The Investor: Property beats shares – or does it?

The article, by Reserve Bank economist Elizabeth Watson, looked at returns on a wide range of assets from 1989 to 2011, and also at their riskiness - how much their values fluctuate.

We'll concentrate on residential rental property and New Zealand, Australian and international shares - with the Aussie and international shares hedged or unhedged. If an investment is hedged, it's protected from the changing value of the NZ dollar.

The returns include dividends on shares and rent minus expenses on property.

Here are the average annual returns, in order: rental property an impressive 9.5 per cent; hedged Australian shares 9.1 per cent; hedged international shares 8.7 per cent; unhedged Aussie shares 8.5 per cent; New Zealand shares 6.8 per cent; and unhedged international shares 4.4 per cent.

And if we take risk into account, property looks even better. Over the period, shares were quite a lot more volatile than property.

But there are a few "howevers".

For one thing, Watson warns that 22 years "is a much shorter time period than would typically be used for investment research", but she couldn't get good longer-term data.

And the last 22 years have been particularly rough for shares, with the bursting tech stock bubble followed by the global financial crisis. Some say that suggests shares are relatively cheap now, and have more "upside potential" than property.

Similarly, assets that have done well may have more "downside potential". Watson probably had property in mind when she wrote, "Rather than suggesting that an asset's returns are reliably strong, high historical returns can sometimes indicate excessive valuation, with low or negative returns following as a consequence."

Another major issue is that, "Not all of the gross asset returns reported here are equally achievable by investors."

The average New Zealander can gain exposure to a share market via an index fund, which invests in all the shares in a market index. Index funds charge fees, but they're relatively low. "On the other hand, there is no cost-effective mechanism by which investors can gain exposure to the residential property or farmland markets as a whole," says Watson.

Most people can buy only one or a few properties, often in the same region, giving limited diversification. And the volatility of Wellington property prices, for instance, is considerably higher than for the nation as a whole.

Furthermore, rental property investors have to meet the considerable costs of buying and selling.

There's limited flexibility, too. What if, for example, you wanted to hold 15 per cent of your $500,000 portfolio in property? Good luck with buying a $75,000 house! And Watson warns that property can be hard to sell in downturns.

Tax further complicates the picture. For one thing, recent tax changes "will have reduced the relative attractiveness of property relative to other assets to some extent."

Also, she says, watch out for personal risk. An example: if you work for the one big employer in a small town where you own a home and rental property, you could lose heaps if the company fails and property values slump.

Over all, "Actual property investments... appear to be considerably more risky than headline risk metrics would suggest."

What can we conclude? "It is not safe to assume that assets' risk and return characteristics in a particular relatively short period will be replicated in the future," says Watson. To keep risk down, diversify across different types of assets and beyond just New Zealand.