I discussed the importance of IRR in a previous blog (Berkshire Hathaway Analysis: click here to read the article). In future posts, I will increase the number of variables to consider such as different tax rates and different growth/income assumptions, however for now I want to provide an IRR analysis of two different investments: shares and property. This analysis is slightly superficial and yes there will be many points of contention such as being able to add value to property etc.
I'm located in Australia and will stick to Australian tax rates and investment examples for this analysis. I can see on my blogger stats that plenty of people from the USA are now starting to view the site (hi!) so I apologise if this doesn't appeal to you at the moment. Key Assumptions:
- The world doesn't blow-up
- 30% flat tax rate on income
- Neither shares or property are sold, therefore no capital gains tax to pay
- No transaction costs
- No depreciation allowance on property
- Cash Deposit $100,000
- Surplus income not re-invested
- Holding period 10 years
- Gear property at 80%
- Gear shares at 40% (more conservative than property to allow for volatility)
- Property:
- $500,000 purchase price
- Interest rate of 5.5% p.a. on loan
- Initial net rental yield 3.5%
- Growth in capital and rent 5% p.a.
- Shares:
- Buy $167k of ANZ Group Shares
- Interest rate of 7.5% p.a. on loan
- Initial gross yield (including franking credits) of 7.8% p.a.
- Growth in capital and dividend 5% p.a.
| Shares | Property | |
| Year 0 | -100,000 | -100,000 |
| Year 1 | 6,057 | -2,538 |
| Year 2 | 6,535 | -1,894 |
| Year 3 | 7,038 | -1,219 |
| Year 4 | 7,566 | -510 |
| Year 5 | 8,120 | 234 |
| Year 6 | 8,702 | 1,016 |
| Year 7 | 9,313 | 1,837 |
| Year 8 | 9,954 | 2,699 |
| Year 9 | 10,628 | 3,604 |
| Year 10 | 116,360 | 319,001 |
| IRR | 8.5% | 12.2% |
In this example, property beats shares. You can see the big gains are made in 10 years when the shares and property have grown in value. Because property involves larger exposure ($500,000 v $167k) thanks to more leverage, the same rate of capital growth allows it to trump shares hands-down. It also means property is more susceptible to changes in growth rates. In fact, it is by far the biggest component in determining long term success.
In Australia, high personal tax rates often means property is a superior investment. However, as we shall we in upcoming posts, shares can really shine in low tax rate environments and other circumstances. It also highlights the goals investors should have for different asset classes and it is my philosophy the two asset classes can work very well together. In the above example, I have made similar assumptions regarding growth rates between the asset classes, however if one asset class, or even one investment in general can generate superior capital growth than other available options, then the difference can be incredible over a long period of time. For example, if we can buy listed property at a significant discount to NTA, then we stand every chance of beating buying direct property. We don't need to be a slave to anyone particular asset class to be happy!
Kristian
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