Shares or Real Estate…that is the burning question?

Over the years there has been a perennial debate concerning the merit of investing in shares versus residential property.

Whilst opinion is often divided, and it is acknowledged that both investments have very different characteristics, informed observers broadly agree that property and shares provide comparative returns over an investment cycle of at least 10 years; often achieving similar annual gross returns in the order of 7 – 10%.

Like ‘blue chip shares’, properties in prime, sought after locations generally perform the best.

These properties are likely to double in value every 8 to 10 years and, predictably, provide annual capital growth in the order of 6 – 9 per cent per annum.

However, on a risk weighted basis residential property generally outperforms shares because the property market is generally not as volatile.

Unlike the share market, approximately 70% of Australia’s residential real estate is owner-occupied and homeowners are less likely to impulsively sell their properties throughout times of financial turmoil.

Shares, due to ease of disposal, can be quickly and easily divested; often resulting in unpredictable returns to the unwary investor.

In addition, share prices can often fluctuate by as much as 30 – 50% in any one year, providing discomfort, concern and uncertainty to inexperienced investors.

By comparison volatility in the residential real estate sector has traditionally been much less, averaging around 3 – 4% annually.

We have recently evidenced daily swings on the stock market that have been of this magnitude and amidst its current volatility there has been an apparent flight from shares by self-funded retirees, self-managed superannuation funds and ‘mum and dad’ investors who are increasingly becoming risk adverse.

Share prices and dividend yields tend to reflect the underlying health of the broader economy and whilst a healthy economy fuels confidence and optimism, which in turn feeds increasing share prices, pessimism about the economy rapidly translates to share price volatility and decline.

Today, more than ever, investors are increasingly fearful that the problems confronting the United States and European economies may be more systemic than first thought, and there is now a view gaining traction which suggests the underlining causes: unsustainable sovereign, corporate and personal debt - may take more than a decade to address and correct.

In this climate of heightened uncertainty, investors are increasingly doubtful about the short to mid-term outlook for shares and are seriously contemplating investment in alternate asset classes where there is less volatility and risk: such as residential property.

Fundamentally, the total returns on residential real estate (including both capital gain and rental yield) are affected by supply and demand and prevailing interest rates.

And as over the last two years, as interest rates have edged up, we have evidenced a significant correction in the residential property sector and property prices have declined to more affordable levels.

During this period, we have also evidenced total returns on residential property increase, underpinned by a shortage of supply of long-term rental accommodation and increased rental demand.

According to the Housing Industry of Australia, Australia’s current housing shortage is in the vicinity of 109,000 dwellings and it is projected that by 2020 we could have a shortage of 466,000 dwellings.

This severe shortage will drive house prices up and increase rents.

And with consumer confidence at a near historic low, financial markets are now predicting a 0.25 per cent cut in interest rates in September and possibly as much as a full 1.00 per cent cut by Christmas.

If timing is everything, now is certainly the time to investment in residential real estate.