The Problem with Property

Australia is heading for an ‘insurability crisis’ the headline screams. ‘About 1 in 25 Australian homes are at high risk of becoming effectively uninsurable by 2030, according to a new Climate Council report based on analysis by a climate risk assessment group’. This rises to 1 in 10 in particular locations such as parts of Brisbane (source: ABC News, 3 May 2022)’ https://www.abc.net.au/news/science/2022-05-03/climate-change-floods-cyclones-bushfires-house-insurance-costs/101021438

Flood and bushfire threats (along with coastal erosion) are increasing insurance premiums and are forecast to make some homes ‘effectively uninsurable’ for an average homeowner over the medium/longer term. While providing no comment on the validity of this prediction, which would be a sad outcome for those with homes in such areas, it does highlight some issues with owning (direct) property as an investment.

Australians have had a love affair with direct property for some time now, many preferring to invest in property (over shares listed on the ASX, for example) that they can see and feel – and which don’t provide a transparent (fluctuating), market price. However, there are problems that come with direct property ownership (in particular, if it represents a large slice of your wealth) and the climate change threat highlights some key issues including:

  • Diversification and liquidity risk;
  • Low (general) yield; and
  • High transaction costs
The problem with property investment over share investment.

Direct property is by nature, non-diversified and illiquid (or typically associated with delays in being able to realise liquidity).

Ownership of direct property most often requires a large investment in (just) one asset – which increases diversification risk – the risk of too few eggs in the investment basket. While owning a property as part of a large portfolio of other assets (such as listed shares and government bonds, for example) may help to manage this risk, many investors hold a significant portion of their wealth in (just one or sometimes more) investment property/ies. If something happens to a property, then the impact will also then be significant. And it is this ‘large egg in the basket risk’ which is typically overlooked. Climate change risks increases this potential risk.

Liquidity risk is more pronounced in retirement as it is not possible to ‘sell a window’ of a property. If the investor needs some liquidity, the whole asset must (generally) be sold and this can take time (and money).

Yields or income generated from a property is typically low (although some commercial property represents a more reasonable return), in particular, after taking into account ongoing costs associated with ownership, such as rates, utilities, maintenance, land tax and agent fees. Residential yields are often less than 3% of a property’s market value and much less after associated costs are taken into account.

Taking into account commonly low yields, many investors rely on the expectation of capital gains (profit) arising from a future sale, which is purely the result of supply and demand tension, rather than the property actually generating any kind of output (unlike investing in a business). So, the outcome is uncertain and does not arise from the result of direct business activity as such.

Perhaps climate change pressures will assist in helping investors understand that investing in direct property can be high risk. There are reduced risk adjusted alternatives such as investing in a globally diversified, index based (low cost) exchange traded fund investment portfolio – which spreads investment risk across hundreds of assets (across and within asset classes), and can incorporate both defensive and growth assets (including businesses which actually contribute to global GDP).

The comments in this article are general in nature and do not constitute general or personal financial advice. Enrich Investing is not licensed to provide direct property advice. The article does not take into account the reader’s objectives, financial situation or needs. You should consider your own personal circumstances and seek personal financial advice prior to making any investment decision and make sure you obtain and read the relevant product disclosure statement(s).