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Is Residential Property A Good Investment?

The arguments in favour of residential property investment appear overwhelming


Housing prices remained reasonably firm through the worst of the "Global Financial Crisis" and have risen steadily over recent months. Many do-it-yourself investors, badly bruised by the battering taken by domestic and international sharemarkets, are seeing investment in residential property as a "safe" investment alternative.

The arguments in favour of residential property investment appear overwhelming and include:

Capital city housing prices have gone up by about 10% since the start of 2008. Over the same period, the Australian share market fell approximately 20%, reflecting a 46% fall in the 14 months to February 2009, followed by 47% rise in the following 12 months. The conclusion being drawn is that residential property is not subject to the negative volatility of share markets;


There is an apparently clear gap between the demand for and supply of residences, driven by immigration and natural population growth, with the estimated shortfall running at the rate of 30,000 p.a. The implication appears to be that this must lead to further increases in both rental yields and property prices;

Residential property investment offers attractive tax breaks, with depreciation and any borrowing costs deductible against other income and capital gains taxed at a discounted rate. These breaks are viewed as benefits peculiar to property investment;

It is easier to borrow against property than shares and without the need to meet margin calls if values fall. As a result, you can purchase more property than shares using borrowed funds. Clearly, this is a very good thing if you believe that residential property only goes up in value; and

Last, but not least, you can touch and feel your property investment. Share investment is more anonymous, apparently more complex and less transparent.

The case for residential property investment is flawed

Given our investment philosophy, we don't believe any of the above arguments stand up to scrutiny. Considering them in turn:

Too many investors fail to understand that the oft quoted statement past performance is not necessarily indicative of future performance means exactly what is says and should be taken very seriously. Residential prices can, and do, fall heavily the recent US and UK experience is evidence of that. The Australian residential property market is not somehow immune from waves of irrational exuberance and the potential for savage falls;

The apparent gap between residential demand and supply is hardly a secret known only to property insiders it is common market wisdom. While residential property markets may not work as well as transparent and liquid share, foreign exchange and debt markets, it seems to us that something that everyone already knows is more an explanation of why property prices are where they are rather than a driver of future price rises;

The tax breaks for residential property investment are not, in our view, either breaks or special incentives restricted to property. For example, property investors are allowed to claim a tax deduction for depreciation, not as an undeserved benefit, but because structures do deteriorate and fixtures and fittings do wear out. Value is diminished and, as such, depreciation is a legitimate business expense. It is offset by a reduction in the cost base of the property and an increase in any capital gain, for tax purposes. The fact that capital gains are treated more favourably than income for tax purposes is a potential break but it is not limited to property;

The ability to borrow more for investment in property than shares means it is easier to take on increased risk. However, most investors in residential property only focus on the opportunity borrowing provides for higher returns. So there is a tendency to overborrow and rely on the sale of the underlying property rather than future cash flow to repay debt. Should property values fall, the chances for financial ruin are correspondingly increased; and

The emotional benefit of being able to touch and feel a property investment rates very low on our list of requirements for a sound investment. This tangible attribute implies a poorly diversified investment (i.e. a big bet on a single asset in a specific location) and hands on management. Most of our clients find their time better spent focusing on what they do well and/or love rather than actively looking after investments in which they have little expertise and/or interest.

Residential property investment is not the panacea

So, we don't think residential property is the holy grail of investment, offering the opportunity for high returns with low or no risk.

Higher returns always require taking higher risk. But higher risk does not imply higher returns. And, often, it is when risk is least apparent or most underrated that prices become overdone, setting the scene for potential disaster should an unexpected event occur to upset the conventional isdom.


The way we see it, a large, highly concentrated holding of any growth asset (i.e. property or share) is always high and avoidable risk. Borrowing to fund the purchase of that asset only compounds the risk.

We believe that the following recent comment from the Governor of the Reserve Bank, Mr Glenn Stevens, is a very timely warning to the increasing numbers of investors that are thinking residential property is a no brainer:

It's a mistake to assume a riskless, easy and guaranteed way to prosperity is just to leverage to property.

by: John Raymond Leske
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Is Residential Property A Good Investment?