Rental Properties vs Shares

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Q: I bought a rental property that has increased in value considerably. The cash is great, but I’m wondering if I should sell high and invest in a different asset.

A: This is a situation where there really is no one-size-fits-all answer, says Sarah Rogers, a qualified property investment advisor, financial planner and mortgage broker.

To tackle this question, you’ll want to first get a handle on just how well this particular investment is performing relative to other assets.

Looking at the asset classes in general property and shares perform relatively similar returns with Australian residential property averaging 11.1% returns and Australian shares averaging 11.5% return, with shares been slightly more volatile. Of course this will depend on where and what you buy.

For a simple apples-to-apples comparison, take the property’s annual net cash flow (income minus expenses) and divide it by the equity in the home. You can use this yield to see how the income generated by this property stacks up against that of other investments, such as dividend-paying stocks.

To calculate your total return, take that yield and add it to your expected annual long-term price gains (what the percentage you expect the property to go up in value by). If your yield is 5%, for example, and you expect the value of the property to appreciate 2% a year on average, your annual total return would be 7%.

Next, you’ll want to figure out just how much you would have left to reinvest after you pay the real estate agent fees and the capital gains tax.

Remember, because this is an investment property and you have held it for over a year, you are eligible for the capital gains discount of 50%.

Assuming you don’t want to re-invest in actual real estate, the big question is where you should invest the proceeds of the sale – and is it better than what you already have?

You could look at alternative assets that have a similar risk and reward profile — dividend-paying stocks, real estate managed funds.

Investing in actual real estate takes time, lacks liquidity, and comes with some big strings attached. On paper, your investment property might seem like a better deal than any of the alternatives, but there are 50 other things you have to think about.

With real property there’s always the risk that you’ll have to pay in money for, say, a new roof or heating and cooling system. That’s one thing you don’t have to worry about with a managed fund or shares, however with shares and managed funds the ability to borrow to invest is not as high as with property.

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