And how many people are telling you to invest in it now that it’s 416,870% higher?As investors we tend to have a bias towards best past-performers.
We (incorrectly) make the assumption that just because something has gone up for the past 20 years, it’s going to keep going up forever.
20 years of price history, stocks vs real estate, rebased to 100 in January 1999Just looking at price appreciation alone and not total returns, London property has massively outpaced the U.
K, the U.
, and even San Francisco in the past 20 years.
All property prices have outpaced the S&P 500 Index in the same time period.
Using past performance only to infer future performance is unlikely to yield desirable investment returns.
In fact, studies have shown a strategy that invests in the worst performing funds, or worst performing countries, or worst performing sectors, or worst performing stocks yields superior investment returns.
For now let’s just ignore past performance for our comparison.
I just wanted to highlight where most comparisons go wrong and this definitely isn’t where we should start.
Theoretical Gross ReturnsFrom an economics standpoint, expected earnings of stocks over the long term is about 7% a year.
Rental property over the long term should also be about 7% a year gross too.
So really if we aren’t particularly active with our investing approach and just look at average expected returns over long time horizons they should be about the same.
We need to understand other factors to do with the investment to decide between the two.
Property: 0, Stocks: 0Fair Value TodayBoth property prices and stock prices have some elasticity to valuations.
Property prices are somewhat dictated by average salary in the area.
The main caveat is that speculative demand can outstrip supply for periods of time, which can inflate prices in a particular area.
It’s also possible for supply to outstrip demand in an area with a lot of new developments.
Stock prices are influenced by forward expected earnings and similar to real estate, new money flowing into the asset class can create an imbalance between supply and demand pushing up prices.
Typically demand/supply imbalances are what create bubbles or depressions that tend to normalise given time.
To gain an understanding of if our asset is cheap or expensive we can look at a very crude measure of price/earnings (share price/company earnings) in the case of stocks and also price/earnings (property price/annual salary) for real estate and compare this to their long term averages.
20-year history price/earnings for S&P 500 and house price / salary for US & UKI realise there’s a lot to take in with this chart but the main take away is that US stocks price earnings are slightly below their historical price/earnings average, US property is slight above, and UK property is quite a lot above.
This isn’t really a perfect science but from this I’d conclude that on one valuation measure UK property looks a bit expensive, US property is pretty much at its long term average and US stocks look a bit cheap.
It’s worth noting just because something is expensive in P/E terms doesn’t mean prices ever have to come down but I think it’s a worthwhile data point if we’re comparing between two assets.
Property: 0, Stocks: 1TimeIf we’re a long-only investor, we’re sensitive to how much time we remain invested in the market.
Any time we are out of the market costs us valuable investment returns.
Remember: time in the market, not timing the market.
tick tockTime affects you negatively in 3 ways when it comes to property:Capital buildingEvery time you want to invest in a buy-to-let you need to build up capital for the investment.
Dependant on your earnings and what area you want to buy this could be anywhere between 1–5 years, or even more.
In those years you’re building up your capital, your money isn’t invested.
Granted this isn’t really an issue if you’re paid huge bonuses in lump sums or have just received an inheritance but for those starting off on their investment journey, this will definitely be a problem.
Transaction TimesTo buy: Average of 65 days (2.
1 months) to complete on purchase.
To sell: Average of 129 days (4.
2 months) to sell from 1st day of marketing to legal completion.
That completion time crushes you again if you’re trying to buy in a hot market.
There’s no law whatsoever to protect you from the seller bumping up their offer in that 2.
1 month period and no law stopping them from sending a draft to two buyers and telling them whoever completes first, wins.
Empty periodsTo find a tenant: Average time to find a tenant is about 2 months, your property will be empty during this time not earning you income.
If you’re levered and have to pay a mortgage those empty months are going to be a pretty huge source of stress.
To evict a tenant: It’s normal to have to give 2 months notice.
These don’t take into account if you operate a distressed strategy where you renovate as well then you’ll have an empty period of up to a year to gain planning permission (and the associated costs) then an additional period up to a year to actually do the renovation (and the associated costs).
In contrast, for stocks it’s about 20 milliseconds to execute a trade during market hours and you can invest from $1.
Settlement is t+2 however the trade is legally binding so you don’t need to worry about your counterparty pulling out in that time.
Property: 0, Stocks: 2PassivenessHaving parents who invested in property in the 1990’s as part of “retirement” I’ve seen first hand the issues they face.
nope, you ain’t Calvin CandieYou will get threatened by angry tenants & potentially sued.
You will always have to do minor renovation between rentals.
Some tenants will completely trash your place leaving you to do major renovations.
Some tenants wont pay their rent and refuse to move out — under squatters rights they may have a legitimate claim over your property.
You subject yourself to the burst pipe problem.
A random issue involving a 2am phone call on Sunday night that will involve some decision that has to be made.
Even if you hire a management company you’re still taking unexpected phone calls but this time in the middle of the working day, and you’re still footing the bill for unexpected expenses except this time it’s probably a lot higher because the management company know they’re passing these costs through to you.
You’re liable for the living conditions of your tenants.
If you’re not willing to run it as a full-time business you risk being subjected to fines and even jail time.
You have none of these issues with stocks.
Property: 0, Stocks: 3Net ReturnsWe can split costs into one-off up front costs and ongoing monthly costs.
Up Front CostsUp front costs when we want to invest in each asset classFor property, Estate agent & solicitor fees are about 5%.
Stamp duty (tax) is about 3%.
If you’re levered and you get a mortgage there’s an arrangement fee of £500-£1000.
For stocks, bid offer is about 0.
1% or less and transaction costs are about 0.
1% or less.
Ongoing costsAnnual costs as a percentage of notional by each asset classFor property, excluding utilities like water and gas, you have monthly liabilities of council tax, service charge, estate agency fees and management fees.
In aggregate, your costs work out to about 30–35% of your gross annual income assuming your property is occupied 12 months of the year.
If we assume a normal empty period of about 2 months a year, your costs could quite easily be 40% of your gross annual income.
For stocks, S&P 500 ETF’s have pretty low expenses’s of around 0.
25% of notional or you could just buy Berkshire Hathaway (BRK-B) which gives you a fairly diversified exposure to the US with a 0% expense ratio.
TaxesWith property you are taxed on capital gains and income at your current income tax rate.
With stocks you get 0% on capital gains up to £20k per year ISA allowance.
Dividends are taxed at 10%, and anything over this is taxed at your current income tax rate.
Up front costs, ongoing costs, and taxes are all lower on stocks when compared to real estate.
Property: 0, Stocks: 4OutlookProperty prices are a huge social issue right now.
There was a recent buy-to-let mortgage tax relief cut in April 2017.
There was an overseas stamp duty surcharge of 1% introduced January 2019.
Landlords have to upgrade energy efficiency in their properties to cut tenants electricity bills from April 2019.
Letting fees to be banned from June 2019 where most likely the fees will be passed to landlords.
There was talk last year of a minimum tenancy period being introduced of 3 years.
how’d you like them headwinds?House prices are elevated and the government is aware of it and they are actually doing something about it.
There are major headwinds for growth.
With stocks, in an ISA you can save £20,000 annually and earn capital appreciation completely tax-free.
It’s likely the ISA allowance goes up again so if anything you’re getting tailwinds encouraging people to invest.
Property: 0, Stocks: 5DiversificationLet’s say on the 1st March 2018 you had just completed on the purchase of a house in Salisbury town centre.
You put it up for rent with the hope of getting your juicy 10% rental yield.
3 days later the Novichok poisoning hit’s the headlines.
Or let’s say one of your tenants decides not to pay their rent.
And they decide not to leave.
What if you want to sue them and your court date is in six months time.
Or what if you buy in a particular area and then there’s huge development works starting next door.
The problem with investing in rental properties is that your risk is very concentrated to a single property or a cluster of properties.
If just one of those is empty it affects your cashflows in a pretty huge way.
With stocks, if you’re buying the index you have diversification across ~500 companies with a very small amount of capital.
You can also very easily diversify across geographies too.
If you are running an Alpha Capture strategy you also have the potential to hedge out market risk completely so economic downturns don’t affect your returns.
Property: 0, Stocks: 6Price VolatilityThe reason why people think stocks are “more risky” than property is because of short term price volatility.
Remember the 65 days to buy a property and the 129 to sell a property earlier?.If you smooth out stock prices by those same 194 days and compare against property we have a completely different picture.
15-year period 194-day simple moving average of US Stocks vs UK PropertyGranted this isn’t an exact science given I’m comparing across continents and across currencies however even with this the Sharpe Ratio is now about the same at 0.
3 and their correlation is 0.
Property: 0, Stocks: 7SummaryYou probably won’t believe me but I genuinely did start this post off with a view to sharing a balanced opinion and discuss the merits of both.
I feel the reason why people feel more comfortable with property is because you can visit it, you can live in it and you can touch it.
Something about the idea of their wealth on a piece of paper or numbers on a screen makes them feel very uncomfortable.
The other reason that people may have a preference to property is that your cash flows for property work out at about 3% net and they are paid monthly whereas with U.
stocks (S&P 500) right now it is about 1.
75% net and they are are paid quarterly.
It’s a wild concept that people consider stocks “too risky” when you can literally be in a situation where your life savings are stuck in an illiquid asset that you can’t sell and you could potentially have an ongoing monthly liability on it.
Also, the level of responsibility and legal liability you’re taking on by providing a home for someone isn’t something you should take lightly.
In conclusion, stocks right now are cheaper from a valuation perspective, the theoretical net returns are higher, there are more tailwinds than headwinds, and they are are actually passive whereas property isn’t and you don’t open yourself up to a world of endless pain dealing with tenants.
Obama out, Janny outThere are some fantastic ways to invest in property without all the risks I’ve put here such as REITs & homebuilders.
There are also ways to boost the dividend yield of stocks e.
investing in a dividend aristocrats ETF.
In general I don’t think now is a good time to run a long-only strategy on stocks or property given we’re at a late stage in the economic cycle.
I think anyone who has their money in passive ETF’s or other long-only investments should really think about moving them into recession-proof investments or an Alpha capture strategy but this is a personal view and I haven’t backed it up with data (yet).
In the next post we can look at how to actually value some of our asset classes to highlight some Alpha Capture opportunities.
The views contained herein are my own and are not investment advice.
Past performance is not an indicator of future returns.
Always seek advice from a registered financial advisor before making any investments.
Right now is probably the worst time to get involved with investing given the obscene bull run we’ve had since 2008 and the low interest rate environment that has created many, many bubbles, but I want you well versed for when the crash comes so we’re starting knowledge time now.
Seat belt, check.
Hard hat, check.