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Transitioning between these two asset classes will create a loss of investment capital. Does this matter?
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We recently wrote about the higher number of landlords selling their investment properties in 2023.
In this article, we look at what would happen if these landlords redeployed their investment capital into ASX shares. Would they make more investment income from shares vs. property?
The first thing to know is that redeploying funds from real estate investment into ASX shares is costly (and quite a hassle).
You will end up with reduced capital to invest due to the costs of transitioning between assets, and this will obviously impact your returns.
So, let’s go over some of the costs involved to more accurately assess whether an investor might receive more annual income in dividends than rent.
Let’s create two case studies, and take a look at how the investment income from both would compare.
This article is about income, and since most Australian property investors are negatively geared, we need to create a cash flow-positive case study to compare the two asset classes.
Let’s say you’re doing really well financially. Perhaps you’re on a high salary, or you’re close to retirement and have paid off much of your debt, leaving you just 30% leveraged on your real estate investment.
We’ll give you a real estate investment in Sydney. Most investors in Australia’s most expensive property market buy apartments because they’re more affordable than houses. So, let’s go with a median-priced apartment worth $832,000, returning a gross yield of 3.9%, as per the latest data from CoreLogic.
You’re about 30% leveraged, so that means you have a $249,000 loan.
We’ll put you on the lowest standard variable investment mortgage interest rate advertised on RateCity at the time of writing, which is 6.96% (interest only).
RateCity calculates your monthly repayments on that home loan at $1,444, or $17,328 per year.
On top of that, you have holding costs like strata levies, property management fees, and insurance. In Sydney, the holding costs for a typical two-bedroom unit are $7,000 to $10,000 per annum. Let’s go with $7,000.
If you’re getting a 3.9% yield on this real estate investment, then you’re getting $32,448 in gross rental income per year, or about $625 per week.
Now, let’s deduct the holding costs and the loan interest, which gives us a net annual property investment income of $8,120.
But we can’t leave out the value of your tax deductions here. So, we’re going to add them to your income return because they do represent a significant tax saving.
The tax deductions are $17,328 in interest + $7,000 in holding costs, and let’s add $2,000 in depreciation on top.
On a 32.5% tax rate, you’re going to save about $8,556 in tax. That’s in addition to your net rental income of $8,120.
But what if you sold your real estate investment and put the proceeds into ASX shares?
To be able to draw a reasonably accurate annual income comparison between shares vs. property, you have to take into account the costs of this capital redeployment.
First, you’ll need to sell your real estate investment.
Say you sell the property for $830,000 and pay off the loan, leaving you with $581,000.
But you’ll also have selling costs.
Let’s budget $15,000 for re-painting, styling and marketing. A typical agent’s fee in Sydney is about 2%, so you’ll be paying a $16,600 commission to your agent, plus about $2,000 for the conveyancing.
That leaves just over $547,000 in capital (without taking into account any capital gains tax liabilities, which would reduce your investment capital further).
Now, let’s create a case study to work out the income you’d get on $547,000 invested in ASX shares.
Ordinarily, with a sum as large as this, you’d want to build a highly diverse portfolio to de-risk your investment.
You’d do that through diversification, and we have some tips on how many stocks you should buy when building a portfolio, too.
But the purpose of this article is simply to look at the process of redeploying your capital from property to ASX shares.
So, we’ll keep this case study simple and divide your capital equally between seven ASX 200 shares.
Let’s buy the five biggest ASX shares by market capitalisation, plus one of the most popular index-based exchange-traded funds (ETFs) on the market today.
And to keep a foothold in real estate investment, we’ll also buy the largest ASX property share.
Here’s your ASX shares portfolio, dividing $547,000 evenly between these stocks at today’s share prices.
We’ve calculated the annual income you’d receive based on trailing dividends over the past 12 months. That dividend income totals $21,723. That is the cash amount you’d receive in your bank account.
If we add franking, you’d be declaring $30,000 in taxable dividend income on your next tax return. The franking credits would then act as a tax offset against the tax you’d otherwise pay on your income.
As shown, this ASX shares portfolio case study delivers a better annual cash stream vs. property.
It does so on less investment capital, too.
Our real estate investment case study is returning an annual income of $8,120 on $832,000 of capital leveraged at 30%. That’s what ends up in the investor’s hands per year, excluding the value of the tax deductions, which amount to $8,556 using basic assumptions.
Meantime, our ASX shares investment case study is returning an income of $21,723. That’s on $547,000 of capital with no debt. Plus, there’s a tax offset worth $8,277 to reduce your tax liability.
While our case studies demonstrate that shares deliver better income than property right now, it’s worth noting that real estate investments may deliver superior capital gains.
Motley Fool contributor Bronwyn Allen has positions in BHP Group, CSL, Commonwealth Bank Of Australia, Goodman Group, and Vanguard Australian Shares Index ETF. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended CSL and Goodman Group. The Motley Fool Australia has recommended CSL and Goodman Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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