power as property.