On average, we think investing in residential property in Australia now will result in a very low (or even negative) return over the next 3 to 5 years. Yes, it’s a big statement but let’s consider one simple fact.
The following information does not take into account your personal objectives, financial situation or needs. You should consider if the relevant investment is appropriate having regard to your own objectives, financial situation and needs.
According to CoreLogic RP statistics the average gross rental yield across Sydney, Melbourne, Brisbane, Adelaide and Perth is 3.5%. As a reminder, the lower the yield, the more expensive property prices are because yield represents the annual income return from investing in property.
So how expensive is Australian residential property?
- On an equivalent share investing perspective, a 3.5% earnings yield is equal to a 29x P/E. That is nearly double the P/E of the MSCI World equity index and the S&P/ASX 200 index in Australia.
- The UK (especially London) is well known for expensive property. On a rental yield basis, Australia’s 3.5% yield is less than (i.e. more expensive than) London residential property (average yield > 4%) and London City offices (average yield of 4%) according to statistics from Savills. Bear in mind, the cost of borrowing in the UK is also far lower with official cash rates at 0.5% versus 2.0% in Australia.
From a pure investment perspective, Australian residential properties on average are immensely expensive. While we are not suggesting a property crash will eventuate, there is certainly no reason to suggest that residential property prices will increase with any strength over the next 3 to 5 years given the astonishingly low gross rental yields. In fact, we suspect smart investors are taking advantage of current yields to sell their investment properties and reinvest into other asset classes.
What to invest in if you’re not investing in property?
If you’re one of those investors looking for smarter investments, we believe it is time to start considering buying more listed shares. What types of listed shares should you invest in?
Let’s look at it based on your primary reasons for investing in residential property in the first place.
1. You invest in property because you can see and touch it
The main reason you invest in property is because you feel it is a safe tangible investment since you can see it, understand it, walk through it and live in it.
Investment suggestion #1: International blue chip listed companies with strong balance sheets will provide you with a similar level of tangible comfort since they produce a lot of goods and services that you use on a daily basis and understand well.
For example, you are likely to know very well the products and services from listed companies such as Google, Facebook, Amazon and Daimler (makers of Mercedes). As for the feeling of tangible safety, what are the chances of a world without products such as Google or Mercedes in the next 20 years?
We prefer international blue chip companies over Australian blue chip companies primarily since many are diversified with revenues from multiple sources around the world which reduces the risk of any single event causing a company to fail.
On a valuation basis, international shares are also much more attractive than residential property investing. The MSCI Wold Index (a broad collection of large international listed companies) trades at a forward P/E of 15.8x (which is nearly half the equivalent P/E of Australian residential property) with average consensus earnings growth of approximately 20%. Do you think there is any chance Australian residential rents might increase by 20% over the next year? We certainly don’t think so.
2. You invest in property because it usually makes good capital returns
You like to invest with a financial tailwind helping you out. For example, Australian residential property enjoyed tremendous momentum with significant capital appreciation over the past 10 years driven by our strong economy. However, real signs of price declines have emerged.
Below are charts showing what happened to UK housing values during and since the GFC. In no way are we suggesting that Australian housing values will follow this experience but it is a reminder that property values can remain below historical highs for a very long time.
Source: Office of National Statistics UK House Price Index (www.ons.gov.uk)
The experience in the US is even more severe where indicators show house prices have still not recovered to previous peak levels from 9 years ago.
Investment suggestion #2: If you picked Australian property as a good investment in the past 10 years, you are likely to have enough knowledge to pick the types of industries that will similarly enjoy strong financial tailwinds over the next 10 years.
Ask yourself, what are you seeing and interacting with in your everyday life that you believe will undoubtedly grow rapidly over the next decade? Is it the growth in use of technology or perhaps a change towards healthier lifestyles? There are a number of long term global trends that have just started that you can invest in through listed shares internationally and in Australia.
For example, if you had picked the trend of rising smartphone usage 5 years ago by investing in Google (the makers of the Android phone operating system) and Apple (makers of the iPhone), you would have more than doubled your money on Apple and nearly tripped your money on Google. This doesn’t even include the gains you would have made from the depreciating Australian dollar over that time.
3. You invest in property because you like the rental income
A 3.5% average gross rental yield income is low. In fact, with some searching you can secure a bank term deposit rate of over 3.0% without the hassle and costs of managing an investment property or risk of the value of your investment falling.
Investment suggestion #3: If you prefer higher passive income there are a number Australian listed companies in various industries that provide a dividend yield greater than 3.5% (in many instances with franking credits). Of course, dividends are not guaranteed and you should be mindful that companies can reduce dividends (e.g. BHP) during difficult periods but chances are you’ll still get a better income yield than buying residential property.
4. You invest in property because you like to negatively gear
Borrowing money to invest in a residential property that will likely returns less than the cost of the borrowed money over the next few years just to get a tax deduction.
Investment suggestion #4: Just don’t do it. Don’t forget negative gearing means you’re making a loss. It could be a reasonable strategy if you can guarantee that you’ll make a profit from capital growth when you sell. In today’s current property market, do you really want to bet on capital growth alone?
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