Negative Gearing:Shares Versus Property

MedAu Columns

Splitting Assests after Divorce

Tax Changes to Provide Opportunities

Share Market Outlook - Dec 1998

Bear Market?

The Share Market - Where Now? (Aug 98)

Big Changes for DIY Super

Outlook - Feb 1998

Divorce and Superannuation

DIY Super?

Gearing into the Sharemarket

Is there a Housing Boom?

Knock-on Effect

Negative Gearing:Shares Versus Property

New Approach to Negative Gearing

Putting Money into your Spouse's Super

Risk

Share Market Gearing Packages

Soverign Risk

Using other people's money to increase personal wealth has a long tradition and lots of people have tried it. Some have succeeded magnificently, others have done tolerably well, while others have failed spectacularly. The late 1980s is strewn with the corpses of failed entrepreneurs who borrowed too much at the wrong time.
But investors who know the risks and take the necessary precautions can make gearing work. The obvious attraction is that gearing magnifies gains and any losses along the way are tax deductible. But to work of course, prices must rise. Gearing up simply for the tax losses is a big mistake.

That said, most investors take their first gearing plunge into the property market and never travel further. This is despite much better returns from gearing into the share market. In fact, there are a number of reasons why a share portfolio appropriately geared can be a better investment than a geared property investment.

In the first place, it costs a good deal less to get into, it costs less to get out, and the income stream that flows during the life of the investment is better from shares. Dividend imputation, for example, means that dividends received from a share portfolio are partly tax paid. If the dividends are fully franked, meaning the company has paid the full rate of company tax on the profits it makes, then a share investor only has to make up the difference between the company tax rate and his or her personal tax rate. Rental income on the other hand is fully taxed.
Stamp duty is a great deal more on property investments as are other costs such as agent's commission, mortgage fees and legal fees.
Share investors do not have to worry about rental vacancies, property damage or difficult tenants.
Shares can be sold immediately while a property sale in a slow market can take months to finalise.

The accompanying table indicates the different after tax returns that come from property and shares after assuming the same rate of capital appreciation. The net capital gains from property are less because of the higher costs. But the big difference comes from the income side where the cumulative losses on a share portfolio are a good deal less than on property. This is mainly due to the tax-preferred status of dividends.

Of course, shares and property are not about to rise at the same rate. No one knows for sure what will happen, but as the table indicates, shares offer more protection in a difficult or slowly rising market. A share investor can still make a profit if shares rise at only half the rate of inflation. Over the past 15 years industrial shares on the Australian market have risen an average 12% a year compound compared with an average 8% for house prices in the major capital cities. If these returns held in the future, then the geared share portfolio will return more than 28% a year and the property portfolio 16%. Although most analysts are optimistic about the share market over the next year or so and pessimistic about the property market, no one can know for sure.

There are other reasons for caution. In a good market gearing will increase returns but it also magnifies losses. As a precaution most financial advisers prepare a worst case scenario to see what the financial consequences would be. If any potential losses could be covered from other sources then the exercise may be worthwhile. An additional precaution is to take out income protection insurance just in case the income stops because of accident or sickness.

SHARES VERSUS PROPERTY

3% PA GROWTH 5% PA GROWTH 8% PA GROWTH

SHARES PROP SHARES PROP SHARES PROP

Capital gain 42,020 31,692 83,104 72,555 127,776 114,169

Income -24,148 -56,131 -19,497 -52,878 -11,821 -47,509

Net gain 17,872 -24,448 63,607 19,678 115,954 66,659

Return pa 6.0% -19.0% 15.3% 7.0% 21.9% 16.0%

Assumptions:

$30,000 invested plus $170,000 borrowed
Rents and dividends rise at same rate as the underlying asset
Dividend yield four per cent, property yield five per cent
Top marginal tax rate
Assets sold at end of eight years
Inflation five per cent
Income and losses adjusted for inflation

Figures are after tax.

Return to top of page

This page was last built on 1/9/99; 7:53:50 AM.
It was originally posted on 1/5/98; 2:11:11 PM.
Webmaster:

lemlink@medicineau.net.au

Knock-on Effect

Index

New Approach to Negative Gearing

MedicineAu