When evaluating investing choices, the first thing to do is compare the return from its current earnings. To make a simple comparison, let’s look at the S&P500 for shares (or the stock market) and the UK price index for the property market.
There are two ways to compare:
What are the historic returns?
i.e. How has it gone up over the last 50 years.
What is the current return based on the cash flow it provides?
i.e. If I buy at the current price, what return do I get on its earnings (or yield)?
The cash flow is an investment-based approach, whereas the historic returns are more speculative.
Property vs Shares: Comparing by historic returns
For the purpose of this example we will assume that income from share dividends and rental income is taxed at the same rate.
To get the total return figures, we need to add the price increase of the asset to any income it makes. Since 1952, UK property prices have appreciated 7.74% per year. The return on property is equal to the price appreciation plus the net income. The net income is equal to the rent, taking void periods in account, minus all costs including maintenance, fees etc. I am going to assume this is 3% per year to allow a good budget for maintenance (which is often overlooked and underestimated).
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Property (UK Property Index)
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Stock Market (S&P500)
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10.74%
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9.84%
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The property return is 1952-2015 and the S&P500 is the total return average 1965-2014.
My gut feeling is that, during this period, shares would have beaten housing easily. One reason perhaps is that UK houses don’t generally disappear, whereas failing companies do.
Property vs. shares: Comparing by current yield
Here we need to compare the net income on property with the earnings the S&P500 makes. Some of the S&P500 earnings are retained and not paid out as dividends, but they still count as the earnings of the asset.
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UK Property Net Yield 2015 (est)
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S&P Earnings Yield 2015
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3.05% (5.02% ex fees etc)
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6.20%
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The property figures again form a non-complete dataset via a report by HSBC. Again, for property we have to estimate what the net yield will be, and this time I am going to estimate that 2% of the property value is maintenance fees etc. to give the actual return.
From a current earnings viewpoint, the market is currently better value, even if we factor in zero fees.
Property and shares: the pros and cons
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Pros
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Cons
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Property
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Something you can touch and feel
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Having something to look after
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Regular work dealing with tenants and service providers
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Unlikely to sell in a crash
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Hard to sell in a hurry if in need of cash
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Good long-term returns
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Can go periods without any capital gain
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Simple to understand
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Harder to implement
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Can use leverage for higher returns
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Leverage can add wipe-out gains in down times
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Good protection from inflation
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Income isn’t sheltered from tax
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Shares
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Liquid, you can sell easily when you need cash
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Easy to sell in times of panic
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Can be bought in tax efficient structures such as ISAs and pensions
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Easy to invest in via trackers or similar
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Subject to sudden drops and gains
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Good protection against inflation
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Harder to understand than property
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In shares in the stock market you can fire and forget, but for property you have to do some level of work. To do well in both, it’s important to take a measured long-term view and ride the storms. Property has the advantage here — when it goes down in value, you are less likely to sell it in a panic, as it isn’t as simple as selling a share on the market. The flip-side of this, of course, is that it’s also harder to sell property in a hurry if you need the cash. Personally I prefer shares, as I pick more specifically not just the whole market, plus there isn’t the hassle of owing property.
Datasources:
S&P Dataset
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
UK Total Return Dataset
http://www.nationwide.co.uk/about/house-price-index/download-data#xtab:uk-series
Disclaimer: The above does not constitute investment advice. The author has invested in the stock market and the property market at the time of writing.
Tim O'Shea
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3 Comments
I'd never be a landlord again, but one way you can have your cake and eat it is to buy a levered property company, such as Land Securities. Something like that produces almost like-for-like performance with a mortgaged buy-to-let, but without any of the horrible tenants or agents.
I'm still fluctuating between two. Yes, there is less hassle with stock market. But isn't BTL earning money which is borrowed? For example, I buy property worth of 350K (100K my deposit and borrow the rest as a mortgage), even if all of the rent is spent on mortgage, maintenance, estate agent fees, don't I in 15-20 years end up with most likely with property that doubled in price with 100K initial investment only. Whereas, if I invest 100K in stock market, it is still only 100K that is earning, I can't borrow from the bank to invest into stock market. Obviously, this is true for areas with high potential property (London area not north of UK for example). Pls explain, I still can't make up my mind. Thank you.
Yes, property does give you the chance to use debt (leverage) to increase the returns but it also increases the risk.
For example:
- What if the property market drops by 30%, your deposit is wiped out.
- What if interest rates rise and your rent doesn't cover the mortgage and then you have to fund the property each month?
The good outcome you explain is dependent on the prices of houses rising which may happen but we don't know for sure.
It is possible to borrow money to invest in the stock market but something I would not suggest doing as it increases the risk.
I would look at the return you get in terms of "owners earnings" eg the amount of cash flow each asset gives the owner after all costs and tax.
In property this is rent less all the fees, maintenance, tax etc etc. In the shares this the earnings your shares make which is the earnings per share (adjusted in some cases). Then you can compare.
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