Property vs Shares: Comparing Investment Options for Australian Retirees

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Introduction

Picking the right investment plan matters a lot for Aussie retirees finishing up their retirement plans. Since superannuation is a big piece of the savings puzzle, the choice usually boils down to checking out two main investment opportunities: direct property and shares, which are often mixed in a varied portfolio.

This comparison explores how these different asset classes perform concerning factors vital in retirement, such as providing reliable income streams (like rental income or dividends), offering liquidity, the impact of tax benefits, and overall portfolio diversification. Understanding these aspects helps retirees make informed choices, potentially with guidance from a financial adviser, to best support their desired retirement lifestyle.

Comparing Potential Income Streams in Retirement

Understanding Rental Income from Property

Investment properties primarily generate income through rent paid by tenants. This rental income can offer a degree of stability, as rent is typically outlined in a lease agreement and may continue even if the property’s market value fluctuates. However, it’s crucial for retirees considering property for income to look beyond the gross rental yield.

Gross yields, often quoted as a percentage of the property’s value, don’t represent the actual cash received. Typical gross yields might range from 3-5% in capital cities or slightly higher regionally, but numerous ongoing costs reduce the net return.

These expenses include:

• Council rates
• Land tax
• Body corporate fees (for units/apartments)
• Insurance premiums
• Maintenance and repair costs
• Property management fees

After accounting for these outgoings, the net rental income available to the retiree can be significantly lower, sometimes approaching zero or even negative on a cash basis, especially in the early years or if significant repairs are needed.

Furthermore, periods of vacancy between tenants or issues with rent payments can interrupt this income stream, requiring the owner to have sufficient cash reserves. While rents can potentially increase over time, sometimes linked to inflation through lease clauses, the net income requires careful calculation and management.

Understanding Dividend Income from Shares (ETFs)

Shares, particularly when held through Exchange Traded Funds (ETFs), generate income primarily through dividends. Dividends represent a portion of a company’s profits distributed to its shareholders. Historically, dividend yields from Australian shares have often been higher than net rental yields from property, forming a substantial component of the total return from the share market.

Dividend payments depend on the profitability and distribution policies of the underlying companies within the ETF. While individual company dividends can fluctuate, investing via an ETF provides diversification, meaning income is sourced from numerous companies across various sectors, potentially smoothing out the overall income stream.

A key feature for Australian retirees is the franking credit system associated with dividends from Australian companies. Key aspects include:

• Tax Offset: Franking credits represent tax already paid by the company on its profits before distributing dividends.
• Reduced Liability: These credits can offset an investor’s personal income tax liability on the dividends received.
• Retirement Advantage: For retirees in the pension phase with a low or zero marginal tax rate, franking credits can result in a tax refund from the Australian Taxation Office (ATO), effectively boosting the net income received from the investment.

This tax treatment makes dividend income from Australian shares held within an ETF a potentially tax-efficient income source during retirement, often yielding more on an after-tax basis compared to rental income, especially when franking credit refunds are factored in.

Understanding the Costs of Investment

Costs Associated with Property Investment

Investing in property involves several distinct costs that need careful consideration. These expenses occur at different stages of the investment lifecycle: acquisition, holding, and disposal. Understanding these ongoing costs is crucial for any potential property investor.

Initial entry costs can be substantial when buying a property. These typically include:

• Stamp duty: A significant government tax based on the property’s value.
• Legal and conveyancing fees: Costs for professionals to handle the legal aspects of the transfer.
• Building and pest inspections: Fees for experts to check the property’s condition before purchase.
• Bank fees: Charges associated with setting up a mortgage.

Holding an investment property also involves regular ongoing expenses. These costs reduce the net rental income received and include:

• Council rates: Local government charges for services.
• Water rates: Charges for water supply and sewerage.
• Land tax: A state tax payable on the value of land owned (excluding the principal place of residence in many cases).
• Insurance: Premiums for building and landlord insurance.
• Maintenance and repairs: Costs for upkeep and fixing issues like leaking pipes or property damage.
• Property management fees: Typically 5-10% of rental income paid to an agent for managing tenants and the property.
• Body corporate fees/Strata levies: Applicable for units or apartments, covering shared area maintenance.
• Special levies: Occasional extra charges from body corporates for major works.

Finally, when selling a property, exit costs are incurred. These often include:

• Real estate agent commissions: A percentage of the sale price paid to the agent.
• Advertising and marketing costs: Expenses to promote the property sale.
• Legal fees: Costs associated with the sale process.

Costs Associated with Share (ETF) Investment

Investing in shares, particularly through Exchange Traded Funds (ETFs), generally involves a different and often lower cost structure compared to direct property investment. The primary costs are typically associated with transactions and ongoing management.

The main costs associated with share and ETF investments include:

• Brokerage fees: Charged by the broker or platform each time you buy or sell shares or ETF units. These fees can be low or even zero on some platforms.
• Management fees (Expense Ratio): For ETFs and managed funds, an ongoing annual fee is charged by the fund manager, expressed as a percentage of the assets managed. The weighted average fee for ETFs in Australia is relatively low, often under 0.4%.
• Spreads: The difference between the buying and selling price of an ETF unit on the market, representing a minor transaction cost.

Unlike property, holding shares or ETFs does not involve costs like council rates, maintenance, property management fees, or land tax. Tax reporting is often simplified, with investors typically receiving a single consolidated statement for their ETF investments, covering dividends and capital gains information.

Tax Implications for Retirees

Property Taxation in Retirement (CGT, Negative Gearing)

Understanding the tax treatment of property is crucial for Australian retirees. A significant advantage is the Capital Gains Tax (CGT) exemption available for your principal place of residence (PPOR). If you sell the home you live in, you generally don’t have to pay CGT on any profit made.

However, this exemption does not apply to investment properties. When you sell an investment property, any capital gain may be subject to CGT. If you’ve owned the property for more than 12 months, you may be eligible for a 50% discount on the taxable gain.

It’s also important to note that claiming depreciation on the property over the years reduces its cost base, which can increase the taxable capital gain upon sale.

Negative gearing, where investment expenses exceed rental income creating a loss that can offset other taxable income, is another consideration. While beneficial during working years with higher incomes, its advantages often diminish in retirement. This occurs because:

• Retirees typically have lower or no taxable income
• The ability to offset losses becomes less relevant
• The focus shifts towards generating positive income streams

Additionally, ongoing property costs continue into retirement, impacting the net return without the same tax offsets. These include:

• Land tax
• Council rates
• Insurance

Share (ETF) Taxation in Retirement (CGT, Franking Credits)

Investing in shares or Exchange Traded Funds (ETFs) also has specific tax implications during retirement. Similar to investment properties, selling shares or ETF units held for more than 12 months may qualify for a 50% CGT discount on any capital gains.

A key difference, however, is liquidity; you can sell shares in smaller parcels, potentially allowing for better management of CGT liabilities over time compared to selling an entire property at once.

A major tax benefit for retirees holding Australian shares, often via ETFs, comes from franking credits. These credits represent tax already paid by the Australian company on its profits before distributing dividends. For retirees, particularly those in the pension phase with a low or zero marginal tax rate, these franking credits can:

• Significantly reduce or even eliminate tax payable on the dividends
• Result in a tax refund from the Australian Taxation Office (ATO) in many cases
• Boost the overall income received from the investment

This makes dividend income potentially more tax-effective than rental income in retirement.

Furthermore, investing in global markets through Australian-domiciled ETFs can provide access to foreign income tax offsets, helping to reduce tax liability on income earned overseas. Tax reporting for ETFs is often simpler too, typically involving a single consolidated statement, compared to the more complex record-keeping required for rental properties involving income, expenses, and depreciation schedules.

Risk Profiles and Management Effort

Diversification Opportunities

Investing in shares, particularly through Exchange Traded Funds (ETFs), offers significant diversification benefits compared to direct property investment. This approach allows investors to spread their risk effectively across different companies, industries, and even countries. In contrast, property investment often concentrates capital in a single asset or location, increasing exposure to specific market or property risks.

Achieving diversification with property presents several challenges:

• The high capital required for each purchase limits portfolio spread
• Most Australian property investors hold only one or two investment properties
• Limited ability to diversify across different locations or property types

ETFs, however, provide instant diversification benefits:

• A single ETF can hold hundreds of companies
• Exposure to various sectors like mining, banking, retail, and technology
• Access to both local and global markets
• Mitigation of the impact when any single company or sector performs poorly

This broad diversification is particularly valuable for retirees seeking stable income streams without concentrated risk exposure.

The Role of Leverage

Leverage, or borrowing to invest, is a defining feature often associated with property investment. The lending landscape shows clear differences between asset classes:

• Banks typically offer larger loans for property purchases (up to 80-90% of property value)
• Share investments generally receive lower loan-to-value ratios (LVRs), usually around 50-70%

This higher borrowing capacity allows property investors to control a large asset with a smaller initial capital outlay, potentially amplifying returns if the property value increases.

However, leverage also magnifies losses and increases risk, which is a critical factor for retirees. High leverage creates significant debt servicing costs through mortgage repayments, which can become burdensome if:

• Interest rates rise unexpectedly
• Rental income is interrupted
• Property values decline

While leverage can also be used for shares through margin loans, it’s less common and carries additional risks like margin calls, where investors might be forced to sell shares at a loss if the market falls. Many retirees prefer to reduce or eliminate debt to minimise risk and ensure financial stability, making the high leverage associated with property potentially less appealing during retirement.

Ongoing Management Requirements

Direct property investment typically requires more active management and ongoing effort compared to investing in shares or ETFs. Property owners often need to deal with various responsibilities, which can be time-consuming and sometimes stressful, particularly for retirees.

These property management responsibilities include:

• Finding and managing tenants, including handling vacancies or late rent payments
• Organising and paying for ongoing maintenance and repairs, such as fixing leaks or addressing property damage
• Dealing with property managers, body corporates (for units/apartments), and associated fees
• Managing paperwork related to expenses, income, and potential tax deductions like depreciation

In contrast, holding a diversified portfolio of shares through ETFs is generally considered a passive investment strategy. Once the investment is made, minimal ongoing effort is required from the investor. The advantages of this approach include:

• No tenants to manage
• No physical maintenance requirements
• Simplified tax reporting through consolidated statements provided by the ETF issuer or broker

This low-maintenance approach can be particularly attractive for retirees seeking fewer responsibilities and headaches during their retirement years.

Conclusion

Choosing between property and shares for retirement involves weighing distinct differences in potential income streams, liquidity, costs, tax implications like CGT and franking credits, diversification opportunities, and management effort required. Ultimately, the optimal investment option depends on your individual retirement plan, financial position, risk tolerance, and how actively you wish to manage your portfolio.

Navigating these complex investment options requires careful consideration tailored to your unique circumstances. For trusted expertise and personalised guidance on structuring your retirement portfolio in Adelaide, contact the financial advisers at Money Path today to help secure your financial future.

Frequently Asked Questions: Comparing Property and Shares for Retirement Funding