Where has been the best place to invest your money – residential housing or the sharemarket?
This is a difficult question but the data in the accompanying table gives a broad assessment of how the two asset classes have performed since the end of 1994.
Based on these figures the sharemarket has done slightly better than residential property as the NZX All Companies Gross Index, which includes all listed companies, has appreciated by 200 per cent while the REINZ House Price Index has risen by 159 per cent.
But the issue is more complex than this and we need to take into account a number of factors including volatility, gearing, tax, costs and the range of returns available from individual houses and shares.
The table, which also includes returns for each of the three five-year periods within the 15 years, shows house prices are much less volatile than share prices.
The best five-year period for houses was a plus 60 per cent and the worst plus 23 per cent whereas the best for shares was plus 79 per cent and the worst plus 1 per cent.
Most investors in the housing market would have done reasonably well over the past 15 years, no matter when they bought. However, anyone who entered the sharemarket in mid-2007 would have suffered huge losses, because of the sharp contraction between then and March 2009, but if they had waited until earlier this year they would be sitting on large profits.
Thus, although the sharemarket has performed better than housing over the 15-year period it is still extremely important to get the timing right as far as buying shares is concerned.
The next issue is gearing, which is where housing has a big advantage over shares.
Banks have been willing to lend more than 80 per cent of the purchase price which means that the return on equity invested in houses has been extremely high even after interest servicing costs are taken into account.
However the flip side to gearing is that it does increase the risks, particularly if a purchaser overpays for a house and cannot meet the interest payments.
This is why there have been so many mortgagee sales over the past 12 months, even though prices only fell 11.4 per cent from top to bottom, according to the REINZ House Price Index.
Tax considerations also favour housing because the Loss Attributing Qualifying Company (LAQC) regime allows house buyers to deduct interest costs yet they don’t have to pay tax on realised profits.
The next issue is costs, which is a negative as far as housing is concerned.
There are lots of costs associated with residential property including rates, insurance and maintenance costs.
These costs can seriously erode the returns from houses and transaction costs are also higher than for shares.
There are no ongoing costs associated with an individually held share portfolio although managed funds attract fees. However investment managers in New Zealand have consistently outperformed benchmark NZX indices.
As there are no ongoing holding costs associated with shares it is appropriate to use gross sharemarket indices, rather than capital indices, because all dividends can be fully utilised by investors.
Finally there is a much wider variation between the performances of individual shares compared with individual houses.
The data in the table shows that Auckland house prices have not risen by as much as national house prices but the gap between the two is relatively small.
Section prices have appreciated more than house prices over the 15-year period but the difference between the two hasn’t been major; 245 per cent compared with 159 per cent.
One of the characteristics of the New Zealand sharemarket is that small companies have outperformed large companies by a considerable amount over the past 15 years, including each of the three five-year periods.
Between December 1994 and October 2009 the NZX 10 Gross Index, which contains 10 of the largest companies, rose by 126 per cent, whereas the Small Companies Gross Index increased by 391 per cent.
One of the NZX’s, and New Zealand’s problems, is that our large companies tend to crash and burn because of poor governance and poorly executed growth strategies.
For example, the largest listed companies at the end of 1994 were Telecom, Carter Holt Harvey, Fletcher Challenge, Brierley Investments, Goodman Fielder and Lion Nathan.
Telecom is the only one of these remaining in its same form and its sharemarket value is now only $4.5 billion compared with $9.6 billion 15 years ago.
Only nine of the top 40 listed companies 15 years ago – Air New Zealand, Cavalier, Guinness Peat Group, Hallenstein Glasson, NZ Refining, Sanford, Steel & Tube, Telecom and The Warehouse – are still listed in the same form today.
This remarkable statistic shows that one of our biggest problems is turning good small companies into excellent big organisations.
Our failure to do this is one of the main reasons why investors have deserted the domestic sharemarket for residential property.
This is reflected in the following figures:
The total value of all NZX listed companies has risen from $42.4 billion in December 1994 to just $54.7 billion at the end of October 2009.
The total value of the country’s housing stock has risen from $165 billion to an estimated $608 billion over the same 15-year period.
In other words our housing stock is now worth 11.1 times the total value of the NZX compared with 3.9 times at the end of 1994.
The other consequence of this phenomenon is that New Zealand households now have $178.5 billion of debt, mainly mortgages, compared with $39.1 billion at the end of 1994. Thus the household debt to total residential property value ratio has gone from 23.7 per cent to 29.4 per cent over the past decade and a half.
Although residential property is now a clear preference over the NZX as far as most New Zealanders are concerned, there have been some excellent sharemarket performances over the past 15 years including TrustPower, which has had a total return of 1738 per cent, Ebos 742 per cent, Infratil 668 per cent and The Warehouse 428 per cent.
A number of other companies, which have been taken over and are no longer listed, have also generated great returns.
Thus the sharemarket has probably performed marginally better than residential housing since the end of 1994, although the former has been more volatile and the gap between the best and worst performing companies has been extremely wide.
The problem is that New Zealanders now have poorly diversified investment portfolios with too much exposure to residential property and far too much debt.
A sustained period of flat or slightly negative house prices would have a major impact on household balance sheets and disposable income, particularly if interest rates appreciate.
This impact would be worse than in the United States because of the following developments over the past the past decade and a half:
The median US house price has risen from US$135,000 to US$205,000 since the end of 1994.
The New Zealand median house price has increased from $134,000 to $355,000 over the same period.
The United States median house price is now 4.1 times the median household income compared with 5.5 times in New Zealand.
It is unfortunate that our capital markets are not highly regarded by most New Zealanders because they offer an important diversification from our over-reliance on highly leveraged residential property.
The sharemarket has also delivered decent returns over the past 15 years, even though our large companies have failed to perform and there have been a number of high profile corporate disasters.