What rising costs and weak growth mean for rental investors.<\/p>\n
If you want real returns that compound over time, relying on rental properties alone won\u2019t get you there.<\/p>\n
That\u2019s the message from Aaron Ibbotson, Director\/Senior Analyst, Equities, at Forsyth Barr.<\/p>\n
\n Forsyth Barr research shows that future property gains almost certainly
\n won\u2019t match up to recent booms, and the true cost of owning a rental usually outweighs the returns.\n <\/p>\n
\u201cIf my house doubles in price, can I now feed two families? No,\u201d says Ibbotson. \u201cIf you buy one property, 50 years later you still have one property. But if you buy shares in a logistics company equivalent to the value of one truck, 50 years later you own the equivalent of many trucks. That\u2019s one of the core principles when you invest in equities [shares] versus properties.\u201d<\/p>\n
We can\u2019t pay an ever-increasing amount for houses <\/p>\n
Since 1992, house prices have increased by 6.2% a year on average, far outpacing household income growth. House prices reached a peak in 2022, when it took 11.2 times the median disposable income to buy. Over the past three years, that ratio has fallen to 9.2 times income, still well above the long-term average of 5.7. <\/p>\n
For growth to continue at 6.2% annually, house prices would need to reach ever-increasing multiples of income, according to analysis in new Forsyth Barr report The House Doesn\u2019t Always Win<\/a>. It would take 13.7 times median income to buy a house in 2040, 17.7 times in 2050, and continue to worsen. This simply isn\u2019t possible, sustainable, or statistically likely, says Ibbotson. <\/p>\n \u201cRents and house prices are not going to grow faster than household income over time. I\u2019m not saying it will be zero growth, but maybe 4%. And the number one thing that people forget about is real [adjusted for inflation] growth. That is about 1% a year over the very long term.\u201d <\/p>\n Better than putting your cash under the mattress, but\u2026<\/p>\n Property is like gold, says Ibbotson: they both hold their value against inflation, but they don\u2019t increase in value, only in price. In contrast, a basket of shares will increase in value and price over the same timeframe. <\/p>\n \u201cMy grandfather\u2019s uncle, Frank, inherited a gold coin from his grandfather that was worth a month\u2019s wages in the 1850s, and it\u2019s still worth about a month\u2019s wages now,\u201d he explains. \u201cIf Frank\u2019s grandfather had put that money in his mattress, now it would be worth only a cup of coffee, that\u2019s inflation. But if he put that money into equities back in the 1850s, in a diversified portfolio, it would be worth half a billion dollars today, that\u2019s compounding.\u201d<\/p>\n That\u2019s the power of spreading your money across a wide mix of businesses rather than locking everything into a single property asset.<\/p>\n While capital gains between 2000 and 2022 were impressive, anyone who bought in 2021 in Auckland or Wellington funded 80% with a mortgage has seen most of their equity wiped out over the past few years. A diversified portfolio of shares might fall in value, but has never historically resulted in equity falling to almost zero in just a few years, he points out. <\/p>\n Property investors often rely on back-of-the-envelope calculations to work out they\u2019re making a gain, tending to brush over the true cost of upkeep and fixed outgoings. Rates, insurance and maintenance have risen to the point where they now consume around a third of gross yields, currently sitting just below 4%, Ibbotson says.<\/p>\n \u201cI ask my friends who own rentals, what is your honest cashflow? The vast majority who are in their 40s have big mortgages and cash losses. If they genuinely deduct all the fees and costs, it\u2019s in the red. The honest cashflow is often very low.\u201d <\/p>\n Plus, he notes, rising property prices reflect renovations and improvements over the years. Homeowners add rooms, refurbish kitchens, and put in pools, which drive up median house prices. If you buy a rental and do the bare minimum maintenance, its value won\u2019t keep up with the rest of the neighbourhood. <\/p>\n By contrast, a diversified investment portfolio keeps working in the background, with different assets performing at different times to smooth out the bumps.<\/p>\n Why buying a home makes sense \u2013 but a rental may not<\/p>\n While he\u2019s highly sceptical about the real returns on rentals, Ibbotson believes that buying a home has plenty of non-financial benefits. A home typically provides a huge sense of security, particularly when you have children, so home ownership can be an excellent lifestyle decision. <\/p>\n Equally, if you have a substantial investment portfolio and property (excluding your home) makes up only 10% or 20% of your overall wealth, that\u2019s a very reasonable approach, he says. In that case, property adds diversification, is tax efficient, and can be enjoyable as a direct investment if that interests you. <\/p>\n For everyone else, though, investing in rental properties is a missed opportunity to put money into the sharemarket and potentially see it gain real value over time. Talking through these trade-offs with a qualified adviser can help investors avoid blind spots and build a strategy that actually fits their long-term goals.<\/p>\n \u201cPeople often don\u2019t understand that when you own a portfolio of equities, you own a small proportion of hundreds of fantastic businesses that do great things. Broadly speaking, you can get nominal returns of 8% or 9% over the long term. Real compounding is why the markets are so fantastic, and why I\u2019m evangelical about people investing in the stock market over the long term.\u201d <\/p>\n For more on how different investment options compare, see Forsyth Barr\u2019s Property Investment Alternatives insights<\/a>.<\/p>\n Disclaimer: Investing involves risk, including the possible loss of capital. Returns are not guaranteed and the value of investments can go down as well as up. This article is general in nature, has been prepared in good faith based on information obtained from sources believed to be reliable and accurate, and should not be regarded as financial advice.<\/p>\n