The Property Liquidity Trap

When asked in isolation if property or shares represent a better investment, my comment is that the most important factor is whether there’s a market to on-sell the property, or an environment where a potential purchaser can obtain finance to buy your property.

Summarised, that’s liquidity, and it has disappeared.
Tony Davison writes.

Property is lower volatility

Property is arguably lower risk than shares, if measured in terms of volatility and over a long period.

Residential capital city property prices have risen around 5% per annum since 2004 while shares have returned around 5.4% annualised over the same period (note, both figures exclude the rent, or dividends). This is not much of a difference in capital appreciation. However, property has delivered those returns with lower volatility, which is why investors generally prefer it.

The chart below contrasts the Australia Bureau of Statistics Capital House Price Series against the ASX 200. Since early 2017, the value of property has declined and the previous link between swings in the prices of shares and property has distanced. Why?

A contributing factor is the well-studied withdrawal of liquidity from the property market by lenders. Lenders have reduced or withdrawn from components of the market such as self-managed super funds (SMSFs) and foreign borrowers plus tightened lending on investment loans. The most recent issues are interpretations of household expenditure and cautious valuations at settlement.

Property, pain

If cash is withdrawn from the property market, what happens?

First, we’ve seen significant capital city property price declines in the past 18 months. In addition, according to the latest CoreLogic Pain and Gain Report, 12% of Australian properties were resold at a loss in the first three months of 2019^. Note, this isn’t a standalone number – the series over time shows properties are regularly sold for a less. However, it appears the number being sold at a loss is growing.

However, capital withdrawal hasn’t been occurring in the same way for the share market. Typically, investors don’t borrow to buy shares, but flow of funds (read: lower interest rates) in the broader system does impact the share market favourably.

Waiting game

If an investor urgently needs capital, it’s hard to quickly sell a property or partially sell a property. It takes around 30 days to sell a property in Australia plus between 30-120 days for settlement (usually longer for land sales to developers). Engaging an agent, bank lending criteria, and spectacular amounts of stamp duty are part of the sale and purchase process with property.

As a rule of thumb, it takes 20-25 years to make a very material capital gain on property and the breakeven point is around six years. Any time period shorter than that and you’re less likely to make money.  Shares on the other hand, being more volatile, can sport a materially different payback profile (up, and down) in much shorter timeframes.

Taxes

For people in the income-building years of life who are focused on making a long-term capital gain, it’s hard to look past property (assuming the underlying asset is reasonably-priced and good quality), given the attractive tax advantages available.

Property investors can claim a range of tax deductions against their income and, under certain circumstances, depreciate components of the asset over time which is a feature unique to property.

Shares offer some unique tax benefits too (namely franking credits), but when it comes to deductibility, property is tough to beat.

Retirement

For those in or near retirement, the illiquid, highly geared and long-term nature of property makes it a risky investment.

With property yields currently below 3% (roughly the same return earned on cash in a bank account), there are more appropriate options for people who need to generate a stable, steady income to fund their retirement lifestyle.

It is important to note, that property inside superannuation is generally inferior to other superannuation investment strategies. The exception is a business property where the trustee has a commercial interest in the premises.  For example, an SMSF with a trustee doctor may invest in a surgery, where the tenant is related party and the rent and terms are controlled.

What to do?

Remember, property is part of the strategy, it isn’t the strategy (just as shares are a component too).

In my opinion, property lending is likely to improve and with it prices – simply because lending couldn’t get much more constrained than it has been in the past 12 months.

Thus, if you’re long investment property, use a rebound in lending (with the recent improvement in sentiment and stabilisation in prices) as an opportunity to consider offloading and re-directing your savings to assets that are more flexible.

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^https://www.abc.net.au/news/2019-07-08/corelogic-property-pain-and-gain/11287638