Why property investing returns may be lower than you think

What are the real long-term returns from property in Australia? We look at the costs of property ownership.

The Great Australian Dream isn’t fading any time soon. Everyone wants the white picket fence. We get it. There’s no denying that home ownership is more than just capital gains, it’s about owning the place you call home.

Bricks and mortar are seen as a secure investment yielding good returns over time. In this blog we take a closer look at the long term returns of residential property and weigh up all of the costs.

What are the real long-term returns from property in Australia?

ABS figures from 2019 reveal a price increase of 7% per annum for dwellings in capital cities in Australia over the last 32 years. However, this 7% p.a. fails to account for the cost of renovations, improvements and maintenance over that time. Here’s a quick example to show the impact of improvements on your return.

Let’s say that a house was purchased for $245,000 in 1986. Nothing has been spent on it in 32 years so the house is quite run down. The property is bought in 2017 for its land value of $1 million. At this point, the ABS would record a price increase of 4.6%  p.a. over 31 years.

Since the house is a knock-down, the new owners spend $1 million building a new house on the land. By their calculations, the property is now worth $2 million. If they sell the house at that price, it would be recorded by the ABS as a 100% price increase over 12 months and 7% p.a. over 32 years ($245,000 to $2 million).

However, the actual return – after taking into account the $1m spent on rebuilding the house – would be just 4.5% p.a. This isn’t too far off reality, according to the ATO depreciation schedule a house will need to be rebuilt or majorly renovated every 25-40 years.

A costly investment to buy, sell and own

The average cost of building a house in Australia is over $1,100 per square metre, so an average size home of 300 square metres will cost around $330,000.

Even if your bank account is healthier than most, it’s a big investment. But that’s only just the start. By the time you add landscaping, outdoor improvements such as fencing, patios or a deck, you’re looking at an investment much closer to $400,000.

Over time, bathrooms and kitchens need updating or replacing, while decks, pools and gardens also need ongoing maintenance. There’s also ongoing costs like council rates, body corporate fees (for home units and town houses), water and insurance which the RBA estimates to be at least 2.6% per year.

It’s also important to take into consideration the transaction costs of buying and selling a property. The RBA estimates that the costs of buying a house including stamp duty and other costs like conveyancing are around 4% of the value of the property.

The cost of selling a house including real estate agent commissions and advertising add up to about 3%. So the total costs of buying and selling a house are in the vicinity of 7%.

Considering an investment property?

The gross yield (rent) on houses in Australia is 3.2% and 4% for units, according to SQM Research. However there are substantial running costs which need to be taken into account to arrive at net yield.

If you own an investment property, you are liable for council rates, management fees, property maintenance and repairs. And if the property value is above the land tax threshold ($629,000 in 2018), there will also be land tax to pay each year.

Short term rentals can yield more than a long-term tenant due to the higher fees to stay for a night. And it’s true – there’s been a boom in the short-term rental market thanks to platforms like Airbnb and Stayz – but this has also increased competition among property owners – virtually pitting them against each other in the bid for the next overnight booking.

According to AirDNA market data, there were 1,034 active listings in Melbourne’s beachside suburb of St Kilda and 812 active Airbnb listings in Sydney’s Bondi Beach alone.

There is also a great deal of additional inconvenience and expense such as managing the property, cleaning and arranging access. And there is the chance that the property is vacant for long periods of time.

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Capital gains don’t add up

Tax benefits of owning property may be disappearing

Hanging out for capital gains rather than rental yield? Bearing in mind that the property dwelling itself will depreciate over time by around 2.5%-4% per year, the capital gain will be based on the value of the land which historically has increased by between 4%-5% per year.  

Once the annual losses are offset against the likely capital gain on sale, the typical long-term return on an investment property in Australia has been marginal.

Tax is a big driver of property investment decisions in Australia. At the highest marginal tax rate of 48 per cent (including Medicare Levy), an annual loss of 4% on a geared property will become 2% after tax.

The favourable capital gains tax (CGT) treatment on sale is also a big motivator for purchasing investment properties. Currently there is a 50% discount for individual investors.

If the profit on sale equates to 4.6% p.a. an investor on the top marginal rate will pay the equivalent of 1.1% p.a. CGT on sale of the property.

Weigh up all your options

Once all the annual costs and the long term depreciation of the house have been factored in residential property is a very marginal investment and certainly performs worse than other investment classes.

While the team here at Stockspot fully appreciates the need to have a secure home and the opportunity to make that home more comfortable and enjoyable, there’s a good argument for taking into account the long-term costs and considering a future nest egg in other asset classes.  

What about investing in other assets?

It’s worth considering all options to invest your hard earned money, and whether an alternative to property may be better suited to your goals.

We know people can be turned off from investing in the share market because they perceive it as too risky and difficult. However, holding a diversified portfolio of shares and bonds gives you access to better return opportunities than putting all your eggs into the property basket – as well as much lower annual holding costs and depreciation than owning property.

capital returns vs annual costs of property

We believe the best way to start investing is via exchange traded funds (ETFs), which give you the benefit of diversification across many assets. This is why we help clients invest across a range of ETF investments on autopilot.

Our clients get a diversified portfolio of ETFs covering Australian and global share markets, bonds and gold, with typical long term returns ranging from  6%-10% p.a. since we launched in 2014.

Find out how Stockspot makes it easy to grow your wealth and invest in your future.

Founder and CEO

Chris has been vocal in calling out the industry 'Fat Cats' and is known for telling it as it is. He sits on two Advisory Committees for the industry regulator ASIC, and was previously a fund manager at UBS. He holds a Bachelor of Commerce (Accounting/Finance Co-op Scholarship) from UNSW.

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