Nothing has changed – residential real estate still fails the investment test

As we are all more than aware, the current ALP Government in Australia has delivered its most recent budget and one area that (rightfully) is getting a lot of attention, and a lot of media, is the change in the capital gains tax (CGT), and the alleged impact it’ll have on young people getting into the housing market. Equally getting a lot of attention is the change in negative gearing, and whether or not this will make any difference for said young people trying to get into the housing market.

I don’t want to turn this into a political piece but suffice to say, the chances that any of these changes make even a small impact on that front anytime soon, or even later frankly, are near zero.

Part of the reason is that these changes are at the edges of the problem. Part of the reason is the grandfathering of some provisions. Part of the reason is that the Government misunderstands what investors are trying to achieve. Part of the reason is that the Government misunderstands who the investors are. Part of the reason is that housing is almost all about supply.

Regardless, it changes nothing about a critical thing for investors – residential real estate will remain a poor option for marginal investment dollars. I went through this in detail in a two-part wire I wrote some time back, see below:

Part 1: Residential investment property is a sub-par way to grow your wealth – Part 1/2 - Sebastian Ferrando | Livewire

Part 2: Residential investment property is a sub-par way to grow your wealth – Part 2/2 - Sebastian Ferrando | Livewire

There are several reasons, truthfully, that residential real estate is a relatively poor investment. But the pieces I wrote concentrated on what I think are the 3 really big ones - high costs, no liquidity, and low yield.

Remember – these views are from the perspective of buying residential real estate, borrowing two-thirds of the money, having someone manage that real estate, and the investor collects the net rent. This is what the overwhelming majority of Australian real estate investors – the ones who got seemingly whacked in the Budget – are trying to do.

It doesn’t include developing real estate, or improving real estate, or investing in commercial real estate. These activities are higher risk and are resultantly higher compensated. As they should be. And it doesn't include buying your own home to live in and, where applicable, a home to raise your family in.

To repeat, these views are only for investors in buy-hold-and-manage residential real estate. Which is the majority.

Back to those reasons - let’s go check if my original thesis from over 2 years ago still holds:

Reason 1: High Costs

It is literally incontrovertible that the costs of buying, holding, maintaining, and selling residential real estate (or any real estate at all) have gone up. A lot. When I wrote the original piece, fancy homes in fancy spots were generating capital returns of less than 4% per year, and that’s before paying any interest (see part 1).

How often have you heard an investor talk about real estate and tell you that they bought it for 2, sold it for 4, I doubled my money? Perfect example – that person has just ignored stamp duty, insurance, rates, repairs, maintenance, taxes, and real estate agent fees.

They nowhere near doubled their money, not even close.

There’s no need to rehash what I’ve already written on this topic as nothing has changed – the costs are very high, they’re very often ignored, and they are the killer of residential real estate as a good investment.

Full stop. Point proven. Nothing to add.

Reason 2: Low Liquidity

Investing involves all kinds of risk – interest rate risk, inflation risk, operating risk, and as we just found out, Government policy risk - and far too often, another risk gets ignored.

Liquidity risk.

In fact, this risk is in the news right now. Go ask Blue Owl private credit investors in the US if their holding is “semi-liquid”?? There’s no such thing, something is either liquid or it isn’t.

And real estate isn’t. Simple as that.

It’ll take you months to get in and months to get out. And if you need any of your investment for some other purpose, good luck – you either sell the whole thing (and that will take months), or you find the money somewhere else. There is no opportunity to liquidate, say, the garage, and then use that money for any other purpose.

Investors should price that illiquidity risk, but they very often don’t.

Reason 3: Low Yields

The Australian obsession with real estate means that many investment purchases are made with the belief that the price appreciation will make up for every other ill in the decision to buy. Paid too much? Don’t worry, real estate always goes up. No tenants for 6 months? Forget it, the price appreciation is worth it. Poor location? Buyers will move out to you eventually, and the price will go up.

You get the drift.

As a result, rental yields are very low. Routinely, residential real estate is getting sold for investment purposes sometimes yielding in the 2s, likely in the 3s, rarely in the 4s. Remember, that’s in a world of 6%-plus mortgage rates, 4.6% inflation, 4.35% RBA cash rate, 4%-plus ASX 200 dividend yields, and 5%-plus TD rates.

Taking the Budget into account, and wrapping it around the points made above, it turns out that investing in residential real estate in a traditional manner is still suboptimal. Mainly for the 3 big reasons above but there are other reasons also. Like that a Government can make changes on a dime, and it’s hard to get out.

To reiterate, if you develop land and/or property, or you’re in the business of improving land and/or property, or you’re into commercial property, different story – my views here don’t apply to you. And they also don’t apply about your primary residence. By all means – buy a home for yourself and if applicable, for your family.

But the majority of real estate investors in Australia buy a place, borrow two-thirds of the money, have someone manage that real estate, and the investor collects the net rent.

That right there, that’s the poor investment outcome.

Not that you won’t make money - you might - but there are significantly better risk-adjusted returns easily available to you. If you don’t believe me, please go up and read those two original wires I wrote 2 years ago…..all the data is in there, and the Budget just made all of those numbers worse for the average residential real estate investor.

Much much worse.

Good luck out there.