There are very few places for investors to hide in a market in which both property values and equity prices are volatile. The question, a perennial one, is which asset class has the potential to generate the greatest return while rising interest rates are still on central banks’ agendas.
Soaring interest rates are to asset prices what gravity is to the apple: they bring everything down, says Contrarian Group independent financial adviser Damian Liddell.
“It’s a pretty lousy time for investors, really. I’d be treading very carefully right now if I was looking to invest in either shares or property. Both are highly correlated to interest rates. I don’t think asset prices are going to go up any time soon. If anything, they are going down,” he says.
Liddell says investors should watch for a pause in interest rates as a sign markets are stabilising. Although that can also be a sign of more pain in markets ahead.
“History suggests even when we finally have our first rate cut, that’s when the share market starts to fall away. In the meantime, most people have to eke out some sort of return. So, it’s what you do with your money in the meantime that’s the big question.”
Stockspot CEO Chris Brycki says nobody knows how different asset classes will perform in the future. Consequently, for the best chance of investing success, the best strategy is to allocate funds to different assets that counterbalance each other.
“Think of the different assets in your portfolio like a FIFA world cup team. Shares are the attacking strikers, bonds are the defensive players and gold is your goalkeeper. You own shares to earn higher returns. Over long periods, shares have generated a higher return than other assets like bonds, cash or even property.”
He recommends owning a diversified mix of shares that includes Australian shares, international shares, emerging market shares as well as exposure to bonds and gold.
“lack of diversification is the main risk of owning shares. If you only own a handful of companies, you risk getting wiped out during periods of market volatility or in a recession, when many companies don’t survive. By spreading your money across different industries and countries, you can protect against this and allow yourself to earn the long-term return of the share market.”
Given property and share markets have fallen this year, some investors are trying to figure out whether now’s the time to pick up some bargains before the cycle turns upwards again. Although it’s almost impossible to pick the top and bottom of a market cycle, there are some signs investors can take into account when making investment decisions about market cycles.
For instance, Alex Jamieson, founder of A J Financial Planning, says at the moment the market is pricing in interest rates to peak around the middle of next year. This has implications for property investors.
“The property market is heavily influenced by moves in the RBA cash rate. I believe in the first quarter of 2023, some high-quality investment opportunities should open up in the property sector, with more stock available and distressed sellers coming into the market.”
When it comes to shares, Jamieson says there’s the potential for the market to fall by 15 per cent next year if a serious recession eventuates. “Although, at the moment the market is pricing in a mild recession, which appears to be in line with economic data. The opportunity may be to pick up higher-yielding, blue-chip companies while share prices are low.”
Current market conditions are only one variable investors should take into account. Proximity to retirement is an important factor to consider when selecting asset classes.
“Historically, property provides a poor rental yield and is more suited to investors in their 30s and 40s. This is because the tax benefits and capital growth associated with property are more in line with many of these wealth builders’ objectives,” Jamieson says.
By contrast, investors in their 50s and those who are near and in retirement are typically more focused on eliminating their overall debt positions and simplifying their investment strategies. They can do this by removing the complexity and costs associated with owning an investment property by switching into other asset classes. “Typically, retirees are focused on high-yielding shares that can provide income streams well in excess of that which may be provided by a property,” he adds.
It’s also important to look at how property and shares have performed on a relative basis when making a decision between the two. Although past performance is never an indicator of future performance.
PRD Real Estate chief economist Diaswati Mardiasmo says although in the near term property has delivered a return lower than the share market, the reverse is true in the long term.
Her data shows over the last two years, returns from some property sub classes, such as units in Sydney and Brisbane, and houses and units in Melbourne and Perth, have underperformed the local share market over this timeframe.
“But houses have proven to constantly yield higher returns than the ASX on a 20-year, 10-year and two-year basis,” says Mardiasmo.
“Properties in regional areas constantly yield higher returns than ASX, while capital city property growth is impacted more by cash rate movements than regional property is,” she adds.
While property market values are still well below their 2021 heights, Mardiasmo says there are still many markets providing a higher return than ASX. Plus the cooler property market may be an opportunity for investors to enjoy more bang for their buck than in markets in which prices are rising sharply. This is because investors are buying when the market is lower, with the potential of higher capital growth in the future.
Although it’s essential to choose the area in which the property is located and the type of property carefully. It’s also important to understand property investments come with costs such as maintenance, rates and strata fees, to which equity investments are not exposed. This should be taken into consideration when comparing both asset classes’ potential returns. Also, taking positions in equities requires less capital than buying property.
The unstable cash rate and little insight into its future direction also means potential property investors must ensure they have the capacity to service substantially higher interest rate payments on their property’s mortgage. Worse, they may not be able to continue to service their mortgage payments at all if rates skyrocket.
Another risk is the property being untenanted or the rent not covering the mortgage payments. Investors in this situation may ultimately be forced to sell their property at a discount to the purchase price.
Investing in shares also comes with substantial risks. For instance, the business may fail and the shares may experience a catastrophic fall in value. Another risk is the business in which the company operates may be subject to new regulations that negatively impacts its performance. Or the industry in which it operates may be disrupted, which also reduces its ability to generate a return.
Ultimately, all investments come with potential risks and rewards. What’s important is to thoroughly assess what these are before taking the decision to invest.