Why you can't invest in residential property on the stock exchange

Brilliant piece Hugh. It highlights the tragedy that is Australia. The bulk of the productive savings shovelled into non productive housing and industry can go hang or be soaked up bu overseas investors.

I have always wondered about this. Thank you for the article. Very well explained. Kevin

Thanks Peter and Kevin. As the manager of a listed property fund, I am frequently asked about my thoughts on the direction of house prices, but like all fund managers in this sector, I have minimal special insight as my daily research activities focus on commercial property, which comprises 95% of the investible universe of listed property.

Also as discussed in the article the exposure to resi real estate is based on developing and selling as quickly as possible and then recycling the capital into a new project. If the trust ends up actually holding onto an apartment or house, this is a negative outcome as it indicates that the buyer has defaulted on their contract.

Thanks, Hugh, great points I have also wondered about. What about some of the smaller property trusts like Cedar Wood? Are building services such as Boral and CSR (maker of gyprock) a better way to gain residential exposure?

Jack, while CWP have a greater exposure to resi real estate than the diversified trusts such as Stockland, fundamentally they are in the same business of developing and selling real estate, not actually owning property.

Building materials companies CSR and Boral have exposure to residential construction (new dwellings) but obviously don't benefit from higher prices for existing houses. However in my view the market have consistently overestimated the leverage that these companies get from increased housing demand, a situation not helped by the tendency to construct new brick and tile plants at the top of the market to service peak demand.

Residentials rental housing is not exempted from capital gains tax and interest on you resident is never tax deductible or other maintenances (unlike in other countries).
The company tax rate is at worst 30% and can be effectively ZERO. Ask some of the overseas companies supposedly resident in tax havens. 47% plus medicare levy is 49%, that is 63% higher than max company tax rate. Negative gearing is also available to companies. Companies can get better net returns in a shorter time than holding residential housing is the real reason.
Also managing a large holding of residential housing has a more time consuming problem of dealing with a large number of individual tenants, plus increasing tenancy acts to deal with.

After >30 years of being a landlady, I have found the obligations of managing rental property increasingly onerous and expensive. If it were not for potential capital gains, it would not be worth the effort. I doubt any listed company would want these obligations.

As a long term resi prop investor I salute your analysis. Very few 'get it '....but you did pretty well.
Here's what you missed! (1) You cannot save your way to wealth. You must use OPM ( aka leverage.) Name me one other asset where the banks 'fall over them selves' to lend you 80% LVR ? ( 90%+ with LMI) And so long as you service the loan, won't make a margin call if the value falls! (2) Now work out the IRR when you only have 10-20% skin in the game and property rises just 3% per year. And that happens year after year and nobody bliks an eyelid ! When we have a 'boom' year, the returns should be illegal ! (3) Next, all the banks and all the gov't are 'in on the bet' and they are on your side. Just take VIC gov't income. Mostly land tax and stamp duty. Do they want property to keep going ? What makes up the banks balance sheets ? Do they want it to 'keep going'? The only game in town for dumb old Aussie battlers.

As a long time resi investor also, I agree with your analysis 100%.

Comparing the levered returns on residential properties to unlevered returns on other asset classes (e.g. shares) is not very useful. The leverage simply magnifies the gains/losses symmetrically - it doesn't make the underlying asset itself superior to other alternative assets. The 3% property rises that you mention is simply a function of demand and supply (which, as you correctly pointed out, is highly influenced by government interference and other external factors e.g. decreasing interest rate and Aussies' pathological obsession of home ownership), not because the underlying 'value' of the property itself has increased - price and value are not the same thing after all.

Thanks great article that points out the natural owner of residential property and probably explains some of the difference between the passing yield of residential and commercial. However, as alluded to by a few posters above, it is a bit more complicated. Firstly, one difference is the different capital gain expectations between the two sectors. Residential may have longer effective lives for their fixed assets, with refurbishments generally having a longer cycle than commercial (a great result, given the environmental benefits of longer cycles). Secondly, the impact of CGT exemptions is probably overstated. You can only claim this exemption on 1 property, so there is a natural limit of demand for this kind of buyer. Of course, you could buy a really expensive property to maximise your exemption, but as you cannot pay yourselfs rent, this cancels itself out as a result of the higher imputed consumption. Thirdly, negative gearing should only have a mild impact on institutional disadvantage. While, households at the top marginal rate can reduce their taxes from year-to-year with gearing there is theoretically nothing stopping them from doing so by investing in other asset classes. A rational household investor should be ambivalent about whether they put their marginal investment dollar in bricks and mortar, commercial property or the stock market. By comparison, institutional investors benefit from a >30% tax rate and their shareholders get the benefit of franking credits, which offsets a lot of the advantage of households. I think the real reason why residential is priced more sharply than other property assets is because households are predisposed to placing their surplus funds in residential assets due to: a) general financial illiteracy, concern about volatility (perception associated with mark-to-market asset classes) and distrust of the equities market b) agency risk associated with third party funds management c) and the perception of houses as being safe. Institutions are quite right to avoid this market; but governments are equally quite right not to provide institutions tax breaks to even the playing field.

Thanks Deo for listing a) (general financial illiteracy) and b) and )c (distrust of the less understood) . Australians are brought up to have a bias towards residential housing investment plus they like to be "hands on", failing to count the cost of the time and money involved - AKA a hobby?

I found this an excellent article. It specifically answered my question which came about while I was looking at ways to diversify my SMSF.