Thursday, 5 February 2015

Hard of Gearing

Property investment may be less lucrative because of the level of borrowing required. 20-year returns on geared residential property in Australia apparently beat local shares. According to the Russell 2014 Long Term Investing Report, geared residential property returned a net annualised rate of 10.1% to 8.7%, compared to a geared portfolio of shares (9.2% - 7.3%,) at the lowest and highest marginal tax rates respectively.

For a level comparison, the authors assumed a 50% borrowing on the initial investments and an interest-only loan. Before we shares-philic investors self-flagellate for our aversion to bricks and mortar, I think the gearing assumption - while fair - is unrealistic.

It is possible to gear 50% for a share portfolio. Heck, it is possible - and, I would say, wise - not to gear equities at all. But with desirable Australian properties fetching upwards of half a million dollars, who has a spare $250,000 just sitting around? If I did, I would be too addicted to the $7K p.a. interest to gamble it on a house.

I daresay that a majority of residential property owners would be geared over 50%. Indeed according to the Reserve Bank of Australia's 2014 Financial Stability Review, over 30% of new loans have a loan-to-valuation ratio of more than 80%.

Gearing has a drastic impact on returns. At the 20-year (to December 2014) average lending rate of 7.52%, each 10% more borrowed would ratchet up your interest by 0.75% and your returns down by the same. If Russell's mythical investor borrowed 80% of property value instead of 50%, their net annualised returns would be 7.85% - 6.45%, well under what they would have reaped from shares.

Also in the above Russell report, shares thrashed property returns over the 10-year span to December 2013. This does not mean that housing should be shunned. There are very real financial and non-financial benefits to residential property, not the least being a potential roof over your head. It is a part of my portfolio. Though due to its cost, an unavoidably huge part.

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