Leveraged IP vs Unleveraged Shares

This thread is in response to the above post in a SMSF thread. I too dislike grey statements so let's test the hypothesis that leveraged IP is best.

I would like to see the comparison done thoroughly and hope It can be done as a community project with assistance from forum members to estimate costs and gain consensus over variable assumptions or at least the range for realistic assumptions to be modeled.

The investment environment for comparison will be Superannuation hence a SMSF structure is required to accommodate the IP option.

more to follow,

@oracle, could you please repost your list of things to consider. Please also anybody else also chime in with things to consider, cost estimates or links where we can get information/data.

 

Thanks @Anchor for leading me to this estimate.

Also found the 2023/24 Safe Rate Harbour rates from the ATO for non-arms length LRBA borrowing which is 8.85% to a maximum 70% LVR max 15year Variable 5 year fixed.

Other super rates and thresholds | Australian Taxation Office

The granite rates sound cheap in comparison - Is the ATO that far out of touch?

Anybody have any links to advertised LRBA rates?

 

For the equity side of the comparison, I intend to use AFI which is Australia’s largest Listed Investment Company.

They are index like and suitable for passive investing and simplifies/clarifies some of the numbers needed for comparison because we don’t need to worry about trust fund taxation associated with ETF's

I would personally argue ETF’s over AFI for passive indexing so don’t feel I am trying to bias the outcome by selecting this as the vehicle for equity side of comparison.

Sticking with Australian only shares to match IP location exposure. Again, I would advocate global exposure but for simplicity and country risk equalization happy to just use AFI.

Any objections to using AFI for shares leg?

AFIC | Homepage




Ps
Objections come with the assumption you are volunteering to help with modelling the equity leg.

 

Please do also factor in the following costs (applicable to property investments only)

- Ongoing property management fees (+ initial letting/advertising/condition report)
- Landlord and building insurance
- Water and Sewerage costs
- Smoke alarm annual compliance
- Annual Rates
- Land tax (if applicable)
- General maintenance and wear and tear
- Occasional tenant vacancy

- Buying costs (stamp duty, lawyer/solicitor fees, building/pest report fee)
- Selling costs (agent commission approx 3%) vs Shares commission approx 0.11%

Cheers,
Oracle.

 

We need to pick a location for the IP. Anybody wish to suggest a fairly representative capital? I was thinking Melbourne only because its last 15 year historicals are the closest to the average of all capitals. Using regional would be too idiosyncratic. Using Average of all capitals makes it a bit hard to pin down exact costs etc because things seem to vary by state for property. I do hope somebody comes on board to help with property aspects because I have never owned an IP and dunno much at all.

 

@dunno Just had a look, AFI trading at a discount I would have been frothing over back in the day! Big job…Share splits, rights issues, DRP discount, LIC capital gain ? Would something like ASX200 Accumulation franking credit adjusted (Super 15%) less 20bps pa be easier? I’ve seen this type of index in the past.

 

Is this data source ok for Melbourne house prices and Gross rentals?

I've picked 3 Bedroom House for the comparison. Is that reasonable?

SQM Research - Property - Weekly Asking Property Prices - Melbourne




I'm normally a share investor, so no idea about property data - please steer me in right direction if SQM is not suitable.

 

Following with a passing interest, but more curious why the comparison has to be made (as it commonly is for some reason) between a levereged investment and an unlevereged one?

It does create an unabalanced playing field and skews the advantage to towards one or the other.
Although leveraging into shares is more expensive than resi property, its not exactly difficult.

I would suggest a conservatively leveraged share portfolio vs leveraged property would be a fairer comparison.
The problem then becomes one whereby changing the parameters can change the outcome to suit any desired narrative.

 

I wonder if it would start to be too much to do different city/property type comparisons?

The economics of leveraged IP vs shares would have been very different across cities and different property types historically.

 

Will consider your suggestion but wonder if an un-investable index makes for a comparison that feels non-transparent to a non-share's person in contrast to an investment you could have, and many have actually done.

I'm sort of thinking we use todays starting metrics but the actual return from the last 15 odd years (Sept 09) to match the SQM date range. On the face of it shares have generally be seen to do poorly and housing good from a price perspective over that time. Using the historical returns, we will have a factual basis to think about varying assumptions going forward where appropriate.

AFI looks like this from a price perspective Arrow at sep 09. 15 years misses the GFC but pricing against LLR averaging is about the same at start and finish. Adjustment for last 15 years not to bad - expect getting property side cash flows accurate is going to be a lot harder.

 

Picking one city and property type to make the comparison manageable - Happy to hear opinions on what is most representative from the property side. My suggestion is Melbourne 3 Bed using SQM data, but happy to consider alternatives. People of course can do their own 22 Wherever Street vs WTC or whatever they fancy but I'm looking for representative and to get the model for comparing cash flows accurate.

 

I think the comparison is fair. Unleveraged equity is the norm, Leveraged IP is the norm. We have the often-stated hypothesis that Leveraged IP wins. I want to test that.

 

I leave it here for a while for other to comment, suggest, link to data, chime in, Run with the ball, whatever.

 

With respect to AFI, is there a case for the modelling to include its DRP/DSSP or any possible tax impacts for the LIC Capital Gain Discount?

Link to AFI's security history with DRP/DSSP prices.

AFIC | Security history

The web-site for its dividend history does not, unfortunately, state if the dividend has any LIC CG Discount included.

 

Is the one thing I don't know where to find. Possibly may need to concede it - In a 10% long term capital gain environment vs 15% without the discount it should not disadvantage AFI too materially.

 

OK. However, I can find that if you wish by going back through my records. It'll take an hour or so.

 

That would be awesome. I was secretly hoping you would offer. There is no rush. This project will take quite a while to get accurate - hopefully there will be enough people involved and interested to make it worthwhile.

 

It might be worthwhile to consider following for property:

• LVRs: As a variable (say 20-90% in 10% increments) as the overall return will vary significantly based on leverage. It might even give a breakeven point between the two asset classes WRT LVR above which Property becomes preferable. I might be showing my bias here.
• Negative gearing: ~30-45% net annual loss on property would be paid back by ATO

 

I would tend to agree that resi property is more typically leveraged than equities, but leverage is merely a tool that property investors need/want whereas share investors dont.

In other words, an investment property is bought, whereas an equivalent sized share portfolio is built.

Happy to follow along, but the small variances in assumptions will yeild wildly different results.

 

I completely hear you MB18.

I’m keen to see assumptions scrutinized before we do the comparison so that we get the outcome given ‘prior’ thoughtful assumptions, not a process of changing assumptions to get the result we want.

Additionally, doing a proper cash flow example enables the very point you make to be born out. Buying an IP with borrowed money vs alternatively building a portfolio with the same investing cash flows.

I,m trying to not have prior beliefs but will be surprised if leveraged IP vs unleveraged Shares results in a one-sided affair even if we hold IP LVR constant (ie interest only).