JOHANNESBURG – Is buying a house an investment if you plan to live there yourself? Should you rather be renting and investing in shares?
There has been some heated debate on the merit of investing in residential property on the Moneyweb website recently. As was to be expected, our readers have some strong views on the topic.
Any analysis of the issue is complicated by the fact that there are numerous variables to take into account that can change over time, that buyers’ circumstances are different and that the future is unknown. Yet, there are some interesting insights to be gained by comparing an investment in a primary residence with renting and investing in shares.
A primary residence does not provide an investor with an income yield and as a result the only return component that has to be considered when doing a comparison is capital growth, a Johannesburg-based analyst says.
Since 1966 average annual house price growth after inflation has been 0.9%.
Adjusting the annual average returns of the JSE All Share Index (Alsi) for inflation, the Alsi has provided investors with a real (after-inflation) return of around 15% per annum over the past 10 years, 9% over the past 20 years and 11% for the past 30 years, he says.
The cash case
Consider buying a house or investing in shares with this data in mind.
If a house was purchased for R1.5 million today, the property would be worth R1.87 million in 25 years’ time after adjusting for inflation (i.e. in today’s money).
Using a long-term average of the historic JSE returns of 10% (after inflation), the initial share investment would grow to be worth R16.25 million during the same time period, he says.
However, not many people have the initial capital to commit R1.5 million upfront to finance their choice of shares or property. Most consumers borrow from the bank.
The finance case
Assuming that the house would return 6.9% per annum and that it was fully funded by debt for 25 years with interest of 10% per annum, the buyer would have a monthly installment of R13 630,50. At the end of the period, the net asset value of the house would be R1.82 million (adjusted for inflation), the analyst says.
If the individual had instead chosen to rent over the 25-year period, had paid rent of R10 000 a month and invested the balance of R3 630,50 in shares at an average annual return of 16%, the net asset value of the investment would be R2.94 million.
“You would thus be approximately 62% better off in real terms by investing in shares with your residual income,” he says.
A monthly rental value of R10 000 equates to R120 000 per annum – an 8% yield on the R1.5 million cost of the property. This would be a reasonable income yield for a residential landlord of a property and affordable for the person who prefers to rent instead of buy, the analyst says.
It should be noted however, that the assessment depends on various assumptions and does not account for interest rate changes, inflation in the rental charge or salary increases – but assumes maintaining the real rate of savings at R3 630,50.
While an assumed average annual return of 16% on share investments, might be considered too high, there are also other factors to take into account.
Many assessments fail to take transaction and holding costs associated with property and share ownership into account, the analyst says.
“Typically, it costs a retail investor 0.5% to purchase shares through a bank (index funds may be even cheaper) while your costs to purchase a property often add up to as much as 5% of the cost of the property (transfer duty, legal fees, etc.).
“It would generally cost an investor in an index fund 0.5% for annual administration and management of the investment. One often spends a lot more than this on security, house upgrades and changes – in the case of my parents, this has been far more than 1% of their property value annually,” he says.
The costs involved in disposing of shares also amount to around 0.5% and could be even more than 6% of the value of a property on sale given the additional marketing costs required to find buyers, he says.
“Bear in mind that it often takes more than two months to sell a property where shares can be sold on the day when one may require capital. This timing or liquidity element is also a cost.
“These costs will likely have a significant detrimental impact on your potential return and will likely push property returns into negative territory on an inflation adjusted basis with a 25-year view,” he says.
Owning shares in the JSE is equivalent to owning small pieces of many different companies. This provides you with a significant amount of diversification to reduce a number of different risks, the analyst says.
“The majority of the JSE earnings are derived from sources outside of South Africa – you are hence afforded geographical diversification and currency protection from the rand continuing to slide (whatever your view on this might be).
“Investing in a single property (or an additional ‘investment property’) will never provide the average investor with the same degree of diversification,” he says.
To each his own
The model highlights that share investments can outperform the gains in property values significantly in the long run, but investors should also consider whether they would have the discipline to invest in stocks consistently over an extended period of time.
While failure to pay a monthly bond installment will ultimately result in repossession, suspending an exchange-traded fund debit order for a month or six when times are tough won’t have the same immediate impact on an investor’s lifestyle.
At the same time, investors should note that while the banking industry is quick to point out that renting is “paying off someone else’s bond”, repaying a bond over 25 years would entail paying more than double the original selling price while the bank will be the party to profit.
Ultimately, investors need to consider their own circumstances, goals and risk profiles before making a decision.