In my previous article we concluded that diversification of investment was very important, and that the timing of when you got into a market had a major effect on the results you achieved.
Or: Does Property in Kenmore QLD beat the Commonwealth Bank?
This article extends the investment discussion which compares shares to property. In my previous article we concluded that diversification of investment was very important, and that the timing of when you got into a market had a major effect on the results you achieved. We also mentioned that dividends and rents are a real factor that needs to be considered.
This article looks more closely at dividends versus rents through the conversation I was having with my friend, Bob. It does so by looking at a specific example that gets closer to what a real investor has to choose between: in this case a property in Kenmore, QLD and the shares in the Commonwealth Bank Of Australia.
Bob was quite frustrated that I couldn’t easily give him an answer on which was better: shares or property, as I kept answering “depends”.
He commented to me, “Even if you can’t tell me which is better, at least if I buy property I can see it, and it pays me rent.”
Which is spot on, property does pay you rent. Something a lot of shares don’t. But there are many shares which do pay the shareholder something – dividends. So I promised Bob I would come back to him with just what the impact dividends and rent had on the money he would get back from buying shares or buying property.
To compare the two specifically, I asked him to name a suburb and to name a stock. Which would be better over say a decade of investing?
Bob, knowing I work for RP Data and have the suburb data at my fingertips, smiled and offered a friendly bet. He likes Kenmore in Queensland for investment. Kenmore is a good suburb, with relatively inexpensive housing, and lots of demand from families for accommodation. Rental properties are normally tenanted very quickly. Bob also likes to dabble in the stock market and is a particular fan of banking stocks. So his choice was not a surprise to me: “Should I buy Commonwealth Bank Stock or buy an investment property in Kenmore? My $100 bet is Kenmore beats the Commonwealth Bank!”
Is Bob right?
If we take the period from September 2002 to February 2012, just how would $100 invested in the average house in Kenmore and $100 invested in Commonwealth Bank Stock have gone?
Bob’s $100 would be worth $203 in Kenmore, and only $164 in Commonwealth Bank Shares. So without looking at rents and dividends he is right – Kenmore easily beats the Commonwealth Bank.
But is growth in value the whole story? If we look a little deeper at those Commonwealth Shares, we can see a different story emerging. Commonwealth Bank pays good dividends, and these must be taken into account.
So taking the fully franked dividends and ignoring any further tax effects we can compare:
1. The total return ignoring dividends
2. The total return assuming we took the dividends and spent them as we went
3. The total return assuming we invested the dividends back into the Commonwealth Bank Stock at the end of the month in which they are paid.
How would we have gone?
Bob’s $164 is actually not $164 – if he invested all the dividends he got in more Commonwealth Bank Stock it ends up being $276 dollars, with more than 50% of the growth just from the dividends! The chart above shows the dramatic extra growth in the green line. If instead of reinvesting all those dividends in stock, Bob had spent them, he would still end up with $164 and another $73 in spending money, with the middle red line showing the outcome of not reinvesting his dividends but spending as he went:
Of course the same argument applies to buying a property in Kenmore. Given it will also have returned rent, how would Bob have gone buying a property in Kenmore?
To even out the tax assume Bob pays 30% of the gross rent he gets in tax. He puts up the rent yearly in January, and has a good property manager who follows the market rental gross yield which for Kenmore is approximately 4.3% over the period we are discussing.
The returns then look like:
So the rent paid makes a big difference. $100 dollar spent in 2002 on buying property in Kenmore is now with rent returned worth $251. In fact if Bob put that rental in the bank and got 5% interest for it before tax the total return is $258.
So if we look at this in a table just to understand it better:
|Invest $100 in: Property In Kenmore
||Invest $100 in: Commonwealth Bank Stock
|Approximate increase I expect ignoring Rent: $100 becomes $209
||Approximate increase I expect ignoring dividends: $100 becomes $164
If I get my rent and spend it? $100 gives me $251 over that time ($203 + $48 in spent rent)
If I get my dividends and spend them?
$100 gives me $237 over that time. ($164 + $73 in spent dividends)
|If I get my rent and put it in the bank? $100 becomes $258
||If I get my dividends and reinvest in Stock? $100 becomes $276
What jumps out for me? Not that with earnings reinvested, Commonwealth Bank narrowly beats Kenmore for this particular period. What jumps out is the effect of dividends and rent. Without it Bob’s returns don’t look too good. With it they look a lot more healthy. Assets that deliver earnings on top of capital growth can deliver substantially more than the capital growth alone.
Do I win the bet with Bob?
Bob doesn’t think so – he reckons he would have spent the earnings and therefore the right numbers to compare are the $251 from Kenmore with the $237 from Commonwealth Bank. He is wrong of course, there is more to look at - the right numbers must look at buying and selling costs, and the total effect of taxes including negative gearing. There is also depreciation of the property.
So we agreed to let the bet ride and look in more detail at buying and selling costs, and tax. This is what we will look at in future articles.