Why Property is Better Than Shares

I'll get this right, yet Austini

 

Sorry I haven't been able to spend time on the forum in recent days to go over this stuff. Visitors return to the Gold Coast this afternoon so life will return to normal except for many damaged brain cells and some liver damage:

 

… which shows you don’t need a big amount of cash upfront to get amazing results. @Perthguy would love this . But maybe not for me: margin loans even at 25% are too much of a worry.

 

I do love it! I love how even a modest additional amount at the start can increase compounding over time. Something to think about for a first time investor is still property then shares.

I am not sure about other states but in Perth, a first home buyer can get a $15k grant for a new build or new home plus a First Home Owner Rate of Stamp Duty where up to a
value of $430,000, no duty is payable.

They could buy a new 2x1 for about $350k near the city. Then pay down some of the loan until they have enough for a split, split it off and invest in shares from the split. Then debt recycle to reduce the PPoR debt, create another split and go again. That way, they are benefiting from the capital growth of the property and the shares.

 

After reading these posts slowly but surely I'm getting more confused! I may be conditioned into a different way of thinking with European parents and the euro stereo type of frugal living and paying off property and being debt free instead of splits and loans for everything imaginable!

Trying to capture the best of both worlds as I own my ppor with no debt and an slowly accumulating lic's for the very long term 20 to 30 years at least!

Very good eye opening threads tho so hats off to the people's replies and opinions!

 

In your case it is an option to borrow against your PPoR and use the borrowed funds to invest. Of course caution is advised as it is a risky strategy. The benefits are higher incomes from dividends and a great boost to capital growth. The risks are: it's your PPoR! If something went really wrong, you may have to sell it to pay down debt.

 

Thanks for that - I've been playing but can't see why you calculated the fully franked dividend in the way you did.
From my calculation, a 4.2% FF dividend on someone with $125,000 in shares at 37c marginal rate would be = $4725 and not $7494 (in your first year).
You essentially multiplied the dividend by 1.43, but I can't see why you're not multiplying it by 0.9 ( = (1-0.37)*1+3/7) )?

 

@mcarthur I think the figure was fully franked dividend BEFORE tax in which case you calculate it by dividing dividend (4.2%) by 0.7.

 

Thanks - can I please go through in a little detail as the difference is substantial in the spreadsheet!

If I have $125,000 invested in shares, and get a 4.2% dividend that is fully franked, and my marginal tax rate is 37%, I thought the calcuation was:

Dividend: $125,000 x 4.2% = $5,250
Imputation credit: $5,250 * 30/70 = $2,250
Taxable income: $5,250 + $2,250 = $7,500
Gross tax: 37% * $7,500 = $2,775
Franking credit rebate: $2,250 since FF
Tax payable: gross tax - rebate = $2,775 - $2,250 = $525
After tax income: dividend - extra tax to pay = $5,250 - $525 = $4,725

So, in the hand after tax, the $5,250 dividend turns into $4,725, or through the power of maths, dividend * 0.9 for 37% marginal.

 

Your figures are correct, however we’re trying to compare apples with apples i.e. income is free of tax for both property and shares in the spreadsheet. That’s why franking credits are treated as before tax.

This should remain a generic model and I guess by trying too hard to account for NG and depreciation in order to give property a fair say, I’ve woken up the tax dragon and caused confusion!

If you want to take income tax into account you can certainly play with the numbers but make sure you do it for both classes. Ideally you should run real numbers using your own properties and tax position, only then can you hope to achieve any level of accuracy.

 

@Il Falco what do you men re"quarantining the debt"?

Yes, beware some of the new mutants

 

Here are three (3) recent time periods that those type of investors who held, continued to invest, or got greedy (i.e.. re-balanced) whilst the fear set in, you would have made huge personal profits as you came out the other side

• September 2001 (World Trade Centre Crash)
• 2002/2003 (Iraq War)
• 2008/2009 (Financial Crisis)

If you are disciplined over the longer term, you can be rewarded

 

3 times in 9 years and nothing since - 8 years have passed. Does this mean its time for something to happen?

 

There was a 20% drawdown on the ASX from about mid 2015 to early 2016. That was an opportunity imho. Same 2011-12 from 5k to 4K.

 

No idea

Hopefully time for the ASX to move north

 

Good post @Lacrim but I thought I would respond in this thread, which is about why property is better than shares.

To address your points:
- yes, leverage is easier for resi property. One option is to take out a resi loan against an existing IP to buy LICs. This is what I am planning to do. I will get the benefit of CG and cashflow from the IP and also the CG and cashflow from the LICs.
- CG with property is definitely lumpy. Sydney 2003 to 2012 is only $174k increase over 9 years, which doesn't appear spectacular.
- Of course there is risk with either property or LICs. What is the realistic risk of funds invested in one of the older LICs going to zero?
- Most of my super is in shares. I am trying to balance my property investments outside of super with my shares in super. I don't want to be overexposed to either.

It doesn't look like you have included franking credits in your analysis of the LICs. These make a big difference especially when retired. Inclusion of franking credits will boost the return.

It doesn't look like you have included expenses in the analysis of the rental property. I have seen examples of expenses for real property at 25% to 30% of gross. Accounting for expenses will significantly reduce the apparent return.

The downside of investment property is the expenses, tenant hassles and repairs.

LICs don't have tenants to deal with, low ongoing expenses and no repairs.

Once franking is taken into account for LICs and expenses for IPs, LICs are far in front as far as I can see. But I will hold both until I can't put up with tenants any more

GUIDE: Listed Investment Companies (LIC) | The Wealth Guy | Expert Financial Adviser

 

G

Good point Perthguy. I forgot to net the rent. However the growth rate would the same, which is the point I was illustrating. I also haven't calculated the cash on cash return, which I suspect would have property trumping shares unless you have a huge risk profile...and even then.

Anyway, I do appreciate the benefits of stocks - liquidity, no blocked toilets, franking etc, but I'm not convinced using equity (debt), cash or margin loans would see me outperform the gains I make in real estate if history repeats itself.

 

I definitely like the CG from real property. For example I invested zero in a property in Melbourne and sold it 9 years later for almost double the price. That said, I am looking at this more from the cashflow side of things as I get closer to retiring. Having made decent equity in property, how do I turn that into cashflow? Equity is great but it doesn't put food on the table

The other thing with property is renovations and development. I am converting a 3x1 into a 4x2 without extending, which is a low cost way to significantly add value. At the same time, I am building in the unused back yard of another IP. Both these activities will significantly increase my equity and also increase cashflow, which is great but I do need the cashflow boosted more.

I am looking at options to get a better return with less hassles and expenses and at the same time boost my annual income. Initially, income will be used to invest but down the track it will cover living expenses when I retire.

Say I have a new build, unencumbered IP. I could sell it, pay CGT and GST, which could add up to more than $70k and then buy ARG and AFI with whatever is left. I lose the rent from the IP, the $70k in taxes and future CG. That is a lot to sacrifice! Or, subject to borrowing capacity, I could borrow against the IP and buy ARG and AFI. That way I get:
- rent
- CG of the IP
- dividends
- CG of the LICs
- save $70k in taxes

That is going to put me a lot further ahead than selling and rebuying. This plan will create surplus income that can be reinvested. One option is to set up an offset account against the loan and deposit the surplus there. Option 1: when the funds build up to a certain amount, buy more LICs. Option 2: let the funds fully offset the loan. Using option 2 would roughly double my income from the one property, which is great.

Then later, if I get jack of the tenants, I can sell the property and move the funds into LICs at that point. In the meantime I would have benefited from depreciation and CG and if I hold for more than 5 years continuously rented I won't have to pay GST, which is another $60k approx. This approach seems to make the most sense to me. YMMV.

 

Thanks for your thinking here @Perthguy , it fills in the picture about how both asset classes can be used at different stages to reach the goal.

 

IMO you don't need an unencumbered IP to benefit from the "own both" strategy. As soon as there is enough equity in an IP you can borrow to buy your ETFs or LICs or whatever takes your fancy. Then set up an offset account against the IP loan and direct all surplus funds there. Once enough funds have built up you can reinvest in your choice of securities. In the mean time, the IP increases in value and when there is enough equity you can borrow again.

Interest is typically around 4% these days so you would really want to be making more than that as a dividend yield. YMAX, for example, has a dividend yield of 12.13% (46.2% franked), which is very good. Of course with that comes a lower potential for capital growth. Still, it would be a good play for a debt recycling strategy.

Even VAS has an average dividend yield of 4.5% plus stronger capital growth. So while 4.5% is not much better than the 4% interest you are paying, you do benefit from better CG. There is always the option to direct surplus funds to an offset account then buy more once you have enough. Over time, the income stream should increase nicely.