Don’t use shares metrics to judge property investment

November 13, 2017

Property is not better than shares. That’s a truth I always try to deliver upfront when I’m asked about which asset class is superior. It’s not an either/or answer.  In an ideal investment portfolio, one would have a generous amount of both.

That’s a safe assertion because time and again, objective research that analyses the historical performance of Australian asset classes shows property and shares tracking one another in terms of total return.

Fair-minded stock-broking professionals acknowledge this. But there are many others who don’t. Indeed, my first forays into media commentary more than 30 years ago were driven by a desire to challenge some shockingly false propaganda about property from the financial services industry at the time.

While I read and hear less of this self-serving defamation of property today, I still see evidence of – and I’ll be generous here – unconscious bias against residential property investment.

For instance, the other day I read an analysis that pointed out that a property with a 3 per cent net return has a price/earnings ratio of 33.3 compared to shares that typically trade at a PE ratio of 14 times, and that shares often delivered twice as much income as residential property. The reader was led on to conclude that their money might be better off in shares than in property.

Now, I don’t dispute any of those numbers. But the scenario contains a faulty definition, the argument is tendentious, and the conclusion drawn highly questionable and easily refuted. The net return of property is not just its net rental yield. One has to add in capital appreciation. For quality residential property, capital growth represents the vast majority of the return.  Hence, quality property will always have a much higher PE ratio than a typical share.

A better comparison is a growth stock – say a Microsoft or a Google – an established company with good earnings whose capital value is growing strongly because the market reasonably anticipates even better years ahead.

PE ratios can be an excellent metric for shares; they are not for property. Indeed, it’s worse than that. Prospective property investors who seek PE ratios of 14 or 15 are likely to make very bad investment decisions that focus on property with gross rental yields of 7, 8 or even 9%. These numbers are attached to the sort of residential property assets that will always deliver inferior total returns because the demand for these properties is weak relative to supply. The smart money avoids them so they sell cheaply, but they are not a bargain.

Be wary of stock brokers and financial advisers who are airily dismissive of property as an investment, backed with evidence that is little more than spurious financial babble. They are either trying to mislead you or worse, they are ignorant of investment fundamentals.

Instead, only buy high-quality assets, whether it is bricks and mortar or a company listed on the ASX. Don’t speculate on unproven assets that might come good. That is little better than gambling.

Richard Wakelin