Thursday, July 06, 2006

Shares v Property - which is better?

I have read many books and articles advocating shares as being better than property or property being better than shares. Harrison at Journey to Financial Freedom recently drew my attention to one such claim .

Often these claims are made by people who have an interest in promoting services (e.g. grossly overpriced seminars) relating to the form of investment that they advocate.

My view is that saying that one is universally better than the other is just plain wrong. There may be times and circumstances where one asset class has greater attraction as an investment than the other, but I do not accept that one will always be superior to the other. Each asset class has its advantages and disadvantages. Shares and property are no exception.

At least some support for the proposition that both shares and property are attractive investments can be found by reviewing the Forbes 400 list of America's richest people - there are examples of people who made their fortunes by investing in real estate and examples of people who did it by investing in shares. More fundamentally, if one asset class was universally "better" than another in terms of risk adjusted expected returns, then investors would bid up the price of the preferred asset class and shun the less popular asset class forcing vendors to lower their asking prices. Eventually, the relative prices of the two asset classes would reach the point where the risk adjusted expected returns were similar.

The following is a comparison of the key features of investing in shares and property.

Diversification: very easy with shares and harder with real estate (unless you have a large portfolio or invest in REITs)

Liquidity: shares are highly liquid. Property is not

Yield: net rental is generally better than the yield on shares but this may be offset by depreciation, maintenance and tax treatment

Potential for yield to grow or decline: yes for both

Capital gains and losses: yes for both

Potential to add value: property generally has some potential to add value. Shares do not

Time commitment: highly variable, but generally more with property

Gearing available: yes, but usually on more favourable terms for property

Outgoings (excluding debt service): only for property and these can be significant

Volatility: both can be volatile, but shares are generally more volatile than property

Risk of total loss of asset (ungeared): companies can become insolvent and do so with depressing frequency. Property is much less likely to go to zero value but it is still possible in extreme circumstances (e.g. flood, earthquake, war)

Transparency/availability of information: generally high for shares and moderate to poor for property (this one is highly debatable)

Transaction costs: very low for shares and very high for property

Taxes: depends on personal and property specific circumstances

Other risks and issues for shares: corporate misconduct, unfunded/undisclosed liabilities, removal from index, competition, lawsuits, overpaid executives, dilution. Any others?

Other risks and issues for property: vacancy, outgoings rising faster than rent, bad tenants, depreciation, changes to neighbourhood. Any others?

Personally, I find both asset classes attractive and prefer to diversify my assets with a mix of shares and properties.


troy said...

How about commodities?

traineeinvestor said...

Good question.

I understand that there have been some interesting studies which show the effect of adding commodities to an investment portfolio. I'll try and dig those out and post separately.