Are Properties Really Better Investments Than Shares?

Perhaps it is part of Asian culture, but most people I’ve talked to tend to feel that properties make for much better investments than shares.

Some common refrains I’ve heard are the following: A property is a safer investment; it never falls in value; and it is a solid and ‘real’ asset. Meanwhile, the following are common criticisms of shares: They are risky; they are speculative; and they are just pieces of paper and not a ‘real’ asset.

There is of course nothing wrong with an investor just simply being more comfortable investing in properties than in shares. But, does the common belief that properties make for better investments than shares really hold water? What I’ve found might surprise you.

Growth in property prices

According to the Private Property Price Index tracked by the Department of Statistics Singapore, the residential category has increased in price from 112.8 in 2003 to 214.3 in 2013. That is an average annual growth rate of 6.6% for that decade. Even if we add in an estimated net rental yield of 2.5% a year (a reasonable figure given that it’s about the rate of inflation), the average returns for investors in private residential properties in that decade would be around 9% a year.

In comparison, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks the performance of the Straits Times Index (SGX: ^STI), has had an average annualised total return (where gains from reinvested dividends are included) of about 8.4% for the 10 years ended 31 October 2014.

Properties and debt

With those two return-figures (9% and 8.4%), the assumption that properties are much (keyword: much) better investments than shares is a myth. The returns are actually comparable for the two asset classes. The only reason why some would feel that properties can produce much higher returns is because of the effects of leverage. Borrowing money to purchase a property is a lot easier than trying to borrow to purchase shares.

But, just as it can be dangerous to buy shares with borrowed capital, the same applies to properties too.

Moreover, due to the high price of properties, investing in a piece of real estate might even be much riskier than investing in shares. For example, if you have S$200,000 in savings, you could perhaps purchase just one property by getting a bank to help finance the other 80% of the property’s value (that’s a loan-to-value ratio of 80%).

But with the same amount, you can easily invest in 20 to 50 companies in the stock market and in the process, help diversify your portfolio and thus reduce the risk of concentration.

Debt and risk

So, think about it. Is it riskier to invest in just one property and have to borrow more than four times your capital, or is it riskier to invest in more than 20 different companies of your own choosing without any leverage? If your property drops by 5% in price, you would have already lost 25% of all your capital. On the other hand,  if one company’s share price drops by 5%, your portfolio would only fall by 0.25% assuming you had bought equal dollar amounts of each share.

Foolish Bottom Line

I don’t think one can conclusively proclaim that one asset class is better than another. At the end of the day, they are just different. Having the wrong assumption that one asset class is always safer and better than another can lead us to make investment decisions which turn out to be highly risky.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.