This article was published on 17 April 2004. Some information may be out of date.

QYour views in the debate about the increase in value (or lack of) of housing over a period of years and the pros and cons of investing in the residential market are curious.

Your response and agreement with the view of the person who purchased a house in 1968 for $19,000 is lost on me, as an example of why not to invest.

Even if the calculations were correct, who of us really sees our own home as a true investment? We’ve had to pay a mortgage on it out of our own pockets.

Investment in rental property is being paid for by the tenant. Even if the property remains at the same price for 30 years (unlikely), an investor reaps the rewards with the full value of the property sale.

Tell me who I can get to pay for my shares to invest in the sharemarket?

AThe companies you invest in, with their dividends.

But more on that in a minute. Let’s take your points in order.

I didn’t say that the $19,000 house was an example of “why not to invest.”

The point the reader and I were making was simply that house prices rose fast in the past, when inflation was high. But now that inflation is much lower, average price rises over the years will also be much lower, despite being high lately.

That doesn’t mean you shouldn’t invest in housing, just that you shouldn’t expect such high average annual gains as in the past.

Is our own home an investment? I agree that that is debatable. We’re really just buying shelter, in the same way as we buy food, clothes and other necessities.

On the other hand, many people say they are buying a more expensive house than they might otherwise, so they can trade down in retirement. That extra spending is, arguably, investment.

More importantly, your comparison between rental properties and shares seems to hang on the fact that most people borrow to invest in rentals, and not many borrow to invest in shares.

But it’s quite possible to borrow for both, or not to borrow for both. For the moment, let’s assume we won’t borrow for either.

What we find, then, is that rental property and a diversified investment in shares are quite similar.

Both should be long-term investments. There’s too big a danger of losing money if you hold them for just a few years.

With both, you get some cash flow, in the form of rent or dividends. And usually you get a capital gain when you sell.

Rental property tends to be somewhat less risky than shares. And, following on from that, average returns tend to be lower.

Now let’s add a mortgage, to buy either property or shares. That gives you more money to invest. So if you make a gain, that gain will be bigger.

On the other hand, you must pay interest on the loan. And in the unlikely event that a long-term investment loses money, your loss will be bigger.

With a property, rent will go a long way towards covering — and may more than cover — mortgage interest and other expenses, and perhaps also repayment of mortgage principal.

Similarly, with shares, dividends may cover, or more than cover, mortgage interest and principal repayments.

Whether the cash flows fully take care of ongoing costs depends on how big your deposit was, rent and dividend levels, changes in mortgage interest and so on.

Rentals have a disadvantage here, because expenses are much higher, including insurance, rates and maintenance. Then again, if you’re in international shares, dividends are pretty low. It all depends.

With either investment, if you have to contribute cash along the way — sometimes called negative gearing — you need to subtract that cash when calculating your gain when you finally sell.

Sure, many people get tax breaks with negative gearing. But you must still pay much more than you get back in tax breaks. Over the years, that can really add up.

Other tax issues? With rentals you get depreciation, but that is usually clawed back when you sell, so it’s not much of an advantage. And the Government is looking at disallowing it.

Apart from that, the tax situation is similar for shares and property. As long as you don’t trade frequently and keep your holding for more than ten years or so, your capital gain will usually not be taxable.

Be careful with this, though. See today’s third Q&A.

All in all, then, the two investments are not as different as you seem to think.

A lot fewer people borrow to invest in shares than property, partly because they are riskier. On the other hand, rental properties carry the extra risk of being the same asset type as your home, if you own one. If there’s a property slump, you’ll be doubly hit.

Whichever you choose, though, if you stay in for the long haul you will usually do pretty well.

QI apologise as I am continuing along the shares vs property debate.

I started investing in shares a year ago. Throughout the year I have bought small amounts of shares as I have had spare cash. It has been relatively simple to study brokers’ analyses and the only person I have had to deal with is my stock broker on making my purchase.

Although I have had some losses, with dividend and capital gains I think it is going well.

On the other hand, I see people borrowing huge sums of money to buy residential property investments.

They can only buy one or two, thereby increasing their risk, not to mention risking their own family home.

Furthermore, usually expenses far outweigh rental returns, meaning they have to top up their investments from their other income, meaning it is not available for other investment opportunities.

Depreciation is a deferred tax, which will catch up with people.

Then there is the hassle of dealing with self-motivated real estate agents, and finding the time to travel around towns looking for suitable property, not to mention being a landlord with the hassles of finding suitable tenants and getting them to pay their rent.

Why then do people want to own residential property? It is no accident that there are no listed residential property companies on the stock market. I am quite happy doing things my way thank you.

AThe debate is running on a bit, isn’t it. But, because the choice between shares, property or both is a key question for most long-term investors, I think it’s worth pursuing.

And I love the way you and the first letter writer come from opposite corners of the ring. Hopefully, what I’ve said above will draw both of you a little more towards the middle.

You make some good points for shares. It’s certainly simpler to invest in them, and much easier to spread your money over many investments than with rentals.

A couple of caveats, though. The past year has been a good one for both shares and property. Investors in both should not expect returns to continue at these levels.

Be prepared to stick with your investment through down years.

Also, stock brokers’ analyses are not always right. I suggest you avoid getting caught up in buying and selling often, regardless of what the brokers recommend. It’s cheaper, and usually more rewarding, to buy and hold.

QDespite being a very experienced professional in the field of land development, I share your caution about the booming housing market in recent months.

I consider that the need for houses has been soundly based, but the steep rise in prices has been fuelled in part by speculative investors as a reaction to the previous sharemarket downturn, and who know little about being landlords.

No rocket science in that, but where both central and local governments are looking for taxation sources that are relatively voter friendly, people should be aware of probable increasing interest in property investment by the IRD.

The article in the Property Investment section of the Weekend Herald of March 20–21 is worth reinforcing to your readers.

AIndeed it is. The article was written by Simpson Grierson partner Stuart Hutchinson and senior associate Paul Windeatt, and I’ve since clarified a few points with Windeatt.

They answered a letter from a reader, who said the IRD had warned investors, last October, that if they bought real estate to sell for a quick profit, the gain would be taxable.

“What if I buy one or more properties for long-term rental purposes and occasionally buy a property for quick sale?” asked the reader. “Will I be taxable on any (capital) gain on the eventual resale of any of the long-term rental properties?”

“At its simplest,” says Windeatt, “where real property is bought for a purpose or intention of resale, any profit realised on sale is subject to tax.” Similarly, such property sold at a loss is normally deductible.

“Even if a particular piece of land was not purchased for resale but for a long-term hold (say, to rent), and the property is resold within 10 years, any gain on the sale (over cost) may be taxed.” This will happen if, when you bought the property, you or an associate carried on a business of buying and selling land, developing or dividing land into lots, or erecting buildings.

“In all cases,” says Windeatt, “it is a question of fact whether such a business is carried on. If there is continual activity or frequent transactions, there may well be a business.”

If you’re caught by that rule, any gain you make on other property you buy while that business is being carried on — whether the property is bought for the business or as a long-term hold — will also be taxed if it’s sold at a profit within ten years.

Who are your associates? They include your spouse, any child of yours under 20, or any trust in which your spouse or child under 20 is a beneficiary.

Any company in which you and/or any combination of your associates and/or any trust in which you are a beneficiary has, in aggregate, a 25 per cent holding or more, will also be associated with you.

“If you intend to hold property long-term, care needs to be taken that your other property activities, or those of an associate, will not bring any gain on an eventual sale of your long-term hold within the tax net,” say Hutchinson and Windeatt.

They add that there are also other circumstances — to do with rezoning, development, subdivision and the like — in which profits from land sales can also be taxed.

So where are we? If you’re not planning to do anything along the lines of development, and you hold all your properties for more than ten years, you’re probably okay. But you’d better keep an eye on what your spouse, 19-year-old or family trust is up to.

Lawyers always recommend getting professional advice, and the rest of us sometimes think that’s self serving. But in this case it sounds like a good idea.

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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.