Super versus residential property: Weighing up retirement income pros and cons

There’s no denying it, Australians love property. From the dream of owning our own brick-and-tile bungalow on a quarter-acre block, for many Aussies the love affair with real estate has expanded to include multiple investment properties, usually bought with the hope of huge capital growth plus a comfortable rental income.

Indeed, investment property is only just behind superannuation as a source of wealth in Australia. Super funds hold an amazing $2.9 trillion in retirement savings, while the total value of Australian residential property is an even more staggering $7 trillion and about a quarter of that housing stock is owned by investors. (It’s worth remembering, though, that there’s $1.8 trillion in mortgages outstanding on that $7 trillion worth of property.)

There’s no doubt that owning even a single property has made many people wealthier than they ever expected. And home ownership still offers a level of security that can’t be matched in the rental market.

Add the fact that for several decades, property prices in many Aussie cities have had  a reasonably consistent upward trajectory, and you’d be right to ask why property shouldn’t be at the top of your list when you’re looking to grow your capital and create a retirement income?

Choose your sources wisely

Actually, though, there are several good reasons to think carefully before you begin amassing a rental portfolio designed to sustain you in retirement, rather than, for example, putting your money into super.

For one, it’s hard to know what to believe when you read about property. Some commentators argue that property doubles in value every seven to 10 years, others claim property beats all other types of investment, including the share market.

But there are just as many unhappy stories of people who bought property that fell in value, didn’t generate the returns they’d hoped for or even drove them to financial ruin. Just ask some of the investors who put their retirement savings into mining town rental properties, only to see the houses sit empty as their value plunged when the boom went bust.

So instead of enthusiastic opinion or sad stories, let’s take a look at some official numbers from the Australian Bureau of Statistics (ABS), which you can see in the graph below. The graph shows how property prices changed in Australian capital cities between September 2005 and September 2019.

The winner when it comes to investment growth over that period? Melbourne. Even if we take the average across all capital cities, house prices nearly doubled over that 14-year period.

Of course, that doesn’t take into account the impact of Covid-19 on property prices. In the three months to June 30, during the thick of the pandemic panic, prices in all capital cities but Canberra fell slightly when compared to the three months to March 31; Sydney was down 2.2 per cent, Melbourne 2.3 per cent, Brisbane 0.9 per cent and all other cities recorded smaller falls.

But where to from here for the property market? Even the experts can’t agree, with some forecasting a massive slump in the market, while others are suggesting another boom is on the horizon. This is why a note of caution is required, despite the strong long-term gains the graph above shows.

You’ve no doubt noticed that the graph also shows that prices haven’t always risen in a straight line; they can stay the same, or even fall, for years (if you doubt this point, check out the line that shows Perth prices). That point is underlined by the price impact of Covid-19, which was painful in the June quarter but not when viewed on a 12-month basis (though, as above, who knows what’s to come!).

This propensity for property prices to rise and fall, sometimes suddenly, or plateau for long periods can be a problem if your need to turn your bricks-and-mortar into cash coincides with a period of flat or falling prices, unless of course you held your property investment for a sustained period of rising prices prior to its sale.

What about superannuation?

Just like the property market, the stockmarket certainly has its ups and downs, as anyone watching the Australian Securities Exchange during the worst of Covid-19 will know. Also like property, super has the potential to achieve considerable investment growth over the long term.

For example, over five years, Industry SuperFunds have returned around 6 per cent to members, even when periods of market volatility such as we saw earlier in 2020 are taken into account. But like property, all funds don’t make a similar gain – which one you choose to invest in matters. Industry SuperFunds have consistently outperformed retail super funds owned by banks and other financial companies over the past one, five, 10 and 15 years.

SuperFunds can also provide a regular income, as we explain below. And that’s not something you can necessarily rely on when it comes to an investment property.

That’s because house prices only show part of the story when it comes to property and your money. If you buy an investment property, you’ll be looking for rental income as well as capital growth on your very hefty investment (the hundreds of thousands of dollars you’ll need to buy a property, plus thousands more for stamp duty).

Unfortunately, rental increases haven’t matched the rapid rise in property prices over at least the past 10 years. It’s important to remember too that from the rent you receive, you’ll need to subtract council rates, maintenance, insurance, real estate agents’ fees, periods of vacancy and other related costs.

This means that the average yield on a rental property in one of Australia’s capital cities has fallen since 2010, even while the capital value of the property was rising and when the costs we mentioned above aren’t taken into account. According to SQM Research, the gross rental yield for a house in a capital city was averaging just 2.8 per cent in October 2020.

Yield is an investment term for the income you earn on an investment but is usually expressed as a percentage based on the cost or value of the investment. In layman’s terms, this means that you have to outlay a lot of money in order to achieve a decent income from residential property  – and that even if you do so, you may not achieve a yield comparable to what you might have obtained by using the same money over the same period of time to purchase a different investment.

And that’s assuming your tenant can afford to pay the rent. With millions of Australians relying on JobSeeker or JobKeeper and thus living on significantly reduced incomes, many people are unable to maintain their payments and have negotiated to reduce or defer their rent. There was also the six-month nation-wide moratorium on evictions introduced at the start of the Covid-19 crisis, which has been extended until March 2021 in Victoria.

Taking SQM Research’s average gross capital city rental yield, and given the average price of a residential property in Australia is $678,500, that implies an annual income of about $14,930 a year – but remember, that’s before all costs, which can run into the thousands of dollars, and assumes that the property remains tenanted and rent is paid as agreed. And, of course, yields in some cities and towns will be lower than the capital city average.

Plus, unlike an income created from super, that rental income may be subject to tax, as we explain below.

Don’t forget diversification

Owning an investment property as part of a broader portfolio of investments is a common diversification strategy.

But Gemma Pinnell, director of strategic engagement at Industry Super Australia, points out that putting the bulk of your retirement savings into a single property, or even several properties in a single location, can have the opposite impact of decreasing your risk by potentially compromising your investment diversification.

“Diversification, or spreading your investments across a number of asset classes and types of investment, can help reduce risk, because if one investment isn’t performing well, it’s likely others in the portfolio will,” Pinnell explains.

Pinnell says some types of property, such as commercial and industrial property, can provide a regular income, though, with the added benefit that the tenant pays many of the ongoing expenses commonly associated with rental properties.

Fortunately, you don’t need to be able to buy a factory building or warehouse to get exposure to this type of investment – you can do so through your superannuation fund. Many SuperFunds permit their members to choose their own investments from a wide range of asset classes and usually offer commercial property funds, trusts and exchange-traded funds as options.

“With an Industry SuperFund you’re getting instant diversification across shares, property, international investments, fixed interest and cash,” Pinnell says. “You’re not running the risk of having all your eggs in the property basket.”

Most Industry SuperFunds also offer access to advisers who can discuss with you which types of assets may meet the investment outcomes you need from your super savings. And if your requirements change, you can change your investment choices with a phone call or even do it online – which is much faster than selling a house even in the hottest property market!

Property has plenty of tax implications

There’s another important factor to consider when weighing up whether property can deliver the capital gain and regular income you need, which is that you might have to share your potential profits with the taxman.

Owning an investment property has several tax implications. For starters, you’ll need to declare your rental income in a tax return and while your expenses are allowable tax deductions and there are ways to maximise those, any profit is taxable, as is any capital gain you may make when you sell the property.

If regular dealings with the tax office isn’t something you fancy for your retirement, Pinnell suggests considering a tax-efficient account-based pension as a method of creating an income.

“An account-based pension is a type of super product that pays you a regular income, while the rest of your super stays invested,” she says. “Not only are your income payments tax-free, but any earnings on your invested savings aren’t taxable.”

Past performance is not a reliable indicator of future performance and should never be the sole factor considered when selecting a fund.

IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.